The Little (business) Gem
My parents owned a diner, “Mario’s Little Gem,” for the majority of my childhood and young adult years. 24/7, 365 was how we rolled with the business and it became a huge part member of our family. My dad, an immigrant entrepreneur from Italy, learned quickly through his working years, despite his shortcomings with the English language and a formal education, that by owning his own business, he could engineer his own future and create more security for our family than any corporate gig.
My parents did well with the business and created and built significant value over the years. There was infrastructure, processes, customers, staff and cash flow. Unfortunately, when the time came that they wanted to sell the business to retire, they were desperately lost. “How exactly does one sell a business,” they wondered? “Where will we find buyers without disrupting the current staff and day-to-day?” And, most importantly, “What is the business currently worth?”
If you scour a Barnes & Noble or any bookstore for that matter, you’ll see several books on starting, growing, buying, creating and driving a business. Unfortunately, not much information is available on selling a business or valuating what your business is worth to make difficult decisions when the time comes. Could be a reason why only 30% of businesses actually close when put up for sale. Sure, you can hire firms that help with this process yet it helps in determining your own net worth to understand if you’re sitting on more (or less) than you really think with your business.
Valuation Techniques for SMBs
According to the Small Business Administration (SBA), Most people believe that a business should be sold for Fair Market Value. The term Fair Market Value is defined by the IRS at Rev. Ruling 59-60 as follows: “The price at which the property would change hands between a willing buyer and willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.” Following are a few valuation techniques from multiple sources to consider when surmising what your business is worth:
- Book Value This is the basic accounting method for valuating a business. Simply put, book value is equal to the business’ assets less liabilities, or the owner’s equity. Accounting records don’t always accurately account for hard assets so this method can be somewhat suspect. In addition, there are other, intangible, assets to consider such as goodwill, patents, start-up costs and financing that are deducted from assets, that go into what’s called an Economic Book Value, of the business.
- Sales & Profit Multipliers Probably one of the more easy ways to value a small business, sales & profit multipliers are just what they say they are. What’s needed are annual sales and an industry multiplier (not always the easiest to get but doable via financial publications and competitive comparisons of similar businesses that have also sold). Sales multipliers usually range anywhere from 0.25 to 1.00 and profitability multipliers, which take into account pretax profits, range from 1.00 to 5.00. There’s no wonder why this is the most commonly used and easy way to value a business.
- Adjusted Net Income SCORE, the government sponsored non profit organization dedicated to helping small businesses get off the ground, grow and achieve their goals through education and mentorship for over 50 years, defines adjusted net income as all of the profits, owner’s salary and cash-related benefits (i.e. company car, insurance, etc.) enjoyed by the principals of a small business. These cash items sometimes never make their way onto a Profit & Loss statement so it’s important to tally them up when determining the adjusted net income valuation technique. It’s advised, however, that all adjusted net income pieces be those that are officially on the books as a buyer will likely lose interest in a business that has been diverting the IRS for any reason.
- The Market Approach In this approach, supply and demand within the market, determine where the business falls on a price scale at that time. The more money and positive cash flow it makes/generates, the more it is worth. And, the more profitable distribution with few hard assets the company has, the more desirable and in demand it will likely be. In determining the valuation of a business using this approach, it’s important to understand if, when and how much other similar businesses have been sold for. Very similar to the real estate market, the same house can be worth dramatically more or less based on the market’s supply and demand conditions.
- Discounted Cash Flow Valuation Venture Line describes this technique of valuation (more accounting based and difficult to understand for the non-accounting types like myself) as the “small business valuation method best used to conduct a business valuation on an entity established for the purpose of fulfilling a specific project, in certain startup and other companies where cash flow is more important than net income, and when a certain time frame is set where an investor wishes to see his investment returned over a specific period of time. In discounted cash flow, the present value of liabilities is subtracted from the combined present value of cash flow and tangible assets, which determines the value of the business.”
- True Value Once again, similar to the real estate market, the true value of your business is ultimately worth what someone, or entity, is willing to pay for it.
It’s important to structure a deal that is in line with your exit strategy. If you require 100% cash for your business after determining the proper valuation and settling on a purchase price with a buyer, you may expect 60 – 80% of that, in that format (SCORE). That amount is more close to 100% of the purchase price with some cash + financing structure in place. There are other opportunities to consider like delaying payment in order to allow for the building of market appeal under a new owner.
It’s usually the sellers that look at fair valuations and a deal structure that have the most success in selling their business at or close to what it’s worth.
About the Author
Angelo Biasi is General Manager of SMART Marketing Solutions, LLC, a leading full-service integrated marketing company in Florida and New York since 2001. He has helped create and execute marketing plans and integrated marketing solutions for companies such as Playtex, Bic, Rogaine, Tauck, and over 35 colleges and universities, to name a few. Angelo has an MBA in Marketing from the University of Connecticut and teaches Marketing at New York University where he has for over six years. He has been quoted and/or featured in USA Today, Mobile Marketer magazine, Mobile Commerce Daily, Luxury Marketing magazine, BNET TV and Business Currents magazine, to name a few. For more information or to learn more, email him at abiasismartmarketingllccom (abiasismartmarketingllccom) , visit www.smartmarketingllc.com, call him at 239.963.9396 and follow him on Twitter @angbiasi.