Selling your business is probably your end goal after spending years building it into something worthwhile, and if you do it properly it can be the biggest earning event of your lifetime. In fact, for most business owners, that is the case.
However, it’s not a very simple process. In many ways, properly selling the business you’ve dedicated your work life to is harder than building it in the first place. There are so many factors that come into play that you can and can’t control, entire decades’ worth of paper trails to follow and organize, and of course, the market you have to present it to is far more niche than if you were just selling a consumer product. You’re talking about a transaction worth millions of dollars, after all.
So, how do get ready to sell without losing out on tons of potential profit or taking forever thanks to an over-evaluation?
Well, whether you’re looking to sell and enjoy your twilight years, or you simply want to start anew with another business venture, we’ve designed this guide on how to value a business for a sale to go over the entire valuation process in an easily understandable, yet in-depth, manner.
Let’s get started on finding the right price for your mid-market business.
The Discretionary Cash Flow Method
At the end of the day, your buyer isn’t trying to take over because they want a nice building or the title of “business owner”. They want the money you’ve been making without building a business from scratch and going through all the ups and downs you went through to get where you are.
So, a good way to start finding the right price is to look at how much cash your business is bringing in.
Specifically, you want todetermine your Seller’s Discretionary Cash Flow, or SDCF. Your SDCF is the general earning potential your business has at the time of calculation, and it fluctuates regularly as sales dip or raise. So, it’s not a spot-on indicator of the exact value your business has, but it’s a good estimate you can combine with other suitable factors.
Finding out your SDCF is one of the simplest methods to value your business, but it’s only really suitable if your business is owner-operated. If you’ve built a business model that more or less keeps you out of the loop, the formula used to determine your SDCF becomes overcomplicated.
Now let’s get back to the point- how to value a business for sale using the discretionary cash flow method.
To start, you need to determine your company’s pre-tax earnings. These are all the profits the business makes before you pay Uncle Sam. Then, add in your non-operational expenses. These are things you pay for besides the cost of tech, payroll, and other things you must-have for the business to operate.
Now, add in your compensation as the owner, any interest payments you might be making for business operations, and oddball business expenses that have been necessary for operations but not usual occurrences. That includes things such as expenses you made to offset depreciation.
You probably have a fairly large number at this point, but you’re not finished. Now, it’s time for subtractions.
It’s easiest to start with the odd one-time bursts of income you get that don’t reflect your business’s normal performance. This can be something like selling a superfluous piece of machinery, selling more of an item for a short time due to unusual circumstances such as how toilet paper sold out during the early days of the Covid pandemic, and similar events that don’t truly reflect how much your company can regularly earn.
Finally, take away any income you’ve added that didn’t come as a result of normal business operations. This can be a personal gain that fell under the business’s account instead of your own, donations from the community or other things that boost your income levels despite the business not actually doing anything to facilitate it.
Once you’ve done this, the resulting number is your SDCF, and it’s a good starting point to value your business.
The Multiplier Method
The multiplier method is slightly more complicated than the previously mentioned cash flow method, but it’s far more flexible and can be used effectively regardless of whether your business is owner-operated or not.
As the cash flow method, this method uses your company’s earning potential as a base, but it then multiplies that base number based on the average figures produced by your industry. Instead of just showing what you’re specifically making, it takes into account what can be made based on how other companies in your industry perform.
For this, let’s say you run a retail company that sells general merchandise. First, you’ll add your gross sales figures to the value of your existing inventory, and that will be your base number.
Then, you need to do some in-depth research into the industry your business is a part of to find out how much a company selling your type of merchandise, and operating how you do, is making on average.
The good thing about this method is that there are plenty of organizations doing the research for you. A simple online search and a few charts from trading magazines, market evaluators, or broker resources will give you the exact numbers you’re looking for. However, you should probably look for multiple sources just to compare your findings and ensure you’re getting an accurate figure to use.
Once you have both numbers, you simply multiply the base number by the industry average, and you have a general value for your business.
However, you should keep in mind that this method is not perfect. While your sales figures and inventory value are great measurements of your general profitability, there are other factors that may make your business more or less desirable; thus, affecting your asking price when you go to sell. This method doesn’t have the flexibility to take those factors into account, and you might end up short-changing yourself to the tune of several million dollars.
For the best results, consider using this in combination with other valuing methods to get a more accurate depiction of an ideal asking price.
The Market Approach Method
Finally, we’re at the last main method for valuing your business for sale. This can potentially be the most complex method you use, but if done properly, it can be the most accurate way to determine a realistic sales figure.
So, how to value a business for sale using the market approach method? In short, this method requires you to look at similar businesses that have already sold within a fairly recent period, and then base your asking price on that information.
However, getting ahold of the information you need, and getting enough information to make a valuation, can be extremely difficult.
Mainly, you want to look for businesses that are the same size and offer the same things. If you’re a mid-market $5M+ business that specializes in selling fishing equipment, you want to look at mid-market fishing retail stores that sold very recently.
Unfortunately, only the largest businesses tend to be publicly traded in the United States; thus, the figures attached to those businesses are only really known by the people buying and selling them. You can’t just go to an online database and check all their financial records.
When this happens, the best solution is to speak to a market expert who frequently brokers such deals. They have a deep understanding of such companies, and they can compare your business to businesses they’ve recently worked with. This requires you to put a lot of trust into someone else’s experience, but if you find the right partner who provides top-quality M&A advisory services, it’s a reliable way to value your business.
If businesses like yours are being publicly traded, this step is far easier. You can just look up their financial information online and use it to value your own business accordingly. Of course, if you’re at the point where similar businesses are being publicly traded, you’re likely in the high-tier of the business world already and have access to people who will do that for you.
Regardless of how you do this, you want to spend a lot of time viewing as many examples of similar sales as possible to find the average. While businesses may be similar, they may have had one or two different features that greatly lowered or increased their sale price. This is not a method you want to use if you’re just going to look one recent sale up and base your entire asking price on it.
Structuring the Deal Appropriately
This is a tactic that doesn’t work on its own. You need to use one of the actual valuing methods before this is even plausible. However, if you do combine this with something like the cash flow method, and you do it properly, you can ensure that you receive the right amount for your business and even make a bit more than what you estimated.
Once you have a general value and can attract a buyer, it all comes down to how you structure the deal to give the buyer what they want while getting what you want.
Obviously, this means the lowest price possible for them, but the highest price possible for you. That’s a bit of a contradiction, right? Well, yes, and that’s where structuring in a fair way comes into play.
There are several methods for deal structures, and rarely are lump-sum sales the best answer. Instead, there are two options that can maximize your returns and get you more than your estimated value while still giving the buyer a deal they’re happy with:
If you structure the sale around installments, you allow your buyer to pay a specified portion of the overall amount in regular intervals, and after a certain amount of time has passed, they pay a lump sum for the remaining balance due. It’s a lot like a rent-to-own system, and like popular rent-to-own services, you end up making more as the money is stretched out and your tax obligations are minimized. This lack of massive upfront commitment by the buyer is also attractive to them, as they can focus their starting capital on making improvements while paying you much smaller payments.
Operational milestones are a bit more complicated. The buyer pays you part of the overall cost upfront, and then they pay you based on the company’s earnings in regular intervals. This can lead to irregular payments, but it’s attractive to buyers and can potentially add value to the deal on your end.
Choosing the right deal, or having a professional aid you in this step, is crucial. If you mess up, the entire valuing phase can be made null and void.
Streamline Your Business Valuation
The sale of your business is not something to take lightly, and it’s definitely not something you want to mess up. For almost every business owner out there, the day they sell the culmination of all their hard work is typically the most profitable earning event of their life. What was once annual five or six-figure earnings finally blossoms into a multi-million-dollar deal that can set you up for a very comfortable retirement.
However, if you perform your valuation wrong or improperly structure the deal, you can lose out on millions with knowing it until it’s too late.
This is why you need professional help of business valuation expert that specializes in business sales.
IAG is the professional team of M&A advisors you need. Our team specializes in facilitating every part of the selling process for mid-market businesses that have too much to organize on their own but also don’t have the resources of the country’s top-performing businesses to simply have in-house professionals do everything.
We have helped sell hundreds of businesses just like yours while ensuring they receive the true worth of their business without spending years trying to find a buyer or fiddling with complicated valuation formulas.
IAG M&A Advisors is a business intermediary consulting firm, facilitating the buying & selling of businesses. With over 100 years of combined experience, the IAG team has been a leader in the industry by helping the owners of privately held companies “cash in” on all their hard work and get the best payoff possible.
We are here for you if you have questions about selling, and ready to help you get started when you are ready.
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