Don’t Misprice Your Business

Mispricing a business due to undervaluing its intrinsic worth is a common problem among many business owners who wish to sell their business. Prior to selling, business owners should be aware that it normally takes 6-12 months on average to sell a business. An attempted quick sale in less than 6 months or a forced sale often results in an undervaluation since there simply may not be enough time to procure the right buyer willing to pay fair value. In general, businesses are undervalued when the true earning power (adjusted owner benefit) of the business is masked by non-transparent financials, or when the business is not given a fair valuation multiple (based on its adjusted owner benefit) that takes into account its growth trajectory, competitive advantages, management team, customer diversity, industry dynamics, or recurring revenue.

Keys to Fair Business Valuations

To receive a fair business valuation, business owners should always hire a local business broker experienced in valuing and selling businesses within the same industry. Then the business owner should obtain a clean and organized financial statement with at least three years of transparent financials (tax returns or profit and loss reports), reduce the level of owner-dependency, and create a transitional plan (if necessary) which outlines ways in which the goodwill and customer base of the business may be properly conveyed to the buyer after the closing. It is important to also focus on the deal terms rather than the headline purchase price. A business deal with significant seller-financing is much more risky and less favorable for a business owner than an all-cash closing. A fair business valuation always takes this into account and assumes that the seller is primarily paid up front at closing.

Use Normalized Earnings for Valuation

Probably the biggest mistake made by most business owners when selling their business is undercounting their normalized annual earnings or adjusted owner benefit (also referred to as Seller’s Discretionary Earnings or SDE).
Most businesses (depending on the industry) are valued as a multiple of their annual adjusted owner benefit (over the last 12 months), so determining the properly adjusted owner benefit is critical.
In order to determine the adjusted owner benefit, an experienced business broker must analyze the financials of the business and adjust the net earnings to include personal expenses of the owner that flows through the financial statement, the owner’s salary, salaries paid to non-working family members, unrecorded cash sales which may be proven to a reasonable buyer’s satisfaction, and any other irregular or non-recurring costs (such as one-time legal expenses) that would not be borne by the buyer.
Non-cash expenses and non-transferable debt-related costs (such as depreciation, amortization, and interest) are also added back to adjusted owner benefit.
Seldom does the net taxable income on a company’s tax return correspond with the actual economic profits or adjusted owner benefit derived by a working owner.
A business with provable and organized ‘add-backs’ that clearly and logically show the adjusted owner benefit is also far more likely to qualify for external financing backed by the Small Business Administration (SBA).
This will greatly widen the pool of potential buyers and makes the business far more saleable at a fair valuation.

Apply Fair Valuation Multiple

In most industries, business valuations involve applying a multiple – typically 2-4 x – against the annual adjusted owner benefit. The valuation multiple of similar businesses within the same industry should be used as a benchmark. Some industries base business valuations more on tangible assets (manufacturing plants) or on monthly recurring service sales (pool/landscaping routes). When applying a valuation multiple, an experienced business broker must zero in on the individual attributes and unique characteristics of the business being evaluated. This often includes its growth rate, location and lease, management team (not dependent on the owner), diversity of customer base, industry dynamics, and any competitive advantages of the business (ability to produce a product or deliver a service for a lower price or higher quality than competitors). Justifying the valuation multiple based on highlighted strengths of the business with provable data and evidence is the best way to avoid undervaluing a business.

Create A Liquid Market

Creating a liquid market and competitive tension among buyers of a business for sale is essential to avoid undervaluing a business. Broadening the potential pool of buyers – including competitors, entrepreneurs, overseas buyers, and private equity groups – assures the business owner of receiving the best possible purchase price and terms. A business owner should never rely on one or only a select few potential buyers since it limits negotiating leverage and prevents the business owner from getting buyer feedback and multiple competing bids. Hiring a business broker that knows how to confidentially market the business (using ‘blind ads’ to shield the identity of the business) and expose the business to a global audience of potential buyers is the best way to create a liquid market.

Set Clear and Rational Expectations

A fair and objective business valuation requires the business owner to maintain clear and rational expectations about their acceptable purchase price and deal terms. Avoiding cognitive biases – or mental shortcuts that simplifies and quickens decisions – is critical for clear and rational thinking. For example, anchoring bias can impact business owners by anchoring their desired price to an irrelevant reference point. The reference point may be a previous valuation suggested by an advisor which is now out of date and below the current valuation. Moreover, business owners must always examine the deal terms of a transaction when setting their expectations. The desired purchase price must be put in the context of other deal terms acceptable to the seller such as the degree of seller-financing, length of exclusivity, and scope of formal due diligence.

Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.