Pricing A Small Business For Sale - Several Key Factors Play A Role!
As an Advisor on BizBen.com I talk to many California business buyers, business owners, business brokers, and agents on a daily basis about valuing California small businesses. It always amazes me on how some of these individuals come up with the values on small businesses being sold. No wonder only 30% of all California small businesses actually end up selling!
In many instances no consideration is given to the total picture - like will the available cash flow of the business be able to pay the debt of a loan or some form of business purchase financing, will the deal as structured or priced even be attractive to financing sources, "cash" price vs. "note" price and how these factors figure into the equation!
I have seen many "professional valuations" where the asking price just doesn't make sense and owner/sellers wonder why their California business being sold just sits there with no action taken by potential business buyers!
Market Approach
There is a solution that is grounded in the fundamentals of economics, and time tested in the marketplace, where the influences of supply and demand ultimately determine where a business belongs on the price scale. One economist explains this market approach by comparing a business to a machine which has the purpose of making money: The more money it makes, the more it's worth. And that explains why, for example, there is a strong demand for a very profitable distribution business with few hard assets; and why it is worth more in the marketplace of available businesses, than a large machine shop that would cost nearly $1 million to duplicate, but can't make a living for its owner.
Adjusted Net Income
The first category of information needed is called adjusted net income (cash flow, SDC: sellers discretionary cash), and is the total amount of cash produced by the money machine. It's a figure that includes the profits, the owner's salary and all of the many cash-related benefits which are enjoyed by the principals of small businesses. Those benefits can include the use of a company car, the company-paid premiums for health, life and auto insurance, plus personal expenditures tucked into travel and entertainment, subscriptions and similar business expense categories. Interest expense should be added to adjusted net income, along with accounting entries "such as depreciation and amortization" that can divert money to the owner's pocket so that it never appears on the bottom line of the P&L.
While some of these items vary from business to business, any owner knows which categories of expenses in his or her financial records include sums of money that should be added to adjusted net income. Many business owners also know of cash income that never sees the business records in any way, shape or form. Some owners feel they should get credit for these sums in the calculation of value. But it's a poor policy to collect unreported income and then attempt to have it included in adjusted net income for evaluation purposes.
When selling, your buyer prospects want any statements you make about your business to be supported by evidence in the form of accounting records and other reliable sources. To admit that you are doing business "off the books" not only exposes you to problems with the IRS, it also sets a bad tone with prospects who if they are going to be interested in your business - need to believe your practices and record keeping are above reproach.
Adjusted net income is usually the first thing any buyer wants to know about when investigating a business; and not just the past few months' worth of income. A seller should be prepared to demonstrate a history of earnings, and have the documentation to back it up.
Multiplier Method
The next piece of the equation comes from the expectations working in the marketplace to shape the multiplier a figure which will be computed, along with the cash flow, to calculate a rough value. The validity of the multiple is that it reflects behavior in the market. There is no need to theorize about a proper multiplier. It's calculated by determining what buyers actually pay for small businesses in California. BizBen.com has a database of comps of pre and post California small business sales and we continually add more weekly. Most multipliers we find at this point in time are between 1X to 4X (provable) annual adjusted net income. The difference in the multiple depends on many factors - supply and demand for that type of business being sold/purchased, competition, history of earnings, and current operations of the business (possible future operations play a slight role).
In many instances no consideration is given to the total picture - like will the available cash flow of the business be able to pay the debt of a loan or some form of business purchase financing, will the deal as structured or priced even be attractive to financing sources, "cash" price vs. "note" price and how these factors figure into the equation!
I have seen many "professional valuations" where the asking price just doesn't make sense and owner/sellers wonder why their California business being sold just sits there with no action taken by potential business buyers!
Market Approach
There is a solution that is grounded in the fundamentals of economics, and time tested in the marketplace, where the influences of supply and demand ultimately determine where a business belongs on the price scale. One economist explains this market approach by comparing a business to a machine which has the purpose of making money: The more money it makes, the more it's worth. And that explains why, for example, there is a strong demand for a very profitable distribution business with few hard assets; and why it is worth more in the marketplace of available businesses, than a large machine shop that would cost nearly $1 million to duplicate, but can't make a living for its owner.
Adjusted Net Income
The first category of information needed is called adjusted net income (cash flow, SDC: sellers discretionary cash), and is the total amount of cash produced by the money machine. It's a figure that includes the profits, the owner's salary and all of the many cash-related benefits which are enjoyed by the principals of small businesses. Those benefits can include the use of a company car, the company-paid premiums for health, life and auto insurance, plus personal expenditures tucked into travel and entertainment, subscriptions and similar business expense categories. Interest expense should be added to adjusted net income, along with accounting entries "such as depreciation and amortization" that can divert money to the owner's pocket so that it never appears on the bottom line of the P&L.
While some of these items vary from business to business, any owner knows which categories of expenses in his or her financial records include sums of money that should be added to adjusted net income. Many business owners also know of cash income that never sees the business records in any way, shape or form. Some owners feel they should get credit for these sums in the calculation of value. But it's a poor policy to collect unreported income and then attempt to have it included in adjusted net income for evaluation purposes.
When selling, your buyer prospects want any statements you make about your business to be supported by evidence in the form of accounting records and other reliable sources. To admit that you are doing business "off the books" not only exposes you to problems with the IRS, it also sets a bad tone with prospects who if they are going to be interested in your business - need to believe your practices and record keeping are above reproach.
Adjusted net income is usually the first thing any buyer wants to know about when investigating a business; and not just the past few months' worth of income. A seller should be prepared to demonstrate a history of earnings, and have the documentation to back it up.
Multiplier Method
The next piece of the equation comes from the expectations working in the marketplace to shape the multiplier a figure which will be computed, along with the cash flow, to calculate a rough value. The validity of the multiple is that it reflects behavior in the market. There is no need to theorize about a proper multiplier. It's calculated by determining what buyers actually pay for small businesses in California. BizBen.com has a database of comps of pre and post California small business sales and we continually add more weekly. Most multipliers we find at this point in time are between 1X to 4X (provable) annual adjusted net income. The difference in the multiple depends on many factors - supply and demand for that type of business being sold/purchased, competition, history of earnings, and current operations of the business (possible future operations play a slight role).
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