Mike Rapoport
Gamma Industries, Inc.
Tel. 323-304-5500
|
Free Value Assessment
|
|
We’ll give you a realistic range of value for your company…absolutely free.
|
Brokers Cooperating Agreement
|
| The Right Price – How To Value Your Businesses Worth
|
Correctly Pricing A Business Is Important If You Really Want To Sell It!
As a consultant I talk to many business owners, brokers, and agents on
a daily basis about valuing businesses. It always amazes me on how some
of these individuals come up with the values on small businesses being
sold. No wonder only 30% of all businesses sell! In many instances no
consideration is given to the total picture – like will the available
cash flow of the business be able to pay the debt of a loan, will the
deal as structured or priced even be attractive to financing sources,
“cash” price vs. “note” price and how these factors figure into the
equation!
I have seen many “professional valuations” where the price just doesn’t
make sense – and sellers wonder why their business for sale just sits
there with no action!
Market Approach
There is a solution that is grounded in the fundamentals of economics,
and time tested in the marketplace, where the influences of supply and
demand ultimately determine where a business belongs on the price
scale. One economist explains this market approach by comparing a
business to a machine which has the purpose of making money: The more
money it makes, the more it’s worth. And that explains why, for
example, there is a strong demand for a very profitable distribution
business with few hard assets; and why it is worth more in the
marketplace of available businesses, than a large machine shop that
would cost nearly $1 million to duplicate, but can’t make a living for
its owner.
Adjusted Net Income
The first category of information needed is called adjusted net income,
and is the total amount of cash produced by the “money machine.” It’s a
figure that includes the profits, the owner’s salary and all of the
many cash-related benefits which are enjoyed by the principals of small
businesses. Those benefits can include the use of a company car, the
company-paid premiums for health, life and auto insurance, plus
personal expenditures tucked into travel and entertainment,
subscriptions and similar business “expense” categories. Interest
expense should be added to adjusted net income, along with accounting
entries—such as depreciation and amortization—that can divert money to
the owner’s pocket so that it never appears on the bottom line of the P
& L.
While some of these items vary from business to business, any owner
knows which categories of expenses in his or her financial records
include sums of money that should be added to adjusted net income. Many
business owners also know of cash income that never sees the business
records in any way, shape or form. Some owners feel they should get
credit for these sums in the calculation of value. But it’s a poor
policy to collect unreported income and then attempt to have it
included in adjusted net income for evaluation purposes. When selling,
your buyer prospects want any statements you make about your business
to be supported by evidence in the form of accounting records and other
reliable sources. To admit that you are doing business “off the books”
not only exposes you to problems with the IRS, it also sets a bad tone
with prospects who—if they are going to be interested in your
business-- need to believe your practices and record keeping are above
reproach.
Adjusted net income is usually the first thing any buyer wants to know
about when investigating a business; and not just the past few months’
worth of income. A seller should be prepared to demonstrate a history
of earnings, and have the documentation to back it up.
Multiplier Method
The next piece of the equation comes from the expectations working in
the marketplace to shape the multiplier—a figure which will be
computed, along with the cash flow, to calculate a rough value. The
validity of the multiple is that it reflects behavior in the market.
There is no need to theorize about a proper multiplier. It’s calculated
by determining what people actually pay for small businesses in
California.
The experience with low risk businesses is that their high market
demand is reflected in a fairly strong multiple. A lot of buyers want,
for example, a well-established franchise, or a grocery store with a
long lease in a densely populated area and little direct competition.
Its multiple might be in the range of two to three times annual
adjusted net income.
A one or two multiple, on the other hand, would be associated with an
enterprise in which the buyer is assuming greater risk. An example is a
retail store near a large shopping area, which leaves the buyer of the
smaller business vulnerable to the competitive marketing activities of
much larger companies. The lower multiple is a consequence of lower
market demand. Fewer people want that kind of business.
Since profitable distributorships and manufacturing companies are much
sought after, it’s not unusual to see them command a price upwards of
four times annual adjusted net profit. The company in this category
providing adjusted net profit of $200,000 might realize a selling price
in the range of $800,000, assuming a favorable deal structure (more
about that shortly). Also warranting a high multiple are businesses
loaded with assets—equipment, trade fixtures and inventory. But
remember that a seller must be able to establish the company’s “history
of earnings” with financial reports and tax returns, before the higher
price will be offered.
More commonly available businesses, such as restaurants, are priced
with a lower multiple - in the one to two range - to reflect the
abundance of this kind of business available for sale at any one time.
In this case it’s purely a matter of supply and demand.
And a company in any industry that is difficult to finance, will be
hard to sell. I’m familiar with a retail business in Northern
California that is not generating enough adjusted net income to support
its $1.5 million asking price. Because a new owner would have a
difficult time paying off a loan that was hefty enough to swing a
purchase of this company, there are no lenders willing to provide the
money. That severely affects marketability. In fact, the company is
probably not saleable as presented.
Importance of Deal Structure/Terms
And the final factor thrown into this equation is particularly useful
in determining the value of businesses offered for sale. It recognizes
that the terms of a transaction--in other words, how a price is
paid--are critical in calculating that price. When sellers demand all
cash for their businesses, for example, the market tells us that they
can expect to receive about 60% to 80% of the sum they would have
gotten by taking a down payment and financing the balance.
It’s easy to understand why deal structure is such a vital component in
the valuation process. For a business to be affordable, the cash flow
needs to be substantial enough to support the price at the multiple
being used. A deal that requires a lot of cash up front, in relation to
the expected amount of adjusted cash flow, will place a greater burden
on the buyer. That principle, translated into the language of the
marketplace, means the business will only be appealing at a low price.
If, on the other hand, the level of adjusted net income supports the
buyer’s ability to make payments to the seller in order to purchase the
business—this opportunity will interest more potential buyers and the
result is a higher achievable sales price.
Other ways an attractive deal structure can be used to build market
appeal include a delay of a few months--after close of escrow-- before
monthly payments on the seller’s financing are due to begin, a low
interest rate, and interest only payments for awhile, until a new owner
is able to build the business to more easily meet the loan obligation.
Creative deal structures always help sell a business and will usually
command a higher market price for the business (remember it has to make
sense)!
Pricing a business is as much or more of an art than a science. Sellers
who take a look at the big picture – looking at both deal structure and
price are usually the ones who are successful in selling their
business!
|
|
|
