If you've ever thought of selling your business - and even if you haven't - you may have wondered what your business is worth. Wonder no more. Contact us for a free, no-obligation estimate of the value of your business. Since 1979, we've helped tens of thousands of owners of small to medium sized businesses learn what their businesses are worth.

The Value Pyramid

To understand how businesses are valued, review the Value Pyramid chart above, which represents a simplified framework for determining the value of a business. The four key value factors are:

• Seller's discretionary earnings
• Desirability/ strategic value
• Risk
• Terms of Sale

Seller's Discretionary Earnings

If you're like most small business owners, you've used every legal trick in the book to avoid paying a penny more federal and state tax than you absolutely must. You know that one of the biggest advantages of owning a small business is having the opportunity to use the business to minimize your personal income tax liabilities.
But many Buyers don't understand the way in which the books and records of a small business are used to reduce tax liabilities. And even if they do understand, the books and records of your business will almost certainly require explanation before the Buyer can comprehend what he or she is reviewing. One of the main tasks that VR routinely undertakes is to work with the Seller's records to paint a true picture of the business' money-making capabilities. We use the results to set a price range for the business and to support that price with the Buyer.

The process of making adjustments to the financial statements of a small business is called Normalizing or Recasting. Normalizing or Recasting means working between the lines (i.e., between Gross Operating Profit and Net Pre-Tax Profit) to add back to profitability all of the legally taken charges to expenses that weren't absolutely necessary. The purpose of Normalizing or Recasting is to identify the dollars that are available to the new owner(s) for their compensation and debt service after all necessary expenses have been paid.

The foundation of value, especially in the market for small- to medium-sized businesses, is Seller's Discretionary Earnings (SDE)-the total cash flow benefiting the owner. Calculating SDE is a bit tricky, so it's advisable to obtain the services of a professional experienced in valuations. The approach is to consider not just the net income, but all the recurring cash benefit flowing through to the owner as follows:

Net Income:

+ Owner salary
+ "Discretionary expenses" (e.g., health insurance, optional travel & entertainment, personal use of products)
+ Non cash expenses (e.g., amortization and some depreciation)
+ Non-recurring expenses (or minus non-recurring income)
+ Non-operating expenses (e.g., interest payments, or minus non-operating income)
= Seller's Discretionary Earnings

The purchaser of a business is buying an income stream, and in most cases, a job. The more SDE a business is generating, the more it tends to be worth, although the relationship is not a linear one. As a very rough rule of thumb, a business typically sells for 1.5 to 3 times annual SDE, with the multiple increasing for businesses scoring well on desirability, risk and terms. See the accompanying chart "Business Value vs. SDE". Businesses that are not generating cash can still have value; provided they score well on the other factors and/ or buyers perceive the opportunity to improve the cash flow.




Desirability/ Strategic Value

The next source of value is the "desirability/ strategic value" of a business. Factors in this category include:

• Level of SDE (higher SDEs get higher value multiples)
• Strategic value (primarily for larger and technology driven businesses)
• The fun & ease of operating the business
• Location
• Facilities
• Employee relations
• Operating hours
• Growth potential

Risk

The third valuation factor is the level of risk. Factors in this category include:

• Years in business and with the current owner
• Profit trend
• Quality of books and records
• Franchise membership
• Brand recognition/ strength
• Level of competition
• Dependence on current owner
• Diversification of customer base
• Lease length and terms
• Asset value

Terms of Sale

The fourth and final source of value is the "terms of sale". This is the one source of value that the business seller can almost completely control. Components of the terms include:

• Down payment
• Interest rate
• Monthly payment
• Non compete agreement
• Seller training of buyer

The first three components of the terms of sale assume that the seller is providing financing to the buyer of the business, which happens in the majority of sales. With seller financing, the seller receives part of the purchase price at the time of the sale ("the down payment") and the remainder over several years. The buyer uses the cash flow from the business to pay off the debt. Structuring a sale with attractive terms can significantly increase the value of a business.

Top of Page