Exit Strategy for Small Business Owners
According to the Small Business Administration (SBA), a small business generally has less than 150 employees or about $41M in annual sales. This criteria varies widely by industry, with certain industries such as restaurants needing less than $8M in annual sales to qualify as a small business under SBA guidelines. For small business owners, having an exit strategy prior to selling should incorporate obtaining a clean set of financial records, streamlining profits, and reducing the owner-dependency of the business. A small business should assemble the right team including a business broker experienced in the industry in which the business operates, as well as an accountant or lawyer as needed. The broker should confidentially market the business to as many prospects as possible, always highlighting the unique competitive advantages of the business.
Valuing Small Businesses
Unlike large businesses, the vast majority of small businesses generally do not have a large executive team or board of directors. Indeed, out of the approximately 33M small businesses in the United States today, about 27M have no employees and another 5M+ have between 1-20 employees. This means that the typical small business tends to be owner-operated. Additionally, many small businesses have non-transparent financials which diminish the true profits of the business for tax purposes. Using the guidance of a professional business broker with experience selling small businesses, it is imperative to value small businesses properly so that the role of the owner is accounted for while using the properly adjusted financials when deriving its valuation.
Small Businesses Often Have Working Owners
- For small businesses, the more absentee the owner is from day to day operations, the higher the valuation the business will receive.
- This is because buyers incur risk and expenses in having to replace the seller after the sale.
- The risk that customers, vendors, or employees may leave after the sale is a very important factor in many small business sales.
- Small business owners should take preparatory steps prior to the sale by de-emphasizing their own personal role in the business and by limiting their involvement in the business as much as possible.
- Moreover, small business owners should have a post-closing transition plan in mind prior to selling their business.
- This plan will detail how exactly the company’s customers, vendors, and employees will be informed of the sale and how these relationships will be properly transitioned to the buyer with the goal of minimize disruption to the business after the sale.
- Large businesses do not often face the problem of replacing a working owner to the same degree as small businesses since large businesses tend to have a management team already in place that is not overly reliant on the owner.
Properly Adjust Financials of Small Businesses
Unlike large businesses, small businesses often have financials that are not transparent and do not readily inform potential buyers of the true economic profits or adjusted owner benefit (also known as Seller’s Discretionary Earnings) of the business. To determine the adjusted owner benefit, begin by uncovering the EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) from the most recent annual financial statement (such as a tax return). This is the pre-tax profits that does not include non-cash charges (depreciation) or payments related to debt service. Then one must ‘add-back’ any non-business related expenses that flows through the financial statement (such as the owner’s personal expenses), the owner’s salary, and unrecorded sales (if proven). The result is the annual adjusted owner benefit, or the true economic profit derived by a working owner from the business.
Adjust Salary Expenses of Owner/Owner’s Family
As noted, a working owner’s salary is considered part of the adjusted owner benefit. But what if the buyer does not want to be an active owner-operator? Such a scenario should not change the valuation of the business as long as it is considered reasonable and common to expect a working and active owner within the industry. Some small business owners also employ family members to work in the business. Often times, the family members (such as a spouse) only work part time (or not at all) but are paid a full time salary. Here, the financial statement must be adjusted to reflect the cost (if any) of replacing the work functions of the paid family members.
Apply Valuation Multiple to Small Business
The average valuation range for small business is about 2-4 x the annual adjusted owner benefit of the business. Many factors may affect the valuation range including the company’s physical assets, the recurring sales of the business, the role of the owner, the margins of the business, the location and leasehold rights of the business, the historical growth rate and longevity of the business, the scalability of the business, as well as any other competitive advantages. For small businesses that are larger in nature or with multiple locations, then the valuation range will increase as a result of its more substantial profits and sustainable (and scalable) business model.
Seller-Financing Option in Small Business Sales
Some small business owners may choose to seller-finance at least part of the purchase price. This will enable the buyer to still buy the business by putting down a down payment of about 50% (or less) of the purchase price. The balance (held as a Note by the Seller) will be financed by the seller over a negotiated period of time with negotiated interest and other terms. The seller typically puts a Uniform Commercial Code (UCC) Lien against the assets of the business after the sale as a way to hold collateral for the Note. If the buyer defaults on the Note, then the seller will have the right to execute their UCC Lien against the business.
Small business sales should be handled with the assistance of a professional business broker so that the business is priced properly, the sale is confidential, and so the transition after the sale is smooth and professional. Active owner-operators of small businesses should attempt to remove themselves from the day to day operations of the business as much as possible. This will result in a higher relative valuation of their small business.
Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.