We recently spoke with business owners that wanted to sell their business for $2,250,000. He and his wife had run a very successful business in the Raleigh market for over 30 years and they were ready to retire.
I asked, “How he had come to the $2,250,000 valuation of their business?” They mentioned that they had done some "online research" and found the multiple of “3” on SDE and there you have it --- 3 multiple x $750,000 SDE = $2,250,000.
Unfortunately, the $2,250,000 valuation for this business was incorrect, it wasn’t even close and here is why:
1. Financials – A closer examination of the financials revealed that the most recent financial performance only produced an SDE of $250,000 in 2019. They wanted to use their 2018 SDE of $750,000 because it's fairly "normal for anyone to expect." The owners assured us that this downturn was only an anomaly and that the business should bounce back strongly for the new owner.
2. The Multiple – When the owners did their "online research” they chose a multiple for the incorrect industry. They chose a multiple from a service sector when he and his wife’s business is in the Arts & Crafts retail industry. Business valuation multiples for the Arts & Crafts retail sector use a multiple of 2 on SDE plus inventory.
3. Inventory – The value we were given for their inventory was $80,000. New Math - $250,000 SDE x 2 multiple + $80,000 inventory = $580,000.
Make no mistake about it. A business valuation of $580,000 is very respectable but it was much less than the owners had expected.
We were asked to complete a business valuation for a Raleigh construction company. This business’s growth trajectory had been explosive in recent years.
Over the last three years, the business’s revenue had grown from $3.5 million to $4.6 million to $14 million. The owner’s SDE had grown from $700,000 to $920,000 to $2,800,000. This business has almost the polar opposite growth trajectory from case study 1.
The Business Reference Guide’s valuation multiple ranges from 1.5 – 2.5 plus inventory. The inventory value for this business that we were given was approximately $7 million.
1.5 multiple x $2,800,000 + $9,000,000 = $13,200,000
2.5 multiple x $2,800,000 + $9,000,000 = $16,000,000
It may be tempting to see this business’s valuation being between $13 & $16 million but unfortunately, lenders like the SBA will not view it this way. Because the most recent year is an outlier in growth the SBA will require a weighted valuation over the last three years.
At what point would you want to know that the SBA would not lend money to a buyer to purchase your business? One of the things that helped us greatly is the fact that we work so closely with many qualify lenders.
The SBA will tell you that their job is not to perform business valuations. And while this is true, there are rules of thump that the SBA uses during lending that help guide their decision regarding lending practices.
1. Good Books – In a business sale, the business enters a phase called due diligence after an offer is accepted and contract signed. Some people call due diligence the place business deals go to die.
Small and larger businesses alike are valued on actual financials. These financials are proven to buyers, accountants, and lenders during due diligence.
2. Net Income – Business buyers are asking the question, “If I buy this business, how much money can I expect to make?” Lenders, like the SBA are asking a different question, “Can this business service the debt after it is purchased. Both buyer and lender are going to be looking at your business’s net income to answer these all-important questions.
3. Revenue Trajectory – Lenders will ask for a minimum of the last three years of business tax returns for loan approvals. They are looking to base the business loan on the business’s most recent financial performance.
Business buyers can easily spot trends as well. Business buyers and lenders especially get excited when they see a year over year net income growth. In the end, that most important trajectory number isn’t revenue, it’s net income.
4. Motivation To Sell – We recently helped value a small Raleigh business around $150,000. The owner was semi-absentee and we knew this would be attractive to potential buyers. After we presented the valuation to the owner, the owner declared that he wanted to go to market at $115,000, significantly under our business valuation.
The owner’s motivation was to sell his business quickly. The owner of this business was leaving on a one-year bike trip on his Harley Davidson in mid-April. We listed his business in early January and closed on the business at the end of February. The motivation of this business owner allowed him to shape the valuation of his business in a way that allowed him to accomplish his goals.
Little did this owner or we know that the country would be quarantined in mid-March because of the Coronavirus. He was glad that he sold earlier rather than later.
5. Economy – Recessions, wars, election years and pandemics all impact business valuations. At this present time, we are being hit hard globally with a pandemic that no one saw coming to this extent. Business owners in many industries are struggling.
At the time of this pandemic, our office has close to 40 Raleigh businesses that we are selling. Many of these business owners have contacted us asking us to lower the listing price of their business realizing that something much bigger is now impacting the value of their business.
6. The Owner’s Role – Some businesses would implode if the business owner left their business. These business owners open and close their businesses, they work 60 hours a week, and they hire, fire, and manage all employees. These types of owners have their hands in every aspect of their business.
Businesses with owners like these are valued at a much lower multiple because they may not survive the transition to the new owner. If you want to sell your business you need to know that there is real value in the power of delegation.
7. Business Trends – Vape shops and retail businesses are struggling. Government regulations are hammering Vape Shops while Amazon’s online domination is squeezing brick and mortar retail businesses.
The reverse is also accurate. Digital marketing firms, software, shared office space and service businesses are just a few industries that continue to demand higher multiples.
Hopefully, you can see by now that an accurate business valuation isn’t an easy proposition. With so many considerations and factors influencing the final number, it is best to rely on professionals.
The business valuation is of utmost importance as it drives the potential buyer pool and ultimately lending approval. So much rides on the valuation so it is best to get it right in the beginning.
Many business owners that we meet with have somewhere between 80-90% of their personal net worth tied up in one asset: the company they own. A business valuation will ultimately be impacted by multiples of a business's financials.
All industries are not the same when it comes to business valuation multiples. There are typically three anchors that primarily influence one's business valuation.
There are three commonly accepted business valuations methods: Asset Approach, Market Approach, and the Income Approach.
· Asset Approach – Values the assets of your business minus liabilities. Some of the methods in this approach are book value, excess earnings, and asset accumulation methods. These values usually mean very little to the market value of most operating businesses. For the most part, the asset approach does not accurately represent the value of an ongoing business that has positive earnings.
· Market Approach - Simply defined, this approach is much like a comparative real estate approach. Like businesses in specific industries look for similar valuations. There are databases that we can research to find multiples of gross sales and earnings to compare for your business valuation. This method can be very reliable in most cases and is a strong indicator of true value.
· Income Approach – Your business valuation is set here by placing a valuation on the current income stream. This approach is a strong indicator of what a business positive income is worth.
We represent Raleigh's largest and most profitable businesses. We would love to sit down with you and learn more about your business and provide a comprehensive business valuation.
Knowing the value of your business is the first and best step to take when considering the sale of your business. Many business owners that we meet with have somewhere between 80-90% of their personal net worth tied up in one asset: the company they own.
Our business brokers start with meeting the owner and hearing their story.
Our professional business brokers will need your last three years of business tax returns and a current P&L.
Financials only tell part of the story. There are many other factors that impact business valuations and we want to make sure that we ask all of the right questions to gain an accurate valuation for your business.
Our business brokers will present a business valuation range so that you can best determine the price that you want to set for marketing.
When your business eventually goes to market, remember that it is marketed at a price that you have determined but the price that you set highly impacts the response that your business receives.
Our Raleigh business brokers like to receive SBA approval for many of our listings. Businesses that have SBA pre-approval receive up to 4-times the attention than other businesses without SBA pre-approval.
The businesses that get through due diligence are the ones with good books. Lenders like the SBA will require 3rd party business valuators to conduct their own business valuations to see if the business can service the debt while providing a livable wage for the new owner(s). Can the business's books be their key witness?
A lot of information changes hands during due diligence. Our Raleigh business brokers will prepare you early for the rigors that await in due diligence.
Attorneys, lenders, accountants, landlords and many other people join the conversation during due diligence. Due diligence is nuanced, stressful and tests patience while waiting on important details to pass hands from other professionals. Our Raleigh business brokers have been through this process numerous times and their coaching and calmness during this time is invaluable to the deal getting closed!
Every business owner will some day exit their business.
Business owner's want to see their business thrive upon their departure.
Business owners deserve to profit handsomely at the time of their exit.
It is paramount and wise for business owners to plan their exit strategy.