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How to Begin to Value a Business

Submitted by HTFDBUS on Mon, 01/01/2018 - 19:43

It's a fact that valuing a business is often the most challenging and difficult part of the process of selling or buying a business. You shouldn't try to do this on your own but rather consult with a Business Broker or CPA. You want to tap into their expertise.

Valuing a Business is really more of an art then a science, and in a recession years (like 2011-12 2013), some of the rules can be thrown out the window in 2017 - it also varies by type of business. If you’re a Buyer you see this process one way and if you’re the Seller you see it a different way. The Seller wants to maximize the sale price while the Buyer wants to pay the lowest amount the Seller will accept. This is American capitalism in operation.

There are several different ways to calculate the value of a small business. The one method most commonly used today is the “Income Multiple”. This is where the income of a business is subject to a certain multiple to arrive at a selling price. You have probably heard or read of a company or a business’s selling at “X time’s earnings”.

It’s not about how much a business earned in revenue, or what it is capable of earning next year, but rather what its Net Income was for the prior tax year or averaged in the last 2-3 years. It’s also not about large amounts of fixtures & equipment – F&E acts as assets that secure a business loan. You could have $500,000 in F&E that generates a Net Income of $100,000 a year. The business would be valued off of the Net Income. This is one reason why every asset in your business must contribute to revenue and income generation.

To express Net Income Finance professionals and CPA’s will commonly use an acronym “EBIT or “EBITDA”.

“EBIT” stands for Earnings before Interest and Taxes.

“EBITDA” stands for Earnings before Interest, Taxes & Depreciation.

Privately owned small businesses under $1 million in Net Income will have a multiplier of 1 to possibly 4; above $1 million but less than $3 million in Net Income a multiplier of 2 to 5; and above $3 million to about $5 million in Net Income a multiplier range of 2-8; I think you get the drift. However there are numerous exceptions to the rule, and within each business segment.

A simple example is liquor stores that normally don’t use the Net Income method but instead use a simple formula of somewhere between 28% and 35% of gross revenues to determine the Listing Price of the store plus inventory.

From the Net Income multiplier, the Business Broker will develop what is known as a Reconstructed Income Statement or an “Owner Benefit” formula:

Pre-Tax Profit plus Owners Salary plus Owner Perks plus Interest plus Depreciation Expense

EQUALS Reconstructed Net Income or Owner Perks

Owner perks are added back-in when personal expenses are paid out of the business. Interest on credit cards and interest on bank loans is a cost to the business that a new owner may not incur.

Depreciation Expense can be added back-in because it is not an actual cash transaction. No actual cash is leaving the business or changing hands, thus the amount can be added back-in.

Real Estate that is owned by the Business owner is normally not part of the Listing Price of the business; but can be purchased separately. It’s to your advantage to purchase the real estate when you can – Banks will give longer loan years, or do a mix of repayment years.

An important point to make here is that in compliance with GAAP (Generally Accepted Accounting Principles), items from the Balance Sheet should never be added back into a Reconstructed Income Statement or Owners Benefit reconstruction.

Mid-Size & Large Companies

Small Business Brokerage is somewhat defined by the revenues (up to $5 million Dollars)

From the $5 million to $75 million dollar range in revenues, a company being listed For Sale is normally represented by an M&A Intermediary company. This is because it can be a more complex sale and also a different breed of buyers. These businesses for sale can be privately held, closely held or publically traded on the stock exchanges.

These companies will sell as a multiple of earnings. You will typically hear some company was sold for 10 times earnings or 15 times earnings and so on.

Please feel free to contact us and let Hartford Business Broker’s interview to sell your Business. We have been in this field for more than 20 years and are experts in just about every business segment.

Hartford Business Brokers represents "clients". Our commission rate is a percentage of the sale price and only paid at a successful closing. We don’t charge retainer fees.

If you have questions or need more information please feel free to contact HBB by e-mail or phone. If more convenient just go to our "Contact Us" page and complete the form and we will call you.