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 5.
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) for a business asking price. 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 why this multiple might be even more appropriate today.
In part 3, we discussed the adjustments that need to be made when calculating SDE. The expenses of the business need to be adjusted back to one owner/operator to make the business sales data we can find reasonably comparative to each other. That has already been done for us in BizComps®. But, we still have to do it for the subject business that we are trying to value.
In part 3, we also discussed that the tangible and intangible assets needed to run the business are included in the multiple-derived value, EXCEPT real estate, inventory for resale, accounts receivable AND, usually, the owner’s personal vehicle. Inventory for resale is valued at the lesser of cost or wholesale, and is added to any multiple-derived value. Accounts receivable are usually collected by the previous owner after the sale and during the transition period between owners, so they are NOT usually sold with the business.
In part 4, we discussed separating real estate value from business value for appraisals that need to encompass both a business and the real estate it occupies.
Because commercial real estate is a different kind of investment, its value is often expressed as a multiple of its annual net operating income (NOI) (gross scheduled annual rent less annual property expenses).
Real estate is different in a couple of important ways. An argument can be made that it is much less risky of an investment than is a business. It also is often owned by an “investor” as a much more passive investment than a business, not requiring the intensive hands-on owner management that a small business usually requires.
This real estate NOI multiplier is larger than a business SDE multiplier. Real estate multipliers of NOI are often in the 8 to 12 range in 2009 in Maine. Small business SDE multiples are in the 1.5 to 3.5 range today.
Finally, the last point in this blog series is to note that we are not considering business debt here in this simplified analysis.
This formula assumes a debt-free business. Existing business debt
obviously must be subtracted from the value estimate to arrive at a net figure for the seller. In addition, if a buyer assumes debt when buying, it is counted as part of the purchase price in this model.
As we pointed out in the first part of this 5-part blog/podcast series, knowing what a business is worth is critical today. Many business owners are trying to figure out what their businesses are worth in this troubled economy.
More than in normal times, they need to know what the business is worth to re-finance, sell in a volatile market, restructure the company, or even to prepare for possible bankruptcy.
Yet, business appraisals are VERY EXPENSIVE.
A business appraisal of the quality that meets today’s appraisal standards takes 40 or more hours of work to produce. At the going rate of from $200 to $400 per hour for accredited appraisers, a business appraisal for most companies will run from $8,000 to $16,000 and up.
The more complicated the company, the more hours needed. And, that’s just for a basic report! It is not at all unusual to talk to an owner who just spent $35,000 on a business appraisal.
Before any business owner goes to that expense, however, it is better to at least TRY to get by with a ballpark estimate using the simplified method we have described in this short blog/podcast series.
If you don’t have to prove value to a bank, the IRS or a court, reasonably bright business people can sit in a room and figure this out, WITHOUT a $35,000 report.
Attached to this blog is a chart that summarizes what this series is about.
We hope you have found this blog/podcast series helpful. There are other helpful business valuation articles on our website.
The "Formula" and relevant considerations for appraising a small business. Does not apply to very large businesses or businesses, like hotels and campgrounds, that are mostly real estate purchases.
