One of the first steps in the process of selling a business is to correctly price it. A good business broker will NOT take a listing until a valuation has been completed, and both the seller and the broker have agreed on the Offering Price. This “valuation” is not an official appraisal. Rather it is what we call a “Broker’s Opinion of Value.” Within that we will come up with the “Most Probable Selling Price,” which is the price we believe the business should be listed at, and that will balance both value for the buyer and maximum earnings for the seller. Below we’ll discuss the basic business pricing process.
Step #1 – Collect the Data
Proper financial documents are critical to have when pricing a business. The business broker needs to see (now) what the buyer is going to see during due diligence. The type of data we need is as follows:
- Financial data
- Profit & Loss statements (3 periods); accrual basis if possible
- Adjustments related to the same periods
- Tax returns (last 3 years)
- Nice-to-haves include: monthly sales (last 3 yrs) and inventory
- Operational Data
- Age of the business
- Years owner has owned the business
- Number of employees
- Franchise info (if applicable)
- Existing debt (needing payoff at closing)
Step #2 – Recasting
Most small business P&L statements and tax returns have one objective: to minimize the profits, and therefore taxes, for the owner. However, when that business owner wants to sell, one of the biggest values a business broker can bring to the transaction is to maximize the value of the business. To do this, we can/will (when applicable) convert taxable profit or loss to “Seller’s Discretionary Earnings (SDE).” SDE is the true net cash flow of the business; the “Earning Power” of the business. SDE is adjusted earnings before:
- Income taxes
- Interest income or expense
- Non-operating income or expense
- Non-recurring income or expense
- Depreciation or other Non-cash charges
- Deducting an Owner/Officer’s compensation
Step #3 – Comparable Transactions
When valuing a business, it is critical to level set your calculations against similar businesses that have sold in the past. When running valuations for our clients, we use industry-standard databases (i.e. BizComps, Business Reference Guide, or DealStats) to find past transactions in the same industry and of similar sizes. We are looking for two key data points in particular: the MVIC of Net Sales and MVIC of Discretionary Earnings (MIVC = Market Value of Invested Capital).
Step #4 – Compute the Supportable Multiple
Now we want to determine what the SDE will multiply by. All too often a business owner spoke to an industry friend or service professional (CPA, etc.) and was told, “Oh, a business like yours goes for XYZ times revenue”…or something like that. We strive to make sure the multiple is as reasonable and accurate as it can be. We’ll take into account both quantitative factors (i.e. number of years the business has operated, number of years the owner has operated it, and owner’s down payment requirement), as well as qualitative factors (i.e. amount of competition, industry trends, location & facilities, marketability, historical profit trend, etc.). Each factor is weighted differently to help arrive at the total Multiplier.
Step #5 – Compute the Price
When we deliver a business value, you are receiving our Broker’s Opinion of the Most Probable Selling Price. It is NOT an appraisal and does not comply with USPAP (Uniform Standards of Professional Appraisal Practice) standards. We did not independently verify the accuracy of the financial statements or representations relating to the adjustments that were made to convert the net operating profit/loss to seller’s discretionary earnings (“SDE”). It is the responsibility of the Buyer to do so during due diligence.
Step #6 – Test the Conclusion
This is a step many brokers don’t do. Let’s say you arrive at a Most Probable Selling Price of $1M. The seller and broker are happy with it, but what would a buyer think? Most buyers need to receive 3 things from the business acquisition:
- Sufficient cash flow to service the debt incurred in buying the business
- Enough cash left over to support themselves and their family
- A decent cash-on-cash return
Our basic assumptions are:
- The Buyer borrows 75% of the purchase price from a 3rd party, or 50% from the Seller on a Note
- The Buyer pays “Current Market Rate” for the money
- The Buyer will not purchase the business unless they receive at least a 20% annual Return on Total Investment (“ROI”)
- The Buyer will get their cash down payment back in 24 -30 months
As you can see, a lot goes into a broker’s opinion of value. By hiring Justin, you are ensuring that your business is priced as accurately as possible using relevant, recent data. Not only that, but he can help ensure that when buyers come knocking, and inevitably want to pick apart the Offering Price, you (the seller) have solid data to back it up.
If you are a business owner considering selling your business, please reach out to Justin Turner for a free consultation. He’ll take time to learn more about your business and reasons for selling, & share his background and an overview of the sales process.