The 6 Numbers Every Smart Business Owner Must Know
Facebook recently made news when it acquired WhatsApp for $19 billion. That's a lot of money. It left many wondering how Facebook could justify spending that much for a messaging-app startup.
But despite rampant speculation about Facebook's motives, you can bet that its decision ultimately boiled down to numbers. Facebook evaluated a set of key metrics that are important to the company and determined that WhatsApp was worth the investment.
Although the dollar valuations are a lot lower for sellers of small and midsize businesses, buyers in the business-for-sale market place a similar emphasis on numbers. In fact, there are at least six important numbers that business sellers need to consider when they prepare to market their companies to potential buyers. They are:
Gross revenue is a major concern for business buyers. When buyers evaluate potential business acquisitions, annual revenue totals help them gauge the size and potential of the business, as well as its relative position within the industry.
As a business seller, it's important to show a trend of positive revenue growth. A top-line growth curve creates confidence that the buyer will be able to generate sales and revenue after the business changes hands. In many cases, a positive revenue trend can justify a higher sale price--especially if you can demonstrate a significant amount of recurring revenue.
2. Seller's Discretionary Earnings
Seller's Discretionary Earnings (SDE) speak to the cash flow of the business and represent net income before taxes, interest, depreciation, amortization, owner's income, owner's benefits, and nonrecurring expenses.
A figure that's often associated with Seller's Discretionary Earnings is EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). However, EBITDA is usually only used in larger mergers-and-acquisitions deals. Business with earnings below $1 million and sales prices in the $2 million and under range tend to use SDE.
Discretionary Earnings averages over the past three to five years matter to buyers because they provide a realistic gauge of the financial benefit a new owner can expect to receive from the business on an annual basis.
3. Earnings Multiple
Seller's Discretionary Earnings directly affect business valuation by way of an Earnings Multiple. Most Main Street businesses ultimately sell for a price that's one to four times the annual Sellers Discretionary Earnings figure.
Of course, Earnings Multiples vary according to the attractiveness and appeal of the business that's being sold. Some of the factors that justify a higher multiple include business performance, financial records, product line, recurring revenue, brand reputation, competitive position, key staff that will remain with the business, and other variables that make it easier for a new owner to successfully operate the company.
The valuation of most listed businesses is based on cash flow or Seller's Discretionary Earnings modified by an Earnings Multiple, plus the cost of inventory and real estate assets.
If the valuation figure is too high or too low, it can easily jeopardize your ability to sell the business in a profitable and timely manner. Since business sellers often lack the expertise and objectivity to accurately value their companies, the assistance of an experienced business broker is critical during this stage of the process. A good broker will also use comparable sales of similar businesses when determining the appropriate valuation for your business.
5. Asking Price
The determination of an asking price is one of the last challenges to be addressed prior to listing. The idea is to identify an asking price that is competitive with other listings and will attract a significant number of qualified buyers, but not so low that it will be impossible to realize full valuation at closing.
Based on the thousands of closed small business transactions that are reported on BizBuySell.com each year, the average business ultimately sells for 87 percent of the asking price. Again, your business broker's expertise will be essential in setting the right asking price for your company.
6. Net After-Tax Sale Proceeds
Net After-Tax Sale Proceeds is another number that should be on the radar of all business sellers. Since a certain portion of sale proceeds may be required to go to the government in the form of taxes, it's important to know the amount you will clear when you walk away from the sale.
The good news is that there are various strategies that can be used to minimize or defer taxes, resulting in a larger portion of sale proceeds going into your pocket at closing. Common tax minimization strategies include delaying the receipt of sale proceeds, converting from a C Corp to an S Corp or LLC, transferring stock to family members, structuring asset purchases to obtain a more favorable capital-gains treatment and using trusts to reduce estate taxes. Consult with your business broker and/or a tax-planning specialist to determine how to maximize the proceeds from the sale of your business.
Selling a business isn't just about the numbers--it's a combination of art and science. But by understanding the numbers that matter to potential buyers, you can better position your business for a smooth selling process.