For small business owners their business can be their most valuable asset. When it comes time to move on or retire selling the business can provide them with the financial means to do so.
But what is a business worth? Well, there are lots of ways to determine that. As a business broker my main interest is in determining what a potential buyer will be willing to pay. There are many “rules of thumb” and you may have heard of some.
However first we must view things from the perspective of the buyer. The key number for most buyers is the amount of cash left over after normal operations. Often referred to as SDE (Seller Discretionary Earnings). This will provide them with a salary, debt coverage and a return on investment. For larger businesses the formula used is a little more restrictive, EBITDA (Earnings before Interest, Tax, Depreciation and Amortization). For Capital ontensive businesses an even more restrictive metric EBIT (Earnings before Interest and Tax) may be used.
Gross sales tend to be a less important factor for buyers who are more focused on the bottom line.
There are other factors that enter in to valuing a business. For example, Manufacturing businesses with expensive machinery and a greater barrier to entry tend to go for higher multiples. Businesses that require a greater amount of Working Capital need will have to factor this into the likely price.
For businesses with repeat clients, customer retention will be an issue. With CPA and Accounting practices some of the price will typically be paid as an “earnout”. This means that a portion of the price is paid back over time based on customer retention.
Opinion of Value or Appraisal
When approached by business owners Quorum Business Advisors will provide a “Broker Opinion of Value”. This is not a business appraisal and is designed only to give a seller a range they can expect their business to sell for on the open market. Business owners who need a valuation for other purposes e.g. Divorce, partner buyout, Employee Stock Purchase, lawsuits etc. will need to obtain a professional Appraisal from a certified appraiser adhering USPAP standards. At Quorum Business Advisors we maintain relationships with such professionals and can facilitate this.
Rules of Thumb
So, what are the typical “rules of thumb” for businesses. Here are just a few. But keep in mind there are lots of factors that go into determining value and this should be understood only as a rough guide.
Full-Service Restaurants 1-3 times SDE or 2-3 times EBITDA. Smaller restaurants sell for lower multiples and larger ones for the higher number.
Pool Service Companies 10-12 times monthly service only income
HVAC Contractors 2-3 times SDE plus inventory, 2.75-3.0 times EBITDA. (Please note that in the recent period Construction Industry businesses have been selling for a premium above historical rules of thumb)
Retail General 1.5-2.0 times SDE plus Inventory
Carpet Cleaning Companies 1.8 times SDE plus Inventory
Hardware Stores 3.0 times SDE plus inventory, 3.5 times SDE to include inventory
Pest Control 3-4 times SDE plus inventory, 4-5 times EBITDA
Grocery Stores 2-3 times SDE plus inventory, 3.5 times EBITDA
Manufacturing 3-4 times SDE, 3-4.5 times EBITDA
Towing Companies 2.75 times EBITDA
There are many things a business owner can do to increase the value of their business. Grow revenues and profits, put a competent team of managers in place, diversify your customer base (customer concentration is considered a big risk factor). Keeping good books is of critical importance. Do not expect to be paid for what you cannot prove.
Most of all be realistic. Overpricing a business, just like overpricing any asset will keep serious buyers away and end up as a frustrating experience.
At Quorum Business Advisors we work hard to get the best possible price for your business. If you are considering selling contact us today to get started.
Anthony John Rigney is Broker and Owner of Quorum Business Advisors. He is a Board Certified Intermediary and has been helping buyers and sellers of businesses for over 15 years.