How A Business Is Valued

How A Business is Valued

by North American Alliance of Business Brokers

www.naabbonline.com

GUESS WHAT: “It’s what the owner wants” IS NOT a viable explanation from
business brokers to how their businesses for sale are priced. Ask the business
broker or seller for a detailed explanation of how it was priced. If business
brokers or sellers decline your request on their businesses for sale THEN GET
AWAY!

Too many business brokers do not do ANY due diligence in pricing their
businesses for sale and most sellers do not have any concept on pricing a
business to sell. IN ADDITION, “my accountant told me” is also not a valid
reason because an accountant places a hard value on a business NOT a market
value as is needed when selling a business.

There are many models used by business brokers in placing a market value on
businesses for sale. In some form of the analysis, a cash flow (true profit) and
true gross sales figure needs to be determined. If real estate is involved, it should
be added in as a separate figure.

The following independent pricing models are widely used by business brokers
and accepted throughout the industry – it is also easily verified (not including real
estate)…

• Cash Flow x Industry Multiplier usually 2 – 4 ( cash flow is the bottom line
+ all unnecessary expenses added back into the bottom line) depending
on industry and growth.
• Cash Flow x 1 – 3 + all equipment and inventory (depends on industry &
growth)
• 70-100% of gross sales for retail or manufacturing related businesses
(depends on cash flow)
• 60-80% of gross sales for food related businesses (depends on cash flow)
• 30-60% of gross sales for service related businesses (depends on cash
flow)

Look past gross sales multipliers as they can be misleading.

If you encounter a detailed and confusing market value formula from business
brokers or sellers then we suggest stepping back because an old ploy by some
business brokers is to complicate a formula to where a buyer gives up and trusts
the business broker or seller. If a business broker can’t give you the cash flow
and gross sales values then move on.

Too many business buyers concentrate on gross sales without proper knowledge
of the basic operating expenses to profit on businesses for sale (cash flow).
Cash flow is the true profit of the business and you should demand that the
business broker show you the cash flow and how it was derived from the tax
returns and/or other financial statements.

Cash Flow – not gross sales – determines the profitability of the business.
What is Cash Flow?

Cash flow is profit before taxes. It is what the owner is truly making. Cash Flow is
determined by taking the Net Profit or Loss from the tax returns then “adding
back” to the Net Profit or Loss any non-essential, non-business related or paper
expenses (amortization, depreciation and interest). There are additional “add
backs” like one-time expenses or payroll expenses on an employee no longer
with the business – just to name a couple.

For example – we have a fictitious business named Widgets Inc. In looking at
their latest tax return we see that it has a Net Profit (bottom line) = $68,787.
In looking at the expenses on the tax returns we automatically add back to the
Net Profit or Loss…

1. the $6,424 Depreciation expense
2. the $3,178 Amortization expense
3. the $1 674 Interest expense

In looking at the expenses on the tax returns we then question the seller and
determine the following…

A. the $12,676 expense for “insurance” was all personal on the owner and
wife
B. the $18,900 expense was a one-time expense for redesigning the interior
C. the $5,323 expense was for the owner’s personal vehicle not made part of
the sale not needed to operate the business.
D. the $4,568 expense was for his yearly dues at the country club – obviously
not needed to operate the business.

So in determining the cash flow…
* Take the Net Profit = $68,787
* then “add back” 1-3 above (cumulative $11,276)
* then “add back” A-D above (cumulative $41,467)
_______________________________
TOTAL (Cash Flow) = $121,530
So while the tax returns showed a NET profit of $68,787 – the actual profit (cash
flow) is $121,530.

The business broker or seller should show you the exact cash flow analysis like
above! And the business broker should show you the actual expenses from the
tax returns. Don’t assume anything – ASK them to show you ALL supporting data.
If you hear terms like EBIT or EBITA and don’t understand it – Don’t panic. Here
is a simplified explanation…

• EBIT (Earnings Before Interest and Taxes) – Cash Flow Above less
Interest
• EBITA (Earnings Before Interest, Taxes and Amortization) – Cash Flow
Above less Interest & Amortization
The EBIT for Widgets Inc above would be $119,856 (cash flow less the $1,674
Interest Expense)
The EBITA for same would be $116,678 (cash flow less the $1,674 Interest
Expense & $3,178 Amortization Expense)

What You Should Be Prepared For

Being Qualified – unless you have 100% cash to buy a business, you will need
either seller financing or lender financing. If financing is needed at all then the
general rule of thumb to follow is that you will need relevant experience in that
type of business (or self-ownership), have at least 20% cash of the overall asking
price to place down and you have good to great credit (credit score of 650 or up).
To determine the price of a business you can afford – take the amount of cash
you have now to place as a deposit then multiply by 5 times that. This will be the
maximum you can spend on a business.

To determine relevant experience – draw up a professional resume on yourself
for the last 3- 10 years or more. A lender will want to see this – but now consider
any field where you have at least 3 years experience in the last 10 years may
apply (3 of the last 5 years is optimum). Relevant means just that – retail is retail
whether it is a liquor store or convenience store. If you have extensive and
successful self-ownership experience then this may apply as relevant experience
in most types of businesses.

To determine your credit score, use one of the credit reporting services like
freecreditreport.com to determine your credit score. NEVER leave a credit report
with a broker or seller unless you authorize a release to them – in writing.
Be prepared to work hard on buying a business while experiencing various
pitfalls that may seriously stress you. There is no perfect business to buy so the
work involved in buying a business is intensive and full of legal issues and
agreements.

Business buyers who try to buy without representation and documentation
eventually find that they get in too deep into areas where they have no
knowledge or experience. At this point the buyer may be in a position to lose
deposits as the deal falls apart.

So make sure you have an attorney and accountant on call to assist you.
Next you should be prepared to place reasonable offers. The reality is that full
offers would be nice but owners understand that offers may come in for less. The
owner will almost always consider all offers – if they are within reason.
Next be prepared to frequently meet with sellers. Most buyers are first time
buyers and while they have to be qualified they do experience fears of the
unknown. Buyers are encouraged to meet with sellers – frequently more than
once – prior to placing an offer.

Last is that you have to be prepared to manage in upwards of 20+ contingencies
before and after the offer process. Failure to understand these contingencies will
almost surely result in a damaged or failed transaction.

FAILURE TO BE PREPARED COULD RESULT IN A FAILED CLOSING

Business Buyer Motivation

Finding The Perfect Business For Sale

by North American Alliance of Business Brokers

www.naabbonline.com

Ask yourself the question “If I find what I want, am I prepared to place an offer?”.
You are doing a disservice to yourself, the business brokers and seller if you are
not prepared to follow through. All business brokers and sellers assume that
interested buyers are prepared to make an offer should the business for sale fit
the buyer’s needs or wants. All business brokers and sellers put a ton of time and
effort into preparing for and marketing the businesses for sale. A “tire kicker” (not
motivated) buyer only wastes valuable time better spent elsewhere.

If you were in a service business – would you want a potential client misleading
you? Truthfully, this is how business brokers feel if an unmotivated buyer goes
through the process.

NOW, if you are a motivated and serious buyer, are you properly qualified –
business brokers can help here – to make an offer then follow up on it? Anyone –
including business brokers telling you that 100% financing is possible is LYING
TO YOU!

As a general rule, you will need at least 20% of the selling price on businesses
for sale – liquid cash – to place as a down payment. Next you will need relevant
experience in either the industry in question or in past ownership and/or high
level sales & marketing. Last, you will need good to great credit – generally a
credit score of 650 or higher. If you are unsure about the qualification – contact
business brokers for said qualification. All good business brokers qualify
business buyers before disclosing businesses for sale.

QUALIFY yourself – do you meet the 3 criteria last above – consider getting get a
credit report on yourself that you can show a broker/seller. NEVER LEAVE THE
CREDIT REPORT WITH THE BROKER OR SELLER! Most business brokers will
not require credit reports and/or financial statements but they are good to have in
place when looking at businesses for sale.

General Qualification Rules Of Thumb…

• Some sellers will hold up to 80% on a note AND some will not hold a note
at all.
• Each seller is different – it’s their decision to hold a note – not yours
• Sellers and lenders will want you to have relevant experience and good to
great credit if holding the note or providing a loan
• Some sellers or brokers will want a deposit before disclosing financials –
DON’T DO IT! It’s an old unethical trick by business brokers
• “Liquid Cash” is cash that you can get within 7-10 days.
• Take your liquid cash figure and multiply it by 5 – this is the high end of
what you can afford

Finding The Perfect Business For Sale

Finding The Perfect Business For Sale

by North American Alliance of Business Brokers

www.naabbonline.com

Unfortunately, finding that “perfect business” is a fairy tale. There is no “perfect
business” – and don’t let business brokers or sellers tell you that it is the perfect
business for you. That’s why 85% of all business buyers end up purchasing
something other than that business for sale in which they were originally
interested in. All business buyers have a general idea on what they want or need
but these general roadmaps are littered with potholes and detours. It’s best for
you to accept the fact that the “perfect business” and the business for sale that
you buy will be different.

We are not saying that if you want a Laundromat you will never get a Laundromat
– rather we are saying is that the dream Laundromat in your mind will never
materialize. A business for sale will never live up to your expectations because
it’s human nature to adjust expectations before they are met. If you are too finicky
then we can guarantee that you will still be looking 10 years from now.
We recommend that you look at businesses for sale in areas where you have
been qualified – good business brokers can help in the qualification – and one that
interests you and one that you feel you can make money and grow. Instead of
finding your dream business – develop it from an existing qualified business. This
is where business brokers can help.

General Rules Of Thumb…

• Write your needs and wants
• Determine if you want employees
• Determine how many hours per week you want to work
• Determine how much you want to make from the business per year
• Determine areas where you have extensive experience
• Determine if you want to manage or have a manager in place
• Do you want a “cash” type business
• Do you want a strictly invoice – check type of business

Be Motivated

How To Buy A Business

How To Buy A Business

by North American Alliance of Business Brokers

www.naabbonline.com

Deciding to buy a business is an emotional decision. When looking for the right
business for sale you have to be both realistic and open. There is no “perfect
business” as all businesses have their positives and negatives. There is also no
business that is considered a steal at its price. If it appears to be a steal then
beware – as there may be something negative lurking beneath the facts and
numbers.

Look at the entire business model. Not only should all financial figures be proven
through financial statements but the entire business should be open to you for
review upon acceptance of confidentiality documents and rules. But there are
certain business related items that are not at your disposal. For instance,
customer names, supplier names and employee names are not something you
should ask for. In addition, you should have no contact, visitation or any other
communication with that business without the approval of the business broker or
if no broker then the owner.

Some things you should ask for include the complete financial history up to the
last 3 years – if owned less than 3 years then adjust these requests accordingly.
You should also be given asset values including individual values of equipment
and inventory. It is also valuable for you to ask where the increased potential
rests in the business. Even though a value can’t be placed on potential, you
should look into the business’ potential for one main reason- DEBT SERVICE.
Debt service is defined as “Cash required over a given period for the repayment
of interest and principal on a debt.” So while potential should not be part of the
price of the business, you should look at potential when considering the
increased debt service associated with the business loan that you will most likely
need to complete the purchase. To keep the current annual cash flow – and
hopefully increase it – the potential of a business should be a key focus. If the
potential is unrealistic or does not match possible debt service then either adjust
your offer or simply walk away.

NO POTENTIAL = NO FUTURE

Look past the present and into the future but don’t pay for this trip!
The business also has to work for you. When looking at the business model you
have to consider the owner hours worked and possible increased expenses in
hiring to replace some of these hours. Replacing these owner hours with a
manager DOES NOT provide valid reasons to decrease the annual cash flow of
the business – rather this represents expense potential that you should consider
in any purchase.

So if the current owner works it then so can you – and if not then the decreased
cash flow should come from your willingness to take less revenue and not be
reflective in the offer process. In other words – you shouldn’t say “The cash flow
is not $150,000 – it is $120,000 because I want to hire a manager at $30,000 per
year thus the price should be reduced by $30,000”. The business model has
proven that hiring the new manager is now a discretionary expense.
But in the end – the offer IS what you are willing to pay for the business!
BUYER BEWARE – if it looks to good to be true – it is!!!
There is no such thing as a business where the annual cash flow (profit before
taxes) exceeds the asking price. So if you are looking to spend $100,000 and get
an instant cash flow of say $150,000 then you will always be looking. This
business for sale does not exist and if it does on the surface then beware as it
may have other issues playing out.

The median asking price on a business nationwide is anywhere from 1 to 3 times
annual cash flow + hard assets like equipment and inventory. This cash flow
multiplier is eventually set by the industry type and provable annual cash flow.
You may also see higher cash flow multipliers as these higher multiples generally
include the hard assets.

Then there are the gross sales multipliers for pricing a business and other similar
formulas basing the price on gross sales. These median gross sales multipliers
generally range between 33% to 100% of annual gross sales depending on the
type of business. These multiples generally reflect a business that has
substantial gross sales but little cash flow. As a reference, this type of business
will generally have existing cash flow potential through better management of
expenses, employees and time. In other words, the current and existing sales
represent a substantial increase in cash flow through better management.

PRICING METHODS on a business are covered completely elsewhere herein

North American Alliance of Business Brokers

North American Alliance of Business Brokers Mission

www.naabbonline.com

We are trained and certified business brokers. A business broker is hired by a business owner to sell his or her business in a confidential manner to qualified buyers. NEVER any up front fees – we earn it by only getting paid if the business for sale closes. We represent you – the seller – from buyer qualification right through to the closing.

The 8 Main reasons to use NAABB as your business broker…

CONFIDENTIALITYat all times before during and after the sale

QUALIFIED BUYERSby experience, net worth and credit

FINANCE THE BUYERSmore than 40 sources to finance buyers

EXPERTISEfully trained and certified by Broker Service Network

CONNECTIONSaffiliate and networking marketing locally and nationally

NO UP FRONT FEESwe earn our commission at closing

ONLY TAKE SMALL NUMBER OF LISTINGS – the attention that you deserve

ONLY TAKE LISTINGS THAT WE FEEL THAT WE CAN SELLmotivated

 

 

 

How To Hire A Business Brokers

How To Hire A Business Broker

by North American Alliance of Business Brokers

www.naabbonline.com

There are many areas of a contract offered by a business broker that you should be aware of. You should always have a written agreement with the business broker – commonly referred to as a Listing Agreement like real estate.

There are terms and stipulations in an agreement that you should understand.

  1. The exclusivity of the agreement. An exclusive agreement provides that the business broker under contract is the only business broker authorized to sell your business for the time period allotted. Yes this protects the broker but it also protects you. A business owner under Non-Exclusive agreements opens his or herself up for litigation should two different brokers work the same buyer – assuming both brokers have followed proper disclosure processes. More so, a broker with an exclusive will work harder on it than a broker doing non-exclusive agreements.
  2. The length of the agreement. Normal lengths of listing agreements range between 9-12 months. Some agreements can be reduced to 6 months provided there are extenuating circumstances. BEWARE of the business broker offering a short term agreement with a retainer or other up-front fee. This allows them to collect money from you without having to obligate to a long term agreement.
  3. The Fee for selling the business. See # 8 above for a break down of fees. The business broker’s fee is NOT negotiable under typical listing agreements. BEWARE of the broker who offers to negotiate their fee – this type of broker lacks the confidence and drive to sell your business.
  4. Understand and review ALL other contingencies built into the listing agreement. Have the broker explain it thoroughly and – if in doubt – have your attorney look it over.

Hiring a good business broker is the most important thing you can do in selling your business. Like all other businesses, there are good and bad business brokers. You should feel comfortable with who they are and be comfortable with how they have represented themselves.  If they refuse FULL DISCLOSURE – that is they do not provide written materials to back up their services then walk away!

BAD BUSINESS BROKERS CAN DESTROY THE PROCESS

 

Fair Payment To A Business Broker

Fair Payment to a Business Broker

by North American Alliance of Business Brokers

www.naabbonline.com

A good business broker earns their fee through expertise, hard work, networking and sales. They are experts at getting you to close. Reputable business brokers also limit the number of business for sale listings that they take so the fee they earn is well deserved for the time and dedication they put into it.

Each individual business broker has their own fee schedule. Most business brokers charge from 10-15% up to a certain value (contact us for our fee) then decrease this % as the asking price rises.

BEFORE agreeing to this fee – make sure that the broker has outlined for you exactly what they will be doing for you and should include…

  1. Determination of a Market Value for Listing
  2. The listing
  3. Buyer Marketing
  4. Qualify Buyers
  5. Get Qualified Buyers under Confidentiality
  6. Full Disclosure to Qualified Buyers
  7. The Tour with the Qualified Buyer the Business Broker and You
  8. The Business Financial Review to the Qualified Buyer
  9. Due Diligence – Getting Updated Info for Qualified Buyer
  10. The Offer
  11. Offer Negotiations
  12. Accepted Offer
  13. Due Diligence Making Sure All Contingencies Are Met
  14. Due Diligence Making Sure Financing Is In Place
  15. Other Due Diligence Making like Lease or Real Estate
  16. The Closing and Dispersal of Funds

In addition, some business brokers charge a retainer though we do not encourage it. Retainers -versus- No Retainers charged by business brokers – what’s better? Really there is no right or wrong answer when it comes to retainer or “listing fees”. We do not recommend these fees in a normal transaction process though may be used by some brokers in higher value deals.  BUT, we also do not necessarily think that retainers are wrong or unethical.

A Retainer or Listing Fee charged by business brokers should only be used and documented for expenses and services rendered. A retainer should not be used as a revenue source for the business brokers. UNFORTUNATELY, most business brokers charging retainer or listing fees use this fee as their primary source of revenue – this is wrong!

How To Interview a Business Broker

How To Interview a Business Broker

by North American Alliance of Business Brokers

www.naabbonline.com

It is very important that you thoroughly interview your business broker before signing an agreement with him or her. FYI – please do not ask for references as part of the interview as a good business broker protects the confidentiality before – during -and after the sale.

Recommended Interview questions to business brokers…

  1. How does the business broker protect confidentiality and can they demonstrate the confidentiality processes? They should have all written materials including the confidentiality documents to leave with you for review
  2. How does the business broker qualify buyers and can they demonstrate it? They should have all written materials including the confidentiality documents to leave with you for review
  3. What types and how many lending sources does the business broker have that are readily available to finance the buyers? They should have multiple levels of lending sources.
  4. Is the business broker fully trained, certified and supported by a reputable source and can they verify it? This would include a contact person to verify it.
  5. Is the business broker willing to leave you full disclosure materials on their entire process and philosophy? They should have all written materials including the buyer and seller agreements to leave with you for review
  6. How diversified is the business broker as far as networking affiliations to find qualified buyers for the businesses for sale. They should be able to list at least a half a dozen affiliations and networking sources – THESE ARE NOT proprietary
  7. How many listing does the business brokers and their agents take. If it is more than 10-12 listings per broker or agent then how could they possibly give your business for sale the time and resources it needs.
  8. Ask the business broker who they work for – you or the buyer. This should always be YOU unless dual-agency is a requirement (certain Canadian Provinces only)
  9. How does the business broker get paid? At closing – never before – unless you agreed to a legal retainer to be represented.

BAD BUSINESS BROKERS CAN DESTROY THE PROCESS

Why Use A Business Broker

Why Use A Business Broker

by North American Alliance of Business Brokers

www.naabbonline.com

Good business brokers are a trained intermediaries experienced in the confidential sale of businesses for sale to qualified buyers. They usually work for and are compensated by the seller though some brokers do represent the buyer. Some states even allow for dual agency (representation). ASK the business broker who he or she represents.

The benefits to a business owner using a good business broker…

  1. Protect Confidentiality at all times
  2. Qualified Buyer Processes
  3. Financing Buyers through SBA acquisition lenders
  4. Placing top market value on the business
  5. Continuously targeting and finding new qualified buyers
  6. Strategic process to getting offers
  7. Strategic process to getting to close

A good business broker represents the seller from buyer qualification till the closing. The business owner can run his or her business while the business broker manages the entire sales process.

A good business broker is like a sports referee who does a great job – nobody knows he or she is there. The same can be said for a good business broker – they work in the shadows and nobody knows that the business is for sale or sold.

 -Scott Radin

President, NAABB

Business brokers are needed to protect the integrity of a business for sale transaction. Confidentiality is the KEY COMPONENT. A good business broker not only finds and brings in qualified buyers but he or she is also an expert at taking the process from offer to closing.

BAD BUSINESS BROKERS CAN DESTROY THE PROCESS

Don’t trust all business brokers

How To Value My Business

How To Value My Business

by North American Alliance of Business Brokers

www.naabbonline.com

One of the truly confusing aspects of a business owner trying to sell on his or her own is that of what value to place on the business. Such thoughts as “it is what I need to retire on” or “it’s what I put into it” are not methods for determining what a business is worth on the market.

Too many business owners also concentrate on gross sales without proper knowledge of the basic operating expenses to profit on their business (cash flow). Cash flow is the true profit of the business and the asking price should be a variable on cash flow. Cash Flow – not gross sales – determines the profitability of the business.

What is Cash Flow?

Cash flow is profit before taxes. It is what the owner is truly making. Cash Flow is determined by taking the Net Profit or Loss from the tax returns then “adding back” to the Net Profit or Loss any non-essential, non-business related or paper expenses (amortization, depreciation and interest). There are additional “add backs” like one-time expenses or payroll expenses on an employee no longer with the business – just to name a couple.

For example – we have a fictitious business named Widgets Inc. In looking at their latest tax return we see that it has a Net Profit (bottom line) = $68,787.

Automatic “add backs” to profit from the tax returns…

  1. $6,424 Depreciation expense
  2. $3,178 Amortization expense
  3. $1 674 Interest expense

Discretionary “add backs” to profit from the tax returns…

  1. $12,676 expense for “insurance” was all personal on the owner and wife
  2. $18,900 expense was a one-time expense for redesigning the interior
  3. $5,323 expense was for the owner’s personal vehicle not made part of the sale not needed to operate the business.
  4. $4,568 expense was for his yearly dues at the country club – obviously not needed to operate the business.

So in determining the cash flow…

* Take the Net Profit = $68,787

* then “add back” 1-3 above (cumulative $11,276)

* then “add back” A-D above (cumulative $41,467)

_______________________________

TOTAL (Cash Flow) = $121,530

So while the tax return shows a $68,787 net profit – the true profit or CASH FLOW was $121,530. Some businesses will show a loss on their tax returns but a good and positive cash flow.

The actual market value of the business should be determined by using a multiplier of the cash flow + the assets.

If you read terms like EBIT or EBITA and don’t understand it. Don’t panic. Here is a simplified explanation…

EBIT (Earnings Before Interest and Taxes) – Cash Flow Above less Interest

EBITA (Earnings Before Interest, Taxes and Amortization) – Cash Flow Above less Interest & Amortization

The EBIT for Widgets Inc above would be $119,856 (cash flow less the $1,674 Interest Expense)

The EBITA for same would be $116,678 (cash flow less the $1,674 Interest Expense & $3,178 Amortization Expense)

One of the main problems of owners selling their business on their own is that they grossly undervalue their business. This results in far less proceeds from the sale than what they could have gotten by using a professional to assist them.

FYI – back to qualified buyers needing financing (Section 4 above). The comprehensive cash flow analysis to market value is the primary method used by the acquisition lenders to fund the buyers to help a deal gets closed.

There are also Third Party Valuation options to get a detailed value on your business. These valuations can be quite expensive but do provide the most concrete “book” of your business market value.