by Glen Cooper, CBI, CBA, BVAL
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 3.
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 the answers they need.
In part 2, we discussed how we arrived at a multiple of 3 to apply to seller’s discretionary earnings (SDE). What the historical sales 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, and is probably more justifiable today than ever before. This multiple, which might be a little high for some businesses, may not be too high today because competing investments of stock and real estate have suffered lately as comparative investments for would-be business buyers.
In other words, if a small business is providing it’s owner/operator with a salary and many indirect benefits worth, say, $100,000 per year, then that business may well be worth $300,000, or 3 times the annual cash flow to the owner, known in BizComps® as seller’s discretionary earnings, or SDE.
Got it?
At this point, nearly everyone asks questions that begin with, “But what if . . .? or But, what about . . .?
Let’s consider 4 of the most common questions in today’s blog:
1) What if the current owner/operator’s salary is too high or too low? What if a whole family runs the business?
2) What about the value of the furniture, fixtures and equipment? Is it included in the multiple-derived business value? What about the owner’s vehicle?
3) What about the value of the inventory? How’s it calculated?
4) What about accounts receivable? Who gets that?
Before we can properly answer any of these questions, we need to
provide just a little more basic detail on two issues – accuracy of the data and how the 3 times SDE “rule of thumb” is most often used. Then we can tackle some specific adjustments.
When calculating seller’s discretionary earnings, BizComps® uses “the most recent reporting period.” How that data is reported can be inaccurate, of course, but that is really an issue for another day. MOST of it IS accurate. That’s the best we’re ever going to get, in any data base, assembled over many years from many sources.
In actual practice, however, the 3 times SDE “rule of thumb” is often applied to future projected earnings. In the real world, buyer prospects don’t really care about the most recent reporting period. They are usually thinking ahead of what the future will hold for them. What the current owner did last year is not as important as what’s happening now, and what estimates the buyer makes of future cash flows.
Is that the “right way” to do it? We could debate that for a long time.
On the specific “What if” and “What about” questions, let’s try to answer a few here.
Answer to Question #1: For the “owner’s salary,” there is not only the adjustment for formal salary, but also for other owner benefits. To obtain uniformity of the data, there is a requirement of adjusting the expenses back to just one owner. If multiple owners run a business, these adjustments can get pretty tricky.
Answer to Question #2: Within the multiple-derived price, the business’ furniture, fixtures and equipment are included, along with all intangible assets. In most cases, the owner’s personal vehicle is not included.
Answer to Question #3: Inventory and work in process values also need to be added at the lesser of cost or wholesale market price. This is NOT included in the multiple-derived value.
Answer to Question #4: Finally, accounts receivable are most often retained by sellers, collected in the transition period following a sale. They are rarely sold.
So, in summary so far:
BizComps® separates the reported business selling price from the sale of inventory and real estate. If we say, for example, that a business is worth “3 x SDE,” it is because there are many comparative transactions to show that businesses often sell for prices which reflect this multiple.
This “3 x SDE,” then becomes our quickest ballpark estimate of business “value.” We use it cautiously before completing any further homework to refine our estimate.
In part 4 of this blog, we’ll discuss the separation of real estate value from business value, and why and how that must be done in any business appraisal. In part 5, we’ll summarize and tell you where you can get help with this process.
Tags: $35000 business appraisal, appraising a business, BizComps, business appraisal costs, business appraisals, business valuation calculator, business valuation costs, business valuation form, business valuation formula, business valuation methods, business valuations, calculate value business, cash flow to the owner, for sale maine business, formula to value a business, how to value a business, Institute of Business Appraisers, inventory adjustment, maine business brokers, maine businesses for sale, restructuring, SDE, Selling a Business, small business valuation, turnarounds, workouts
[...] Glen Cooper put an intriguing blog post on Appraising A Business in 60 Minutes - Part 3 of 5 | Maine Business …Here’s a quick excerptThere IS a simple way to value a business for most purposes. It can be done quickly and relies on using an earnings multiple. Some adjustments are needed, however. We cover 4 of the 5 major adjustments in this, part 3 of our 5-part … [...]
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