Valuing Your Business

What Is My Business Worth?

By Jerry Myers, MBA, CBI

 

If you’ve ever thought of selling your business – and even if you haven’t – you may have wondered what your business is worth.

Since 1979, VR has helped hundreds of thousands of business owners learn what their businesses were worth.

There are four key dimensions of a business, called value drivers, which business valuators consider in valuing a business:

  • The business’ historic Discretionary Earnings or EBITDA (Total Owner Benefit)
  • Its desirability/ strategic value
  • The level of risk that its historic success will continue for a different owner
  • The terms of a possible sale

Discretionary Earnings or EBITDA

The value of most businesses is based primarily on their historic cash flow to the owner, also known as Total Owner Benefit.

For small businesses this measure of cash flow is called Discretionary Earnings (DE).  For larger businesses, EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is the measure of earnings more often used.

The best way to think of DE is that it is the amount of cash a different owner would have had available to them, in whatever year, to do two things – make the payments on the loan taken out to purchase the business, and to pay themselves a salary, had they owned the business in that year and operated it no better nor worse than did the current owner.

The best way to think of the EBITDA calculated for a business is that it is the amount of cash a different owner would have had available to them to service the debt.  A ‘normal’ salary for them has already been removed from the EBITDA amount.

Calculating the DE or adjusted EBITDA of a business is called ‘recasting the financials’.  The task is complex, so it’s advisable to obtain the services of a professional experienced in business valuations to assist with this important calculation. The determination of DE or adjusted EBITDA considers not only the net income of the business shown on the tax return or income statement, but all the benefits flowing to the owner, as follows:

Some possible adjustments to Net Income to Calculate Discretionary Earnings or adjusted EBITDA

  • Wages paid to the owner
  • “Discretionary expenses” (e.g., health insurance, optional travel & entertainment, personal use of products)
  • Non cash expenses (e.g., amortization and depreciation)
  • Non-recurring income
  • Non-recurring expenses
  • Non-operating expenses (e.g., interest payments)
  • Imputed expense for occupancy cost
  • Imputed expense for unpaid employee (e.g., owner’s spouse)
  • Expense increase or decrease due to change in business model

The purchaser of a business is buying an income stream. The more Discretionary Earnings or EBITDA a business is generating, the more it tends to be worth, although the relationship is not a linear one. Most privately owned businesses sell for 1 to 3 times Discretionary Earnings or 3 to 5 times EBITDA.

A Few of the Factors (Value Drivers) Affecting a Business’ Value

  • Amount of Discretionary Earnings or EBITDA (higher amounts get higher value multiples)
  • Strategic value (primarily for larger and technology driven businesses)
  • The fun and ease of operating the business
  • Location
  • Condition of equipment
  • Facilities
  • Employee relations
  • Operating hours
  • Growth potential

Risk Factors Considered by a Business Valuator

  • Years in business and with the current owner
  • Profit trend
  • Quality of books and records
  • Franchise or non-franchise
  • Brand recognition/strength
  • Level of competition
  • Dependence on current owner
  • Management team that will remain in place, if any
  • Diversification of customer base
  • Lease length and terms
  • Asset value

Terms of Sale

  • Does the business qualify for SBA financing?
  • If not, the down payment, term of loan, and interest rate on a seller note
  • Non compete agreement
  • Training seller will provide buyer at no additional cost

Structuring a sale with attractive terms can significantly increase the value of a business.

Copyright: VR BUSINESS SALES, Springfield-Branson MO office

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