There is a simplified method for appraising most businesses. And we are covering it in a five-part series of daily blogs and podcasts. This is part 2.
In part 1, we discussed the need for business appraisals. We noted that they can cost as much as $35,000 for just a normal business! We said that there is a better way for business owners to get what they need.
So, what’s the method?
The short-cut method that would allow anyone to value a business in less than an hour comes from the use of comparable data from businesses that have sold.
1) BizComps,® (available at http://www.bvmarketdata.com/).
2) Pratt’s Stats®, (available at http://www.bvmarketdata.com/), and
3) The Institute of Business Appraisers (IBA) database. (data available only to IBA members)
Pratt’s Stats® and the IBA database have similar, but not exactly the same, earnings definitions for small businesses. In today’s blog/podcast, we’re only going to work with BizComps® definition, but if you use the other databases, beware that there is a difference you will need to adjust for, if comparing data from one to the other.
SDE, the BizComps® definition for small business profitability, is calculated by taking EBITDA and adding owner’s salary.
EBITDA, a common accounting definition of earnings, is “earnings before interest, taxes, depreciation and amortization.”
Technically, SDE also calls for the adding back of all non-cash, non-operating and non-recurring expenses, as well as income taxes paid, but for most small businesses, these are either obvious, inconsequential, and/or illegal for you CPAs out there, and we business brokers, to even know about, so we are ignoring them here.
SDE, or “cash flow to the owner,” is thought to be a more appropriate measure
of earnings for smaller businesses.
EBITDA, when it is used instead, is used mostly to measure earnings of the so-called “mid market” businesses - those with professional management separate from ownership.
What the historical sales data in these databases tends to show is that small businesses tend to sell for between 1.5 and 3.5 times historical SDE, not including inventory and/or real estate.
The data is messy, however, so a multiple of 3x SDE is often used in business pricing. This multiple, which might be a little high for some businesses, is a good starting point for an asking price.
Actually, I would argue that, even though the economy is in a current recession, this value of 3 times SDE is even more valid today as a pricing “rule of thumb” than in better times. The BizComps® average has always hovered around a 2 times SDE multiple, but today, I really think that is going up to 3 times SDE.
In better times, competing investments seemed to be less risky. Stocks and real estate seemed never to go down. Now that we see stocks and real estate decline in value, that actually improves the competitive position of a small business investment, in my opinion, particularly to a laid-off middle management worker, the kind of person who most frequently buys a business!
So, today I leave you with this thought. The value of a small business today is likely to be around 3 times SDE, seller’s discretionary earnings, also known as “cash flow to the owner,” as measured in the BizComps® database.
In part 3 of this blog, we’ll talk more about this and apply some numbers. In part 4, we’ll discuss exceptions and adjustments. In part 5, we’ll summarize and tell you where you can get help with this process.
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