If you’re thinking of selling your business, the most important factor to consider is the potential purchase price you can expect to realistically receive from the sale. No two businesses are exactly alike, and it is critically important for a professional business broker to evaluate your business properly. Let’s explore the various factors and methodology used to see how much your business is potentially worth.
Business Sale Valuations Ultimately Dependent on Owner Benefit
Most buyers typically ask themselves one simple question: How much money can I make from owning the business that I am purchasing? The answer of course depends on how much money the business makes today for the current owner (the seller), and how much money the business will make in the future for the buyer.
What is Owner Benefit?
- Owner benefit is simply the total amount of monetary benefit that an owner derives from a business.
- The owner benefit may accrue from a variety of different sources such as taxable profits, the owner’s salary, and any personal expenses of the owner that flows through the business.
- There are many hidden assets that comprise owner benefit, such as expenses or salary paid to non-working family members of the owner.
- Importantly, owner benefit is different from EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) because EBITDA does not include the owner’s salary, irregular expenses, or personal expenses that flow through the business.
- For small business sales, it is critical to use owner benefit rather than what the net profit appears to be from a tax return or profit and loss statement.
- Only the owner benefit will tell the true picture of the profitability of a business.
Use A Multiple of Owner Benefit To Determine What A Business is Worth
The typical rule of thumb in business sales is to apply a multiple of 2-4 times the owner benefit in order to derive the approximate value of the business. For example, if the owner benefit is found to be $200,000, then the general valuation range of the business is $400,000-$800,000 (or 2-4 x $200,000). The buyer of the business would thus expect to receive his or her investment back in two to four years. As we will see, this range depends on several factors. If the factors accelerate the buyer’s return on investment (by shortening the time in which the buyer may expect to receive their investment back), then the valuation multiple will increase.
Factors Affecting Valuation of Business Sales
Quality of Financials Affect Business Valuation
First, the quality of the seller’s financials will greatly affect the business valuation multiple assigned to the owner benefit. Without transparent financials that coherently explain and prove the actual owner benefit of the seller, it is difficult for a buyer to believe (and thus pay for) the owner benefit that is being represented. Moreover, if the financials show that the owner benefit is increasing over time, then the valuation range will increase.
Physical Assets Affect Business Valuation
Next, the physical assets of the business (at depreciated value) must be factored in to the valuation multiple. Physical assets include owned equipment as well as leasehold improvements that will benefit the buyer. In some cases, physical assets comprise the bulk of the valuation if there are minimal or non-existent profits.
Lease Affects Business Valuation
If the business premises is under a lease, then the quality and length of the lease will greatly affect business valuations. Particularly in retail businesses – especially restaurants – a buyer will be much more willing to pay a higher multiple of owner benefits if they are secure in the knowledge that they have a favorable long term lease where their rent is at least below ten percent of total sales.
Seller’s Role in Business Affects Business Valuation
Another major factor affecting the valuation range is the degree on which the seller of the business is involved in the day to day operations of the business. The more involved the owner is in the business, then the lower the valuation range. This is because it is much harder to replace a working owner with a special skill set or to whom employees, customers, or suppliers may be loyal. Buyers will thus discount the owner benefit of the seller because they may not be comfortable that the owner benefit will remain the same when the seller is no longer running the business.
Competitive Advantages of the Business Affects Business Valuation
Finally, the overall competitive positioning and niche of the business being sold must be examined. A business will be assigned a higher valuation multiple if it is insulated from competition (healthcare companies for example have valuable government licenses thus creating barriers to entry of new competitors), has high margins, and has established a unique niche in the marketplace that is difficult to replicate.
Every business owner should understand what their business is worth and why. A professional and competent business broker will explain the valuation and methodology to the seller and to potential buyers.
Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.