How Are Small Businesses Valued by Buyers and Lenders?

If you're taking the time to read this, the last thing I want to do is waste your time or mislead you, so I'm going to give you the disclaimer right up front --- there is no one single pricing formula that applies to all types, sizes and businesses in all areas across the US. So, after that initial disappointment, read on and you will start to have an understanding of the many different, very subjective issues that are involved in valuing a privately owned business.

In the vast majority of cases, a buyer will come to a decision as to the value of a business he or she is interested in buying based upon six primary issues: {a} the business' demonstrated and historic earning power, {b} what the buyer believes can be generate in the way of future earnings with his or her efforts, talent, drive, capital, etc., {c} the value of the assets, minus any liabilities that are assumed, that come with the business as part of the purchase price, {d} the tax benefits, or lack thereof, that are part of the structuring of the business, {e} the type and nature of financing that is available, and {f} the buyer's perception of the risks involved in the particular business, its industry and the anticipated economic environment.

While some of the above are simply mathematical computations, the others are highly subjective issues that vary from one buyer to another. Thus, the first understanding of business valuation is to be aware that it is not a single number to designate value but, more appropriately, it will be expressed as a range of value. Why a range? Simply because different buyers view the above 6 factors quite differently and therefore come to very different assessments of value.

Other than a buyer's evaluation of the degree of the risk involved, a buyer's perception of future earnings will drive the individual's Return on Investment (ROI) calculation. Simply stated, all buyers tend to have minimum ROI expectations, and those expectations vary from buyer to buyer. The ROI calculation is made by determining the business' recast stabilized earnings (typically expressed as EBITDA --- Earnings Before Interest, Taxes, Depreciation and Amortization), which is after a reasonable rate of owner compensation. EBITDA is then computed as a percentage of the total purchase price to determine the projected ROI for someone acquiring the business at that purchase price, regardless of whether payment is in cash or the purchase is financed.

In the preceding paragraph I refer to the word 'recast', and it simply means that few privately owned businesses operate in such a manner as to maximize their earnings (and taxes) on their tax returns. Therefore, a vital and necessary step in the valuation process is to recast the tax return numbers so as to eliminate the influence of owner discretionary and non-cash items.

The degree of risk, high or low, that is anticipated in a given business will be reflected by the buyer demanding either a higher ROI or a willingness to accept a lower ROI. Thus, as a buyer's ROI expectation goes up, the purchase price goes down and visa versa. To further add to the variability of value conclusions is the fact that different buyers will assess risk differently, and an issue that might really concern one buyer might be of little concern to another. An extension of this axiom is that the same earning power in two businesses that are in two different industries will have very different market values, just as two 'identical businesses' located in different parts of the US can sell for significantly different prices as there are regional differences in both supply and demand.

The reality of "the range of value" in valuing privately owned businesses underscores the critical importance of effectively and confidentially marketing a business. By logic and reason, a minimal marketing effort, or simply waiting for an unsolicited buyer, does little to assure your business being exposed to enough different buyers to come across those who will consider paying the upper end of your range of value.

While I know that you have heard of people who sold their businesses at "x" times revenue or "y" times earnings or some other shortcut abbreviation of valuation, please don't make the mistake of assuming that the same shortcut formula applies to your business. Whether a business sells at 3 times revenue, 1 times revenue or 50% of annual revenue, those numbers bring about an incidental and meaningless relationship as, most assuredly, that is not how the buyer determined a price he or she was willing to pay. To prove the point, two businesses with identical revenues but with very different levels of profitability will obviously have different market values.

Another key aspect of selling a business is to make certain that you get paid for it, as agreed. "Seller provided financing" is a very high-risk approach, and thus getting either cashed out or substantially cashed out is invariably in your best interests. The fact of the matter is that, unless the value of your business is a very low dollar amount, few buyers will have all the cash necessary for the purchase and will need to have an outside lender involved. While it will vary by the value and type of your business, you will find that conventional bank loans are "collateral based" --- they will only lend a small percentage of the purchase price of a given business --- and therefore are not an attractive resource.

If your business has a market value of less than about $2.5 million, you will find that SBA guaranteed financing can provide your buyer with a high percentage of the funds needed to get you either completely of very nearly fully cashed out.  Above that value range, the SBA is not meaningful source; however, the nature of the buyers tends to change so that they tend to have access to greater funds, etc.  You should also be aware that out of all of the SBA ‘preferred lenders’, only a small percentage are highly responsive to and effective in expediently approving, processing and closing transactions.

So much for lender background. Let’s look at how lenders approach the issue of valuation of a business.  Non-SBA lenders will generally loan about 60% to 80% of the liquidation value of the assets or collateral provided to secure the loan.  On the other hand, SBA guaranteed lenders are "cash flow lenders" who look at the last two years for which tax returns have been filed and recast the reported earnings, from which they deduct a reasonable owner salary and determine the "available pre-tax cash flow".  This dollar amount is then compared to the annual debt service necessary to amortize the loan (generally over 10 years), and a reasonable ratio between the two is required.  In practical experience over a number of years, the SBA valuations tend to be higher than most buyers will agree to pay for a given business.

Hopefully the foregoing will have been of assistance in understanding that in valuing a privately owned business "one size does not fit all" and that the process is highly subjective and best approached by an honest and experienced individual who is actively involved in the sale of privately owned businesses.

About The Author:  Steve Fitzgerald is with Acquisition Services Group, a Southern California business brokerage firm, specializes in Seller Representation of businesses in the manufacturing, distribution and service industries. We offer our services on a success fee basis with no up-front fees: We get paid out of escrow when the company sells. Steve can be reached at 858-320-0474.

Categories: Buying A Business, Selling A Business

  Helpful Resources To Assist In Selling And Buying California Businesses
Diane Boudreau-Tschetter: Escrow & Bulk Sale Services - CA

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.

William F. Ziprick, Attorney: Legal Services For Buyers And Sellers

Through creative problem solving, attention to detail, accessibility, & understanding that unnecessary delay is often a deal killer, I work closely with my clients and other professionals to consistently achieve a high rate of closings. Office: 909-255-8353, Cell: 509-951-7230.

Shalonda Chappel: Escrow & Bulk Sale Services - Southern California

Escrow services to brokers/agents, sellers, & buyers. Established 43 years. Extraordinary service. Experienced with handling difficult transactions. One stop for all your escrow needs: Bulk sales, lien searches, UCC searches, liquor license transfers, publishing & recording services. 951-808-3972.

Janet Carrera: Escrow & Bulk Sale Service - SF Bay Area

Redwood Escrow Services, Inc. is a full service, licensed independent escrow company. We are EAFC Fidelity bonded, fully insured & licensed with the Department of Corporations. Committed to offering our clients the most comprehensive variety of escrow services available. Phone Janet at 510-247-0741.

Elizabeth McGovern: Escrow Services - San Francisco Bay Area

McGovern Escrow Services, Inc., is a leading independent escrow company. We are a trusted partner with our clients, assisting them through the tangled bulk sale & liquor license transfer process. We provide attentive, quality & innovative customer service. Phone Elizabeth McGovern at 415-735-3645.

Helen Yoo, New Century Escrow - Escrow Services In 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.

Brad Steinberg, Business Broker: Laundromat Specialist

PWS is the leading laundromat broker in California. Since 1968 PWS has brokered over 2,500 laundromat sales. With over 90 employees dedicated to the coin laundry industry, PWS has 18 licensed agents, a 3 person in-house finance department, 10 service technicians and a 20 person parts department.

  Related Articles, Events, Blog Posts, Discussions, Videos, Interviews
Financing Advice: Showing Add Backs To Get Business Acquisition Financing

When seeking business acquisition financing, it helps to review a seller's addbacks as a source of funding to service the debt service. But explain them correctly. Peter Siegel, MBA business acquisition financing expert and advisor at 925-785-3118 covers this topic on financing a business purchase.

Absentee Run Businesses - A Myth Or Reality When Buying A Small CA Business?

Buyers search for an absentee business, wanting to collect profits generated by a successful enterprise without having to stand at the sales counter or cash register, without having to cook, operate equipment or talk to customers. Peter Siegel, MBA offers his intake on absentee run businesses.

Unreported Income Cash Claims By The Seller-What Should A Business Buyer Do?

One of the most difficult challenges when purchasing a California small business is expressed by a prospective buyer of a liquor store who is told by the owner/seller that there is more money being made than shows up on the books. Should this buyer accept that statement and go ahead with the deal?

Selling California Small Businesses: 13 Crucial Items To Selling A Business

Only 30% of all CA small businesses for sale that are put on the market overall are sold! A surprising statistic to most business owners, agents, and brokers trying to sell a California business! If however you follow the strategies (BizBen Protocol Method) in this blog post you should see success!

4 Reasons Why Business Brokers Do Not Cooperate With Other Brokers & Agents

Despite challenges in the business for sale marketplace, some of the business brokers who make a living by facilitating a deal between buyer and seller are known to stand in the way of a completed transaction because of some outdated ideas. Too bad they put greed ahead of the needs of their clients.

Business Sellers: Do Not Make It Hard To Buy Your Small Business: Owner Tips

Successful sellers of small businesses need a game plan to sell their California small business for maximum price and for the best terms. Peter Siegel, MBA discusses these seller strategies with BizBen Blog readers based on his experience as the lead Advisor with the ProSell Program on

Is There Such A Thing As Paying Too Little When Buying A Small Business?

We all understand the idea of paying too much for a small business. But is there such a thing as not paying enough? That seems like an odd notion, but I'm familiar with situations in which a buyer acquired a small business for a figure substantially under what probably was market value.

Thinking Of Selling My Business: What Factors Create Value And Drive Price?

There are a lot of misconceptions about what enhances the value of a business. The following factors in this Discussion Post on BizBen are aspects of a business that really drives its value and pricing. Business owners thinking of selling should check these out these factors before selling.

Escrow Services Diane Boudreau-Tschetter
SF Bay Area Business Broker Manjit Singh
Health Care Broker Ralph Santos
Michael Brewer, ABC License Consultant
Vlogs and Podcasts
BizBen ProBuy Program
Business For Sale California Stats
Advertise On BizBen
New Postings Reports On BizBen Sign Up
BizBen ProSell Program
BizBen Blogs And Articles

BizBen - Where California Deals Get Done! 888-212-4747
7172 Regional Street #364 · Dublin, CA. 94568
BizBen · Copyright © 1994 - 2020, All Rights Reserved

Clost Login

Please confirm your registration by clicking the link we've sent to .

If you can't see it, please check your junk mail folder.

If you have any problems registering, or need assistance with your new BizBen User Account please phone BizBen Customer Support at 888-212-4747.

First Name:*
Last Name:*
Email Address:*
Confirm Email:*
Create Password:*
Confirm Password:*

You Are A:

Email Address:

500 New & Refreshed Detailed Postings Daily
Over 2500 Resources Available On BizBen
Since 1994. Where California Deals Get Done!
Absentee Run Small Businesses - Is That Really A Possibility For Buyers?...
Read More News
Financing A Business Purchase With Limited Or No Real Estate Collateral
Read More News