Business valuation is a vital part of the selling process. Just as a business plan must be drafted before starting a business, so an owner who wishes to sell needs to determine a realistic value of the business. The valuation needs to be accurate and based upon actual data, both within the business itself and the business market.
Having a professional by your side is key. Competent business brokers know the rules and methods to accurately value your business.
Typically, a broker will determine a business valuation by the seller discretionary income method or the market analysis method. The most accurate and broadly accepted method involves finding the discretionary income of a business and multiplying it by an industry specific figure to find a business value.
Seller Discretionary Earnings Analysis (SDE)
What is the seller discretionary earnings?
In short, it is the “actual” cash flow to the owner of a business. A business will show a net profit if it is making money, but that number is not a real picture of how much the owners are really making. Of course, this is because business owners wish to minimize taxes. So an SDE analysis looks at the real numbers – adding back into the income items such as owner salary, expenses incurred by the owner but run through the business, and personal perks provided to the owner. Non-cash expenses, such as depreciation, are added back. Amortization and interest are added back. Any “one time” expenses (legal fees, i.e.) are added back.
The sum total of these figures is the seller discretionary income. This number is then multiplied by another number, called a multiple, which is normally between 2 to 4. The total valuation is the SDE times the multiple.
The whole idea is to arrive at the real cash flow of the business. Business buyers need to know what they will actually be making when they take over, and SDE evaluation, or normalizing income, gives them this.
Market Comparables Analysis
There are several sources providing updated records of what businesses in various categories are selling for. Different industries have different rules for valuations. A manufacturing company, for example, is valued differently than an online swap and sell. The rules are different because the manner in which money is made is different. It is more than just how many dollars were generated in a year’s time…there are many other factors.
Businesses in a declining industry tend to sell at lower multiples than businesses in a booming industry, all else being the same. Businesses which rely heavily on expensive equipment are valued differently than those with little to no equipment.
So when a broker provides a valuation of a business, he or she will likely consult a trade journal or other resource to find out what the average business in that particular category is selling for. The broker will make adjustments based on niche, location, and volume. Then he will compare that data to the valuation determined on SDE and come up with a broader, more rounded estimate.
Contact Centurion 7 today to obtain a professional valuation of your business!