While we offer this tool to you, we must caution that it is based on what are called “Rules of Thumb” and is likely to be inaccurate. It is based on sales throughout the country and does not account for sale terms. It also relies on your ability to properly input the data with the understanding of GIGO (Garbage In, Garbage Out).
Business valuation is an art and not a science. It is much more difficult than pricing a home, for example. While when valuing a home, we can look at what similar homes sold for in the same area & school district, make reasonable adjustments for location, size of plot, # bedrooms, etc.. Comparing your business to another in your industry is difficult, especially since the sales price of a business is often affected bythe terms of the sale. An all cash transaction normally realizes a lower sales price than a deal financed at attractive terms with long repayment at a low interest rate. Typically, we will present a range of values for a business depending on the terms ofthe sale. Further, in the parlance of evaluators Value is what you think something is worth and Price is what someone will pay. They are not the same.
In general, there are three methods for valuing a business: Asset, Market & Income Approaches. The Asset Value approach looks at the book value of the assets of the business and is most often not significant for a profitable business.
The Market Value approach is very popular and looks at the sale of “similar” businesses to obtain a multiple to apply to a business; multiples normally considered are multiples of earnings & multiples of sales. The IBBA recommends theuse of Sellers Discretionary Earnings (SDE) as the most relevant metric in evaluatingbusiness value. SDE may be defined as all the benefits realized by one owner operator of the business and will include owners draw, net profits and all owner perks. This is the multiple considered in our “Rule of Thumb” tool contained herein. We appreciate that many will want to get an idea of their business value before discussing the deal in detail with us. So, we have included this tool for your use. However, you must be advised that it is just a “first-cut”, and will only be indicative if you properly account for SDE. It does not consider the terms of the deal and relieson the accuracy of the data analyzed; e.g., are you properly considering all income and expenses.
In the Income Approach, the financial performance of the business is reviewed over a period of time (typically 3 to 5 years) and normalized to properly reflect SDE. Normalizing involves adjusting income and expenses to properly reflect what the new owner would expect to report; e.g., if a family member not working in the business was included in payroll expense, the amount would be deducted to compute the “normalized” income. Based on the SDE, we would then compute and review financial metrics to determine a business value. Among the metrics considered will be Debt Service Coverage (DSC), expected Return on Investment (ROI) & Return On Invested Capital (ROIC)
While we are offering this market tool to help you, we recommend that you contact us to evaluate the value of your business more accurately. As part of our commitment to main street business owners, we offer a free business evaluation prior to accepting any engagement. We will be happy to meet with you to review the process and prepare a free business evaluation for us to discuss. We will review the company’s financials to compute SDE on a normalized basis and analyze the deal from the buyer’s perspective.
In general, all buyers will consider a deal with three questions:
- Can I make a living?
- Can I pay off a debt?
- Will I make a reasonable return on my investment?
