| > | | | | most business will be within the 3 to 5 range. |
| Selling a business is an important decision. Are you | | | | The decision to sell is a big one. The business is |
| better selling or keeping the business cash flow? | | | | worth $400,000 in before tax cash flow to the |
| In fact, there is ultimately only one reason to | | | | owner. The owner, of course, will have to pay |
| create a business of your own, and that is to sell | | | | income taxes at ordinary income rates at least of |
| it. Michael Gerber, The E-Myth Revisited. | | | | 35%, so the owner could net about $260,000. |
| Some people create a new business so that they | | | | The real value to the owner, while still working in |
| can do what they love to do and/or what they | | | | the business, is $260,000 per year. |
| are really good at doing. They think they can | | | | Compare to the sale of the business. Assume |
| make a business out of their talent. The new | | | | that the sale was at a five times multiple, then a |
| business owner may not realize that there is | | | | sales price of $2,000,000. The business has been |
| much more to creating a business than just doing | | | | owned for more than a year so the proceeds will |
| the technical work. Financials, marketing, ordering, | | | | be taxed at long term capital gains rate, which is |
| collecting, etc. are all additional tasks to just doing | | | | at this time, 15%. The owner will pay $300,000 in |
| the work. Is this a business that is building equity | | | | taxes with a net of $1,700,000. This net is about |
| or are they just creating a job that looks like a | | | | seven times the annual after tax value of |
| business? | | | | $260,000. |
| The goal according to Mr. Gerber is to build a | | | | The point of selling is to free up the equity. If the |
| business that has equity. This equity comes from | | | | net equity of $1,700,000 were invested at 5%, |
| cash flow, not the kind of equity one gets from | | | | the interest earnings would be $85,000 per year, |
| buying a building and paying off the note. A | | | | before taxes. The seller of the business is trading |
| business, that has cash flow, can be valued as a | | | | $260,000 per year for less than $85,000 per |
| cash flow stream. That cash flow stream | | | | year. |
| translates into equity when it is multiplied to figure | | | | Most sellers focus on the gross amount of the |
| the value of the business. A business with cash | | | | sale, $2,000,000, in evaluating the transaction. The |
| flow sufficient to pay the owner’s salary | | | | important issue is not the gross amount but the |
| plus pay additional profits becomes a saleable | | | | comparison of the cash flow before and after. |
| asset. | | | | There are other factors to consider: need for |
| How much is business equity worth? A business | | | | retirement, desire to use the equity to buy |
| pays its owner a salary of $150,000 per year plus | | | | another business, desire to escape the business |
| has net profits at end of year of another | | | | regimen, etc. The desire to build equity is not the |
| $250,000, for that year, is worth $400,000 to the | | | | only reason to create a business. If a business is |
| owner. But what will someone pay to buy the | | | | properly created using the six systems for proper |
| business from the owner. At a multiple of 3 to 5 | | | | planning, the business also is a cash flow machine. |
| times earnings, assuming continuing income at that | | | | The cash flow of the business may very likely |
| level, this business would be worth $1,200,000 to | | | | exceed the potential reinvestment value (cash |
| $2,000,000. If the multiple were higher, the | | | | flow) of the sales proceeds. The seller needs to |
| business value goes up. The normal range for | | | | look at all aspects of the decision to sell. |