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Cash Flow, SDE - Determining The Worth Of A Small Business

The value of the small business is mostly determined by the cash flow (or business brokers use the term "Seller's Discretionary Earnings" instead to be more accurate).  Seller's Discretionary Earnings (SDE) is defined as net income before taxes (operating income); interest; depreciation and amortization; owners compensation; owners benefits; and non recurring expenses.

Most small businesses sell for 1.5 - 3.5 (multiples) times the yearly SDE, depending upon the value factors of the business. Things that determine the multiple or value factors are the stability of historical earnings; business & industry growth; type of business (service with few assets to manufacturing with significant assets); location & facilities; stability & skill of employees; competition; diversification of products, service & geographical markets; desirability of the business; depth of management; and terms of the sale. The national average is 2.76 times SDE.

The inventory, equipment or fixtures are included in the price because they are what is required to generate the SDE. Some businesses need inventory, some need equipment (assets) and some need both, depending on the type of business.  The amount of assets is one of the criteria that helps determine the value a business.

Some value (but not too many small business brokers) the business by its  EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization. The multiple that is used is generally in the area of 4 to 6 times EBITDA.  EBITDA is mostly used by investment bankers or M&A folks, people who usually handle bigger stuff ($ 20 million+ price tag).

Business brokers count owner's compensation and owner's benefits as part of earnings or SDE (Seller's Discretionary Earnings).  You can also define SDE as EBITDA plus owner's salary plus owner's benefits.  Basically, if you take SDE times 1.5 to 3.5 multiple, you should have similar numbers if you calculate EBITDA times 4 to 6 times.

The reason business brokers don't usually go by EBITDA times 4 to 6 times is that, it's basically the owner's discretion to pay him/herself salary of whatever the amount and most owners write off a lot of personal expenses through the business (called owner's benefits).

This is one of the worst times to sell a business right now.  No bank financing is available these days so multiples are down, demand is down and a lot of buyers are cash strapped.  I tell sellers if you don't absolutely have to sell, then maybe he/she should hold off.  No one knows when the economy will turn around but it eventually will and once bank starts lending again, multiples of businesses should slowly inch up again.

Below is a list of documents that a typical business broker needs in order to package a business for sale;

1)  last three years of profit & loss statements including balance sheet

2)  last three years of tax returns

3)  copy of the lease

4)  major fixture, furniture & equipment list

These days, selling a business is a tough task.  If your business does sell, it takes an average of 3 - 6 months to find a buyer.  And after negotiating the price, seller and buyer will go through due diligence and then escrow.

There are buyers out there for good, solid businesses - perhaps even more so now, so good luck!

About The Author:  Ron Hottes is with Business Team - a business brokerage team of 28 highly skilled and seasoned professionals within Los Angeles. Our business brokers have over 100 years of cumulative experience and the expertise to help you buy or sell a business in the Los Angeles County area. Ron can be reached at 310-539-8300.


Categories: BizBen Blog Contributor, Business Valuation Issues, How To Sell A Business



  Helpful Resources To Assist In Selling And Buying California Businesses

Helen Yoo: Escrow & Bulk Sale Services - Southern California

New Century Escrow, Inc. is a fully licensed & bonded independent escrow company. Over 20 years combined experience in handling bulk escrow transactions. Multi-lingual staff that speaks your language, including Korean, Chinese, Vietnamese. Call Helen Yoo direct at 626-890-1151.

Willard Michlin, CPA, Certified Fraud Examiner, Due Diligence Services

Willard Michlin, CPA #106752, offers buyers step by step training & assistance in doing Due Diligence Services when they are thinking of making an offer, or are in process of investigating a business purchase. He helps to determine the actual net profit even when there is cash. Call 800-864-0420.

Mark Chatow, Esq.: Legal Services For Buying, Selling Businesses

Mark has a broad range of small business purchase & sale experience from analyzing potential acquisition targets to successfully guiding buyers and sellers through the purchase & sale of small businesses. Mark can assist with contracts, negotiations, legal matters, etc. Reach Mark at 949-478-8393.

Diane Boudreau-Tschetter: Escrow And Bulk Sale Services

California Business Escrow, Inc. is a full service independent escrow company serving all of California and has expertise in a wide range of escrows. Our team prides itself on providing an exceptional escrow experience. For more info phone Diane Boudreau-Tschetter at 888-383-3331 or 209-838-1100.

Bob Baumgarten, Business Broker: Orange, LA Counties

National Business Brokerage is a full service brokerage company that has been serving buyers and sellers of Southern California businesses since 1994. We are dedicated to providing the highest standards of professional service for our clients. Phone Bob direct at 949-588-8727.

Mike Hurrell, Broker: Coin & Card Laundry Specialist Brokerage

Providencia Properties Inc in association with Golden State Laundry Systems is a full service Coin Laundry Real Estate Broker. At GSLS you will receive personalized attention from our professional staff of coin laundry experts. To sell or buy a Southern CA laundromat call Mike at 310-223-2240 X209.

Joanne Weber, Broker - Preschool Specialist - Southern California

The Ryan Craig Company is in its 35th year as the recognized expert in Southern California, dealing exclusively in the sale of preschools, Montessori schools, day care centers, and private schools. Our extensive list of references speaks for itself. Phone Joanne at 818-760-3684 for more info.

Bob Hughes: Business Broker, Palm Springs Area

Bob Hughes is a business broker & is President of Hughes Properties. Hughes has a wide variety of entrepreneurial experience with the personal ownership & sale of numerous businesses, and has sold over 200 small & mid-sized businesses in the Riverside County marketplace. Call Bob at 760-323-8311.


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