9 Steps to Valuing Your Business & Preparing for Sale
Recap from the last issue:
Only 20% of all businesses end up selling.
72% of business owners don’t have an exit plan of any kind
The first step to selling your business is to determine a true value based on numbers and circumstances, not fairy tales and wet dreams.
1. Gather 5 years of tax returns. Yes, that’s kind of a lot but it will paint the most accurate picture, especially now. The Hard Core Covid Years will be in the middle of that 5-year span.
2. For each year, calculate the EBITDA. Earnings, before Interest, Taxes, Depreciation and Amortization. (Don't panic! All these can be found on the tax return.)
SIDE NOTE: Use tax returns and not financial statements printed from the bookkeeping software.
3. Calculate the weighted average of these five years of EBITDAs.
Weighted average means some years are more important, and therefore given more weight, than other years. In this case, the most recent year will have the highest weight, a weight of 5, and the oldest year will have the lowest weight, a weight of 1.
4. Multiply that weighted average number by two factors, called multiples. I usually use 2 and maybe 4, 5 at the highest, unless we’re talking about something like a software company.
This will provide a reasonable value range for a typical small business. For frame of reference, of all the companies sold through BizBuySell.com, the average multiple is 2.59. I chatted with an older M&A gentleman earlier this year. He buys manufacturing companies in small town Midwest USA and he usually pays about 4.5 times EBITDA.
Clear as mud now? If you would like a copy of the spreadsheet used for this calculation, just shoot me a reply and I’ll send it over😊
Let’s cover a few definitions.
a. EBITDA is a true profit number that removes tax deductions due to factors that business owners have discretion over, such as debt financing, capital structure, and method of depreciation for example. EBITDA is typically used for somewhat larger businesses that are operating with an outside general manager
b. SDE is seller’s discretionary earnings, or the total financial benefit that a full-time owner operator would derive from a business on an annual basis. This is kind of the same thing as EBITDA, for smaller businesses. SDE may include the owner’s pay, health insurance, cell phone, and auto expenses that are being run through the company.
c. Multiple- the value of a company is often expressed in terms of a multiple, and this would be a multiple of profit, or seller’s discretionary earnings or EBITDA. In real life, I may be interested in buying your business. And because I’m familiar with your industry, and I know exactly how I’ll be financing it, I may be willing to pay a multiple of 3. You’ve presented your average profit as $800,000 so you’re excited to think I’m going to pay $2.4 million. But as we go through due diligence, I determine that my opinion of your average profit is more like $725,000. I’m still willing to pay 3x, but now that amounts to $2,175,000
d. And one of the reasons we may not agree is Addbacks. We’ll chat about these next time, plus a whole lot more!
