Business brokers can provide a Calculation of Value for your business. The president of Mill Creek Partners is a Certified Business Analyst and CPA and often provides valuations buyers and sellers.
A valuation provides a starting point for listing a business. It can be helpful in justifying a selling price to a seller. The natural tendency is to want more for the business than a buyer will pay. Philadelphia business brokers are often confronted with explaining to buyers why the price is not what they were planning in retirement. We often must turn away sellers who will not accept the “market” price.
A commonly accepted method to price a small business is to use Seller’s Discretionary Earnings (SDE). The International Business Brokers Association (IBBA) defines SDE as follows:
Discretionary Earnings – The earnings of a business enterprise prior to the following items:
• income taxes
• nonrecurring income and expenses
• non-operating income and expenses
• depreciation and amortization
• interest expense or income
• owner’s total compensation for one owner/operator, after adjusting the total compensation of all other owners to market value
Here are some terms as defined by the IBBA:
• Owner’s salary – The salary or wages paid to the owner, including related payroll tax burden.
• Owner’s total compensation – Total of owner’s salary and perquisites.
• Perquisites – Expenses incurred at the discretion of the owner which are unnecessary to the continued operation of the business.
Developing a Multiplier
Once the SDE has been calculated, a multiplier has to be developed. The following (just as a guideline) should be rated from 0 to 5 with 5 being the highest. For example, if the business is a highly desirable business in the current market, “desirability” would be rated a 4 or 5. If the business is in an industry that is quickly declining or nearly obsolete, “industry” would be given a 0 or 1 rating.
Age: Number of years the seller has owned and operated the business.
• Terms: Is the seller willing to offer terms? For example, will the seller accept 40 percent as a down payment with the seller carrying back 60 percent at terms the business can afford while still providing a living for the buyer?
• Competition: Consider the local market.
• Risk: Is the business itself risky?
• Growth trend of the business: Is it up or down?
• Desirability: How popular is the business in the current market?
• Industry: Is the industry itself declining or growing?
• Type of business: Is the business type easily duplicated?
The average business sells for about 1.8 to 2.5. Obviously, if the SDE is solid and the multiple is above average, the price will be higher. Keep in mind that the price outlined includes all of the assets including fixtures and equipment, goodwill, etc. It does not include real estate or saleable inventory. The price determined above assumes that the business will be delivered to the buyer free and clear of any debt.
When all else fails, the words of a veteran business broker will work.
Asking Price is what the seller wants.
Selling Price is what the seller gets.
Fair Market Value is the highest price the buyer is willing to pay and the lowest price the seller is willing to accept.
Sellers should keep in mind that the actual price of a small business is about 80 percent of the seller’s asking price.