Ready to sell? How to price your business

July 7, 2009: 12:13 PM ET

Your true net profit is the number that potential buyers will want to know.

Susie Pemberton, Centralia, Mo.
I live in a small town and own a child care facility. My gross income in 2008 was $126,134. Someone's interested in buying it, and they're waiting for me to give them a price. I understand that I need to "adjust" my expense report for 2008, but I'm not sure what to use for a multiplier. I've been in business for six years, and can see room for expansion in the future. How do I name my price?

By Lenora Chu, contributing writer
Valuing a business is not an exact science. Many factors come into play when you're determining an appropriate selling price.

At its simplest, that price will be based on the economic benefit the business is expected to generate for the new owner.

Start your calculation by determining the "seller's discretionary cash flow," (SDCF), or true net profit.

To arrive at this number, examine your 2008 accounting records to pinpoint your net income, says Terry Monroe, president of the St. Louis brokerage firm American Business Brokers.

To that number, you should add back any personal expenses such as your cell phone, health insurance and travel costs, Monroe says. The new owner may not choose to pay for such things out of the business cash flow. Including them artificially lowers your business's apparent income, and therefore your selling price.

To put some numbers to the calculation, say you have a business that generates $140,000 in gross income. Your cost of goods was $40,000. That means your gross income before expenses is $100,000.

Then, subtract your expenses. Say you have utilities, payroll, taxes, insurance and advertising costs of $65,000. Personal expenses covered by the business, such as a car payment, health insurance, and travel costs, added another $15,000. For such a business, total expenses would be $80,000.

That leaves a net income of $20,000. But adding back the $15,000 in flexible expenses brings the business's discretionary cash flow, the true net profit, up to $35,000.

Once you've arrived at the SDCF, you'll need to determine an appropriate multiplier to arrive at your business's valuation.

Multipliers vary widely for small companies. Factors include the economic issues affecting your industry, the size of your business, how long you've been around, and any risks the buyer might face, says Mark Gottlieb of MSG, a Great Neck, N.Y., accounting firm that specializes in business valuations.

An appropriate multiplier for your industry will likely fall between 1.0 and 2.5, according to Monroe and Gottlieb's estimates.

Thus, an appropriate selling price would be the SDCF times this multiplier.

With an SDCF of $35,000 and a multiplier of 2, a reasonable selling price would be $70,000.

You'll also want to tack onto the selling price the used value of any physical assets of the business, such as furniture or playground equipment, says Monroe.

If you're serious about selling, the best first step is to consult with a business broker or investment bank to evaluate the specifics of your business and determine an appropriate multiplier.

Give us your advice: Check out recent "Ask & Answer" questions.

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