How to Evaluate A Business For Sale

Steps to Evaluate A Business for Sale

In order to sell one’s business, the business should be evaluated by a professional business broker. For a first time business seller, the evaluation process may seem like a difficult task. In practice, the process is not so difficult so long as the seller is prepared with the right information and documents necessary for the professional business broker to properly evaluate the business.  Let’s figure out the basic steps necessary to evaluate a business, and how the evaluation process should lead to the optimal asking price.

Analyzing the Company’s Financials: Determine True Profits of Business

  • Business valuations ultimately depend on the seller’s owner benefit.
  • The owner benefit is defined as the seller’s true earnings which incorporates the owner’s salary, personal expenses of the owner paid by the business, irregular expenses not to be incurred by a buyer, depreciation, and even unrecorded cash sales (if provable).
  • In order to determine the owner benefit, the business broker must generally analyze the company’s financials including at least the last two years of the company’s tax returns or profit and loss statements.
  • The seller should always remember that disclosing these documents to the business broker is strictly confidential, and will not be shared with any buyer until the buyer is fully qualified and signs a non-disclosure agreement.

Trajectory of Financials Important

In reviewing the company’s financials, it is critical to determine whether the company’s sales and profits have been growing or falling over the last two or three years (or more). If they are falling, then a coherent and reasonable explanation must be given. Hopefully, the reason(s) will persuade a buyer that the trend can be reversed with new management or with more favorable business conditions. If sales and profits are growing, then the trend should be highlighted in the information presented to buyers, and should be reflected in the company’s valuation. It is helpful to note how and why the upward trajectory may continue in the future for the buyer of the business.

Most Recent Financials Most Important When Evaluating Business For Sale

Irrespective of the company’s trajectory of sales and profits, buyers will want to see the most recent financials available. If, for example, the business evaluation takes place in September of 2021, a buyer will typically not be satisfied with 2020 financials. In such a case, the buyer will also want to see the interim (or year to date) financials for 2021. This is because a buyer’s main purpose (and hence the evaluation’s main purpose) is to determine what sales and profits they will make from the business after the closing. As a result, the buyer will want to know to the best extent possible what the company is currently doing. The most recent financials possible will help answer this critical question and should be given to the business broker in order to make the best evaluation possible.

Physical Assets of Business Key Part of Evaluation Process

  • A business seller should have an equipment list ready for the business broker’s review at the evaluation meeting.
  • The equipment list does not need to list every single item of company owned equipment.
  • Rather, the list should identify the major pieces of equipment (such as vehicles and any movable item owned by the company worth more than a couple thousand dollars or so) as well as their estimated depreciated value.
  • Additionally, the business seller should have an idea of what their current inventory is worth at cost.
  • Inventory (unlike equipment) consists of items that may be sold to the public.
  • Often times, inventory is not included in the business evaluation and is sold separately by the seller to the buyer at cost.

Seller’s Role in the Business Must Be Evaluated

An often overlooked part of the business sales process is determining how the seller (and potentially family members of the seller) will be replaced by the buyer of the business. Thus an important factor of the evaluation process is exploring the precise role of the seller (and potentially family members of the seller) in the business. The more absentee a seller is in the business, the higher the valuation of the business. This is because the buyer will not face any expenses (by virtue of hiring more staff or having to work in the business himself or herself) or risks (that staff or customers may leave) in having to replacing the owner. If the seller does have an active role in the business (which is typically the case), then a well thought out plan must be constructed as far as how a smooth transition can occur.

Explore All Key Facets of Business to Assign Correct Valuation

Every business has unique characteristics that must be addressed during the evaluation process. For retail businesses, an exploration of the lease and location are of paramount importance. A favorable long term lease for a retail business in a good location will certainly add value to the company’s valuation. A service business that has valuable licenses (which can be transferred) or long term contracts with customers (which can be transferred) will likewise place a premium on its valuation. A thorough discussion and understanding of the company including its staff, customers, suppliers, competitive advantages, and growth prospects all must be addressed in order to best determine the company’s valuation.

Determining the Best Asking Price of Business For Sale

All of the above factors come into play when determining the best asking price for a business. Unlike with real estate, ‘comps’ (or comparable sales) are relevant for business sales but are far from perfect and often misleading. Typically, the business is assigned a multiple of its true owner benefit. The multiple varies by industry and with business conditions, but typically the asking price is between 2 and 4 times the company’s true owner benefit. A well prepared seller with the correct documents and information for the evaluation process (and the right business broker!) is sure to have the best possible chance of receiving the best possible purchase price.

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