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SELLING A BUSINESS

What's Your Right Asking Price

Anyone considering a business sale faces the same question: How much is my business worth? A few quick exercises can give you the proper asking price.
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It's time to put some thought into how much your business is worth. A few quick exercises can give you a good estimate, allowing you to properly set an asking price.

Step 1: Get your financial statements in order.

If by any chance you keep your business records in a checkbook register or shoebox, here's what you absolutely have to do before pricing your business for a sale: You have to assemble formal financial records for your business for this year and the previous three years (if your business is that old).

Unless you're skilled in accounting, work with a bookkeeper or accountant to prepare the following forms:

  • Income statement showing your gross revenue, costs, and how much your business made or lost each year.
  • Cash flow statement showing how money was received and paid out of your business and how business assets changed as a result.
  • Balance sheet showing the value of all tangible assets owned by your business less the liabilities your business owes.
  • Seller's discretionary earnings statement, also called the owner's cash flow, showing how much your business makes after backing out non-recurring and discretionary expenses as described in Step 3.

Step 2: Estimate the value of the tangible assets of your business.

It's essential to list and price all physical assets of your business, including furnishings, fixtures, equipment and inventory, for two reasons:

  • The worth of tangible assets is important to business buyers, who will require you to provide a complete asset list including purchase prices and current market values.
  • The worth of tangible assets is also important to you, because if you determine that the value of the assets of your business is very similar to the price you're likely to receive through a sale - which you'll calculate following the next two steps - you may decide liquidation is a more expedient route to recovering value from your business investment.

Step 3: Prepare your statement of seller's discretionary earnings.

To calculate your business asking price, you first need to work with your accountant or bookkeeper to recast your business income statement into what's interchangeably called a statement of owner's cash flow or a statement of seller's discretionary earnings (SDE). Under either name, it is the basis for sale pricing and of primary interest to buyers.

Following is a sample of an SDE statement.

It differs from an income statement in two ways:

  • The income statement reflects the full range of normal and legal deductions, resulting in the lowest-possible bottom line and taxable profit.
  • The SDE or owner's cash flow statement presents the full earning power of your business after adding back in one-time, non-recurring purchases and discretionary expenses shown on your income statement but not essential to business operations.

In the following example, shaded cells indicate areas where the income statement is adjusted to reflect earning potential - called recasting or normalizing your financials.

Annual Seller's Discretionary Earnings

 $

Annual Revenue

 

Annual Cost of Sales

 

Annual Expenses

 

Annual Net Income

 

Adjustments for Interest, Depreciation, Tax and Amortization deductions

 

Add-back for Interest paid on loans

 

Add-back for Depreciation

 

Add back for Taxes paid

 

Add back for Amortization

 

EBIDTA (Earnings before Interest, Depreciation, Taxes and Amortization)

 

Adjustments for Personal, Discretionary and One-Time Expenses

 

Add-back for Owner's Salary, Payroll Tax, Benefits

 

Add-back for Family Member Wages, Payroll Tax, Benefits

 

Add-back for Owner/Family Personal Auto Use

 

Add-back for Contributions/Donations

 

Add-back for Fair-Market Rent Adjustment

 

Add-back for Owner's Insurance premiums

 

Add-back for Legal, Accounting, Tax services

 

Add-back for Owner Retirement Plan contributions

 

Add-back for Travel/Entertainment Expenses

 

Add-back for Subscriptions and Memberships

 

Add-back for extraordinary, one-time, non-recurring expenses reflected on Income statements

 

Adjusted Statement of Projected Annual
Seller's Discretionary Earnings

 

Step 4: Estimate the earnings multiple that's likely to apply when pricing your business.

Most small businesses sell based on an earnings multiple of 1-4. Translated, that means most owners receive somewhere between one and four times the annual SDE of their businesses, with the multiple pegged to the attractiveness of the business being purchased.

To begin to estimate where on the 1-4 range your business attractiveness is apt to fall, use the following chart:

ATTRIBUTE

Rate Your Business from 1 (lowest) to 4 (highest)

Recent Performance: Over past 2-3 years did your business revenues and profits increase steadily (highest), or were they flat (average) or declining (lowest)?

 

Ease of Transition: Does your business have policies, procedures, systems and staff that will make a new owner's transition very easy (highest) or difficult (lowest)?

 

Financial Records: Does your business have clean, complete, accurate financial statements that reflect all income (highest) or are your records informal and not inclusive of all your business revenue (lowest)?

 

Clientele: Do you have a broad base of profitable clients with no client representing more than 5% of your revenues, and do you have good customer lists and contracts (highest) or do a few customers account for most sales, without customer lists or strong, transferable contracts (lowest)?

 

Products: Does your business offer distinctly different, better, and difficult-to-copy products and services; does it serve an exclusive territory; does it offer an exclusive product line under transferable contracts or arrangements (highest) or does it offer products identical to those offered by other businesses in your market area with no distinct competitive advantage (lowest)?

 

Recurring Revenue: Does your business sell via subscriptions, monthly fees, automatic delivery programs or other approaches that deliver ongoing revenue from established customers (highest) or are most sales single-time transactions by one-time or occasional customers (lowest)?

 

Staffing: Does your business have key staff with transferable contracts who will assist with the business transition (highest) or are you the one-and-only key person (lowest)?

 

Location: If your business success is reliant on its location, is it located in a growing and desirable market area and in a location with a long-term, transferable lease and good facilities and equipment (highest) or will a new owner need to move or improve the location (lowest)?

 

Brand and Reputation: Does your business have a well-known name, respected reputation, and top-position within its competitive arena (highest) or are the reputations of competitors considered stronger and preferable (lowest)?

 

After completing this chart, you'll begin to understand the probable attractiveness of your business to buyers. If it is strong in areas of high importance to its current and future success, it's likely to command a higher-than-average earnings multiple. Conversely, if it's weak in key areas buyers will assess its worth at a lower-than-average multiple when arriving at a purchase price offer.


Step 5: Do the math to arrive at an early estimate of your purchase price.

Based on how attractive your business appears in key areas that most affect its future success under new ownership, you can multiply your annual seller's discretionary earnings (from Step 2) by your estimated earnings multiplier (from Step 4) to arrive at a preliminary estimation of your business purchase price.

Realize this early price estimate will likely be adjusted before you present it for two reasons:

  • You may not be the best person to assess the attractiveness of your business to buyers, which is why outside intermediaries and assessors are so valuable.
  • Your asking price needs to account for the fact that buyers negotiate downward. Of the thousands of closed small business transactions reported to BizBuySell each year, most businesses sell for about 87% of their asking price. Your asking price will need to account for that variance without stating a number so high that it reduces buyer interest and inquiries.

Your asking price must be in line with prices of comparable business sales, which is the topic of the next step.

Step 6: Do some price checking

After arriving at your estimated purchase price, conduct the following research:

  • Use business-for-sale services to find information on recent listings and sales in your business category, market area, and price range. The findings will help you determine what businesses like yours are going for and what separates one business from the next in terms of what the owner is asking for the business. Keep in mind that these are only asking prices, and they are no guarantee that the business will actually sell for the asking price (Remember that BizBuySell data reflects that businesses sell, on average, for about 87% of their asking price).
  • Work with your sale advisors, including your broker if you're using one or with industry association contacts if available, to see how your pricing estimate syncs with the prices of recent comparable-business sales.

In next week’s installment of “Selling Your Small Business” we’ll begin preparing a selling memo explaining your business and why it is a good purchase prospect.   

Editor’s Note: This article is the ninth piece in a series taken from BizBuySell.com’s Guide to Selling Your Small Business. The guide is a comprehensive manual to help small business owners maximize their success when the day to sell arrives. Each Wednesday, Inc.com will publish a new section of the guide outlining BizBuySell.com’s best practices, from the initial planning stages of a sale all the way through negotiations and post-sale transition.

IMAGE: Shutterstock
Last updated: May 9, 2012

MIKE HANDELSMAN | BizBuySell.com

Mike Handelsman is group general manager for BizBuySell.com and BizQuest.com, the Internet's largest and most heavily trafficked business-for-sale marketplaces.




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