An experienced business broker has two jobs. The first is to help you determine a price for your business that will net you the most value. The second is to find qualified buyers and structure the best deal possible.
Here’s what goes into determining the sale price.
You may have heard that your business will sell for “net times a multiple,” so let’s start with what the “net” is in your business. There are a couple of common definitions. Your franchisor may use EBITDA as net. That’s an acronym for Earnings Before Interest Taxes Depreciation and Amortization.
We use another common formula to get Seller’s Discretionary Income (SDE.) Seller’s Discretionary Earnings is a calculation of the total financial benefit a full-time owner and operator would derive from their small to midsize business on an annual basis. SDE is calculated using the business’s net profit from income tax returns plus depreciation, amortization, interest, non-operating income and expenses, non-recurring income and expenses, and the owner’s or manager’s compensation.
You might also hear that your business price will be based on a percentage of revenue: “Joe’s franchise sold for 80% of the annual revenue.” I always like to use the example because it helps make sense to sellers: we could have two stores both generating $1M in revenues; one nets 200k; the other nets 50k. Almost never will they sell for the same price.
Once we have our number, we start to calculate the multiple we’ll be using. The most useful data in determining multiples is obtained by looking at previous sales of comparable companies. We compare franchises with similar revenues and similar SDE to make sure we’re comparing apples with apples. That’s part of the value a business broker who specializes brings; we are experts in the industries we work with.
Other things influence the sale price. For example, the condition of your equipment, your facility, and how much of the business will need improvement or upgrades soon. Buyers will factor in how much they’ll have to invest after the purchase when they make an offer.
Your geographic location will also be important to the number and quality of offers you receive. In the end, a buyer is buying a cash flow, and the value of that varies with location. The cash flow must cover the debt service and the salary of the owner or manager. Most buyers and lenders also want a 20 to 25 percent cushion beyond that figure so they’ll be covered if the business starts to decline.
You can see why your location can play a big part in how many buyers will be interested. A $250,000 cash flow will go a lot further in suburban Florida than it will in downtown San Francisco. We advise the buyers we work with to focus on the cash flow number, rather than the price.
Finally, an experienced business broker can help you understand the full impact of your sale price and what options you have. For example, you might want to accept a larger offer that provides a benefit over time rather than a one-time cash windfall. Your broker can help you evaluate risk and calculate the cost of money. We advise our sellers to look at more than just the top-line offer number.
Knowledge is power. Understanding how buyers determine the value of your business will help you get more comfortable with the process of selling your business. If you’re contemplating a sale, The first step is to see what your business is worth.