| Selling a business can be a challenging | | | | generate into the future and then discount the |
| undertaking. For most people, they have not | | | | stream of future cashlfow that has been |
| been through the business sales process before | | | | estimated back to the present by applying a cost |
| and are surprised to learn how different it is when | | | | of capital. Confused yet?? |
| compared to a typical real estate transaction. | | | | The principle is that a business is worth the |
| The entire process of selling a business is usually | | | | ‘present value’ of the future earnings it |
| much more involved and can be much more | | | | will generate; adjusted for time (a dollar earned in |
| complicated. For instance, finding an appropriate | | | | the future is worth less than having a dollar |
| business buyer, qualifying leads, maintaining | | | | now). So, when a business buyer buys a |
| business confidentiality, tax issues, asset sale vs | | | | business, he or she are really buying a stream of |
| share sale, due diligence, VTB financing, transitions, | | | | future cashflow. The earnings that the business |
| employee issues, liabilities, working capital… and | | | | will generate in the distant future are worth less |
| so on. | | | | than the earnings it will generate in the near |
| Besides all of these issues though, probably the | | | | future so time-based adjustments need to be |
| most confusing issue for many owners when | | | | calculated. |
| selling a business is determining an appropriate | | | | Please bear in mind that this methodology is |
| selling price. For most people, determining a | | | | generally not used for small businesses. If you |
| selling price (or business valuation) is a mystery. It | | | | are selling a business that is mid-sized or more |
| is one of the most important decisions a business | | | | complicated you may encounter this methodology. |
| seller can make though. Setting the selling price | | | | Asset Based Business Valuation – use caution |
| too high will discourage potential buyers from | | | | Please use extreme caution if you want to value |
| inquiring about the listing. If the price is set too | | | | your business based on the value of the physical |
| high and it stays on the market too long it may | | | | or tangible assets. Often, business sellers believe |
| lead to red flags (buyers may think there is a | | | | that the only way to value their business is by |
| problem with the business if it is listed for too | | | | adding up the market worth of their physical |
| long). Conversely, setting a selling price that is | | | | goods. This is could lead to a costly |
| too low is not good in that a business owner is | | | | underestimation of the business’s value. This |
| not realizing the fullest value for their business. | | | | approach does not factor in the intangible value |
| There are some common useful methodologies | | | | that is inherent in the business (example – |
| that can be used to assist in determining the | | | | goodwill). |
| listing price of a company when selling a business | | | | For instance, suppose an owner of a very |
| and help arrive at a fair number. | | | | profitable service based company with very little |
| Discretionary Earnings Multiple Method | | | | ‘hard assets’ were selling and he or she |
| This method is a common way that small | | | | decided to value the company based on the |
| businesses are valued. It is a (relatively) easy | | | | market value of these hard assets. The owner |
| method to determine a business’s listing price | | | | would be grossly underestimating the |
| and is quite intuitive. Essentially, the concept is to | | | | business’s true value by neglecting to take |
| determine a business’s ‘discretionary | | | | into account the company’s goodwill and any |
| earnings’ that it delivers to the owner and | | | | other intangible assets. |
| then applying it to a multiple to determine the | | | | If you are selling a business and want to base its |
| value of the business. A simple example - if the | | | | value based on the tangible assets, please use |
| discretionary earnings of a business is $150,000 | | | | caution and consult with a reputable business |
| and it is determined that the earnings multiple is | | | | broker or business appraiser. |
| 2.2x then a valuation of approximately $330,000 | | | | Sometimes emotions can work against youMany |
| would be appropriate ($150k x 2.2). | | | | times business owners get emotionally attached |
| It is important to properly calculate | | | | to their companies. Especially those that have |
| ‘discretionary earnings’. A qualified | | | | built their businesses from scratch and have |
| business broker or business appraiser can assist | | | | personally invested years of hard work. Selling a |
| you with the calculations but the concept is to | | | | business is more than just a business |
| calculate the earnings available to an owner as a | | | | transaction. Emotions must be acknowledged |
| result of running the business. It usually involves | | | | – and managed. Oftentimes, these owners |
| taking pre-tax income and adding back some | | | | may think their business is worth far more than it |
| discretionary items like owner’s salary, | | | | really it (which is understandable and natural). |
| personal items and so on. | | | | Emotions can, however, get in the way of |
| The next step is to determine the right multiple. | | | | prudent business decisions so please take care to |
| Multiples vary by industry, geography and time so | | | | not make selling decisions (or pricing decisions) |
| it is important to get a supportable multiple that is | | | | based on an unsupportable value. |
| in line with the market reality. Again, a qualified | | | | Please bear in mind, there are many other detailed |
| business broker or business appraiser can assist | | | | issues surrounding a business valuation that must |
| you. If you are selling a business please work | | | | be considered that can impact the methodology |
| with a professional to help you determine a selling | | | | used when selling a business (for instance, an |
| price. | | | | asset sale versus a share sale). This article is a |
| Discounted Cashflow Method | | | | general overview of the process and a brief |
| A much more sophisticated method to determine | | | | summary of a couple methods used. If you |
| the selling price of a business is the discounted | | | | decide upon selling your business please consult |
| cashlow methodology. Essentially, the concept is | | | | with a professional about determining a fair |
| to forecast the cashflow that the business will | | | | market price for your company. |