By Glen Herman, Business Intermediary, Creative Business Services
We often discuss the importance of clean and accurate financials when running a business or positioning it for sale. To properly value your business, you will need to have 5 years of financials (specifically, the Profit & Loss Statements and Balance Sheets). While the financials will help determine the baseline of your value, they may not reflect the potential pricing of the business in terms of what the market is willing to pay.
We often see “rules of thumb” and see calculators on the internet when it comes to the value and pricing of businesses. These are often based on a multiple of revenue or income but inevitably fail to consider some key components that will leave money on the table when you exit your company. The reason is simple, they often fail to account for the personal use items that can be added back to earnings (cell phones, autos, etc.) and, also fail to consider the market forces that impact value (scarcity of labor, geography, availability of capital, etc). We will discuss a few of these methods and considerations:
Multiples of earnings: While these are typical starting points for the value of a business, there is a lag time between the data reporting of business sales across the nation, and the valuation of a business at a given point in time. We have seen an increase in multiples since 2021 in several sectors. Although these multiple changes do not represent dramatic shifts, having an in-depth understanding of the market niche clients are in can have an impact on value. Think about the difference between a multiple of x3.5 and x4.0 would do to a business with earnings of $500,000/year. “Rules of thumb” in the case of multiples are not the most effective means of determining value. They really need to be considered by a valuation and pricing specialist.
Scarcity of labor: There are occasions where a buyer is looking to expand market share or grow into a specific territory but is constrained by labor. This can mean a potential value proposition in terms of sale value. Labor can be a large barrier to entry for competing firms to enter your market. If you have a well-trained and professional team, there is value there. A firm’s greatest asset is often times it’s people!
Geography: For well established companies (not in terms of longevity but in terms of market share) that have 90% market share in specific communities, geography can be a barrier to entry for competition. If demand for entrance into a specific geography is desired by the market of buyers, a premium may be available in terms of pricing of a company.
Buyers-test method: This is a determination of value that provides the value based on what traditional lending sources are willing to lend to a buyer to purchase a business in a particular industry of a particular size. While this approach takes into account traditional financing, it does not look at creative deal structure, like owner financing and earn-out provisions. This is often the consideration of value that individual buyers will focus on because they are using traditional lending. A business broker can help add value to the sale through creative deal structure to maximize seller value.
When considering the sale of a business, a professional business broker sets a sale pricing with their clients based on the determination of financial value, market value, and market appetite. While the process of setting a price begins with the valuation, the process of positioning a business for sale often starts years before. An early result will almost always result in a higher sale value!
If you have any questions regarding the sale of your business, please call or email me today!
Glen Herman | Business Intermediary
Creative Business Services / CBS-Global LLC
Business Brokerage | Mergers & Acquisitions | Consulting