When determining the value of your South Florida business, the most important step is accurately defining and uncovering the true amount of profits that the business will generate for a typical buyer of the business. This will enable the valuation to reflect the true value of the business, and will enable the buyer to get the true picture of the income that they can expect to derive from the business.
First Step to Value Business Properly: Determine EBITDA
The term EBITDA refers to earnings before interest, taxes, depreciation, and amortization. The purpose of using EBITDA is to get a better picture of a company’s real earnings by stripping out non-cash expenses, taxes, and the costs of debt or capital equipment. If the business is sold debt-free (usually the case), then EBITDA will more accurately tell a buyer the real cash flow of the business that they reasonably expect.
An Example to Determine EBITDA
- Bill’s Cabinet Shop has $200,000 of taxable net income (or pre-tax income on its tax return).
- To determine the EBITDA, one must take this pre-tax income of $200,000 and add-back any interest, depreciation, and amortization expenses that appear on the tax return.
- Let us say that the business incurred $20,000 of interest expenses made toward its vehicle debt.
- Additionally, let’s presume that the business incurred a $10,000 depreciation charge and a $30,000 amortization (which is debt service on loans or long term assets) charge for capital equipment.
- The EBITDA of Bill’s Cabinet Shop is thus $260,000.
‘Owner Benefit’ Captures More Add-Backs and Increases Business Valuation
The EBITDA of the business does not necessarily incorporate the true cash flow for the buyer of the business. In reality, the business also may have paid significant salaries or management fees to the owner of the business (or to family members of the business), and the business may also have paid personal expenses of the owner (and treated such expenses as business deductions in the tax return). These salaries, fees, and expenses are hidden assets that benefit the owner and in reality constitute economic profits to the owner.
Objective is to Determine Owner Benefit for Buyer of Business
The owner-add backs not reflected in EBITDA should also translate into economic profits to the buyer of the business. This is true so long as the buyer does not need to incur costs to replace the owner (or members of the owner’s family). If the buyer will need to replace the owner or working members of the owner’s family, then these replacement costs which the buyer will incur must be deducted from the owner benefit. Often it is a judgment call and one must analyze on a case by case basis whether it is fair to expect a buyer to replace a ‘working owner’ or even working members of an owner’s family with paid employees. If the working owner has a high skill set (such as a working plumber), then it is reasonable to assume that a buyer will not be able or willing to replace the working owner with himself or herself.
Owner Add-Backs Common in South Florida Business Sales
In small businesses throughout South Florida, such accounting treatment or personal owner-add backs is very common and the business owner need not worry that their business valuation will not reflect these legitimate owner add-backs. It is the job of the professional business broker to uncover these hidden assets and incorporate them into the advertised owner benefit.
Example: Incorporating Owner Add-backs After EBITDA Determined
- In the above example of Bill’s Cabinet Shop, the determined EBITDA was $260,000.
- Looking at the tax return more closely reveals other hidden assets that may be used to decide the owner benefit of the business.
- The officer’s salary (paid to Bill) is $100,000.
- Additionally, Bill reveals that he expenses $10,000 of his personal vehicle costs through the ‘Auto Expenses’ category on the tax return.
- Lastly, it is revealed that the company pays a $30,000 management fee to Bill’s wife (who is not active in the business).
- These costs amount to $140,000 and are appropriately deemed to be owner add-backs.
- Thus the true owner benefit of the business is $400,000 ($140,000 of owner add-backs plus $260,000 of EBITDA).
- Note, however, that Bill’s $100,000 salary may not be viewed as an add-back by some buyers if they can not or will not replace Bill’s role in the business.
Deriving the true owner benefit of your business is the most critical step when it comes time to sell your business, and can be a far more complex exercise than one may anticipate. Using the right valuation technique that incorporates owner add-backs along with the traditional EBITDA will result in the fairest outcome for all concerned.
Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.
