Pricing A Business For Sale - Key Factors All Play A Role!
Correctly Pricing A Business Is Important If You Really Want ToSell It!As a consultant I talk to many business owners, brokers, andagents on a daily basis about valuing businesses. It alwaysamazes me on how some of these individuals come up with thevalues on small businesses being sold. No wonder only 30% of allbusinesses sell! In many instances no consideration is given tothe total picture - like will the available cash flow of thebusiness be able to pay the debt of a loan, will the deal asstructured or priced even be attractive to financing sources,"cash" price vs. "note" price and how these factors figure intothe equation!I have seen many "professional valuations" where the price justdoesn't make sense - and sellers wonder why their business forsale just sits there with no action!Market ApproachThere is a solution that is grounded in the fundamentals ofeconomics, and time tested in the marketplace, where theinfluences of supply and demand ultimately determine where abusiness belongs on the price scale. One economist explains thismarket approach by comparing a business to a machine which hasthe purpose of making money: The more money it makes, the moreit's worth. And that explains why, for example, there is astrong demand for a very profitable distribution business withfew hard assets; and why it is worth more in the marketplace ofavailable businesses, than a large machine shop that would costnearly $1 million to duplicate, but can't make a living for itsowner. Adjusted Net IncomeThe first category of information needed is called adjusted netincome, and is the total amount of cash produced by the "moneymachine." It's a figure that includes the profits, the owner'ssalary and all of the many cash-related benefits which areenjoyed by the principals of small businesses. Those benefitscan include the use of a company car, the company-paid premiumsfor health, life and auto insurance, plus personal expenditurestucked into travel and entertainment, subscriptions and similarbusiness "expense" categories. Interest expense should be addedto adjusted net income, along with accounting entries—suchas depreciation and amortization—that can divert money tothe owner's pocket so that it never appears on the bottom lineof the P & L. While some of these items vary from business to business, anyowner knows which categories of expenses in his or her financialrecords include sums of money that should be added to adjustednet income. Many business owners also know of cash income thatnever sees the business records in any way, shape or form. Someowners feel they should get credit for these sums in thecalculation of value. But it's a poor policy to collectunreported income and then attempt to have it included inadjusted net income for evaluation purposes. When selling, yourbuyer prospects want any statements you make about your businessto be supported by evidence in the form of accounting recordsand other reliable sources. To admit that you are doing business"off the books" not only exposes you to problems with the IRS,it also sets a bad tone with prospects who—if they aregoing to be interested in your business-- need to believe yourpractices and record keeping are above reproach.Adjusted net income is usually the first thing any buyer wantsto know about when investigating a business; and not just thepast few months' worth of income. A seller should be prepared todemonstrate a history of earnings, and have the documentation toback it up. Multiplier MethodThe next piece of the equation comes from the expectationsworking in the marketplace to shape the multiplier—afigure which will be computed, along with the cash flow, tocalculate a rough value. The validity of the multiple is that itreflects behavior in the market. There is no need to theorizeabout a proper multiplier. It's calculated by determining whatpeople actually pay for small businesses in California.The experience with low risk businesses is that their highmarket demand is reflected in a fairly strong multiple. A lot ofbuyers want, for example, a well-established franchise, or agrocery store with a long lease in a densely populated area andlittle direct competition. Its multiple might be in the range oftwo to three times annual adjusted net income. A one or two multiple, on the other hand, would be associatedwith an enterprise in which the buyer is assuming greater risk.An example is a retail store near a large shopping area, whichleaves the buyer of the smaller business vulnerable to thecompetitive marketing activities of much larger companies. Thelower multiple is a consequence of lower market demand. Fewerpeople want that kind of business. Since profitable distributorships and manufacturing companiesare much sought after, it's not unusual to see them command aprice upwards of four times annual adjusted net profit. Thecompany in this category providing adjusted net profit of$200,000 might realize a selling price in the range of $800,000,assuming a favorable deal structure (more about that shortly).Also warranting a high multiple are businesses loaded withassets—equipment, trade fixtures and inventory. Butremember that a seller must be able to establish the company's"history of earnings" with financial reports and tax returns,before the higher price will be offered. More commonly available businesses, such as restaurants, arepriced with a lower multiple - in the one to two range - toreflect the abundance of this kind of business available forsale at any one time. In this case it's purely a matter ofsupply and demand. And a company in any industry that is difficult to finance, willbe hard to sell. I'm familiar with a retail business in NorthernCalifornia that is not generating enough adjusted net income tosupport its $1.5 million asking price. Because a new owner wouldhave a difficult time paying off a loan that was hefty enough toswing a purchase of this company, there are no lenders willingto provide the money. That severely affects marketability. Infact, the company is probably unsalable as presented. Importance of Deal Structure/TermsAnd the final factor thrown into this equation is particularlyuseful in determining the value of businesses offered for sale.It recognizes that the terms of a transaction--in other words,how a price is paid--are critical in calculating that price.When sellers demand all cash for their businesses, for example,the market tells us that they can expect to receive about 60% to80% of the sum they would have gotten by taking a down paymentand financing the balance. It's easy to understand why deal structure is such a vitalcomponent in the valuation process. For a business to beaffordable, the cash flow needs to be substantial enough tosupport the price at the multiple being used. A deal thatrequires a lot of cash up front, in relation to the expectedamount of adjusted cash flow, will place a greater burden on thebuyer. That principle, translated into the language of themarketplace, means the business will only be appealing at a lowprice. If, on the other hand, the level of adjusted net incomesupports the buyer's ability to make payments to the seller inorder to purchase the business—this opportunity willinterest more potential buyers and the result is a higherachievable sales price.Other ways an attractive deal structure can be used to buildmarket appeal include a delay of a few months--after close ofescrow-- before monthly payments on the seller's financing aredue to begin, a low interest rate, and interest only paymentsfor awhile, until a new owner is able to build the business tomore easily meet the loan obligation. Creative deal structuresalways help sell a business and will usually command a highermarket price for the business (remember it has to make sense)!Pricing a business is as much or more of an art than a science.Sellers who take a look at the big picture - looking at bothdeal structure and price are usually the ones who are successfulin selling their business!© Peter Siegel, MBA - All Rights Reservedhttp://www.BizBen.com * http://www.USABizMart.com--------------------------------------------------About The Author: Peter Siegel, MBA is the Founder & Principalof BizBen.com - California Businesses For Sale andUSABizMart.com - USA Businesses For Sale, two of the mostpopular business for sale related websites on the internet. Heis also the author of three books on the topic of business salesand business buying. The most current book is "Businesses ForSale - How To Buy Or Sell A Small Business". Mr. Siegel alsowrites a daily Blog - at www.USABizMart.com/blog that covers alltopics on selling, buying, valuing, and financing businesses.--------------------------------------------------Attn: Website Owners & Ezine Editors:Feel free to reprint this article in its entirety on yourwebsite or Ezine so long as you leave all links in place, do notmodify the content and include the resource box as listed above.Thank you.
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