Ready to sell? How to price your business
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, CNNMoney.com 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.
From Kevin, Daytona Beach, Florida It would seem to me that calculating the apparent SDCF would be the most beneficial to do, that is, when even examining the thought of selling an assets. Especially in this economy, the brokerage firm and business valuation company may grade your business with a extremely low SDCF muiltplier; not only driving away the buyers, but you as well. In my opinion, exiting this recession, banks and privitized small capital loan companies are going to be very inparticular on economic conditions from the past.
Like mentioned here before, if not impossible, it will be extremely difficult to get the muiltiplier to a reasonable price, as well as a bank to hang out a business loan; especially, when the business has been or can be affected by the condition of the economy.
From Chris, Omaha NE Yes, but you won't have an established business with staff and kids. Building that from scratch will take time with a whole other set of risks.
From Cal, Deer Isle ME By far the best comment. Most people seeking to buy a business even if it is expansionary seldom have their own cash. With the exception of flamboyant investment bankers looking to generate high fee income no bank will ever loan for goodwill of which a day care is mostly goodwill. On top of which the buyer will need 30% down with few exceptions as well as 3-6 operating cash. If the buyer will be leaving his current job the cash flow will be critical. A smart buyer will look at the number of hours worked at "X" dollars per hour before seeing what the ROI is projected to be. I am an accountant who has bought and sold over 100 businesses and the fact is 90% of sellers far over value the business exspecially when useing a business broker. Unless you are ready to retire or sick of the work you are better of keeping the business
From Dave, Grand Rapids, MI An alternative method of valuation on a day care facility (other than SDC as was fully explained in the article already) is using the number of children cared for. SBA uses a valuation of somewhere between $1,000 to $2,000 per child. Obviously you'd be nearer the lower end of this if you were counting soratic clients, and nearer the higher end if you're counting long-term clients. Realistically, if the buyers need to get a loan to purchase the business, their lender is going to ask them to negotiate a price which can be paid back over 7-10 years at the maximum. Five years is probably a bit more reasonable. This, more often than not, is what your business is worth – not an esoteric valuation derived by highly paid accountants and valuation specialists. Back into a value by using a 5-7 year repayment on the sales price at a market rate in your area. Unfortunately, too many valuation specialists value businesses too highly for skittish bankers, and therefore the business never sells unless you can find someone with all cash. Those folks are becoming harder to find, so assume your buyer will need a loan for the majority of the purchase, and use my method to back into a price. In many ways it similar to SDC, but gives you a better multiplier than the 1-2.5X offered by the writer.
From Daddy, Lexington, KY The $35,000 / year in this example would be the profit. You would pay your salary out of the gross income. The business is a seperate entity and as such would pay you for your services, even if you are the only shareholder. The manager would be included in the payroll.
"Say you have utilities, payroll, taxes, insurance and advertising costs of $65,000."
From ownedmybusiness31yrs, Denver, CO I don't see the value of the owner's time spent at work here. How many hours a week? There is a huge difference in 10 hours a week of purely management expertise to manage a business that largely runs itself as compared to the usual small business owner who is putting in 50 hours a week as bookkeeper, tax accountant, janitor, substitute child care worker, driver, etc. in which case the buyer is really buying themselves a hard job, so investing up to $230,000 to work 50 hours a week for $35,000 a year is not attractive. If we can't put a number to the owner's contribution to the business then we really do not know if it truly is profitable, or not.
From Brad, Myrtle Beach, SC Another thought in valuation might be to determine a reasonable return on investment.
So, if a buyer wanted to see a 15% annual ROI, they might look at $35,000/.15 = ~$230,000.
If you knew you could put away $230k and get a 15% return, would you? Many people would.
Any valuation needs to consider other factors too of course, like the stability of the company; belief that NI will remain or increase over time; growth trends over the past five years; growth trend for the current year; etc.
From Sandy, Newport News, VA So, the sell price would be $70,000 plus the equipment? You could start up on your own for less than that.
From Brad Austin, TX This is the best write-up I've found on evaluating a businesses worth:
http://www.businessbrokers.net/businessvalues.html#basicmethod
I have always valued my businesses at 3-5 times the excess earnings of the company + FMV of the companies assets.
From Rick S., Boston MA They did a good job outlining the example for SDCF.. It's high level, but directional correct.
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.
-
Wireless electricity and invisible speakers -- see what's coming from entrepreneurs in 2010. More -
These 6 businesses took advantage of crashed real estate prices to trade up. More -
These 7 entrepreneurs are bringing tech, medical research and design jobs to the Detroit metro area. More -
Arson. Scrappers. Blackouts. It's part of business for the last tenant in Detroit's Packard Plant. More -
Inventing is the easy part. Marketing? Trickier. Experts tell how they'd advertise 5 hard-to-tout products. More
Is capitalism dead?
I believe your evaluator – ignores the realities of the day – and comes up with a number that will not offend any one's sensitivities except mine.
the number of questions I would have would create a book and may enlighten some – but is not worth the effort. I would rather chew nails.
Capitalism is dead for those that do not know it – and has been dead since 1926 – but the economists choose to call state socialism – capitalism and every body feels better. and my dentist too.