What Is Your Business Worth? (Part 1)

What does the Price Tag say?

When we go shopping for most items in a typical retail store, and even when shopping online, we can easily look at "the price tag" to determine how much the item will cost. However, when looking at buying or selling a business - finding that "price tag" and knowing what the business is worth can be a little more complicated! 

One of the fascinating things we've observed is that when business owners invest in organizing their business, putting systems into place, and documenting the direction their business is headed in a business plan, they inevitably reap dividends! They increase their profitability, increase their efficiency, and increase the value of their business when it comes time to sell!

Which of those three reasons would motivate you to spend some time on your Business Plan? 

In the midst of our daily business routines, it's easy to get side-tracked with things that keep us busy, and to many, it may seem like work is being done. Having an outside perspective take a look at your situation can provide valuable insights and value to your operation!

"Being busy does not always mean real work. The object of all work is production or accomplishment and to either of these ends there must be forethought, system, planning, intelligence, and honest purpose, as well as perspiration. Seeming to do is not doing."    - Thomas A. Edison

Having a business plan can help make sure you're heading in the right direction and have the necessary resources to get you safely to your intended destination!

We can help you with the development of a business plan, or provide you with feedback on one that you've already put together. Working together with you and your team of business advisors, we'll map out a path that will help guide you on your entrepreneurial journey! 

In this post, our friends from Sunbelt Business Brokers take a look at some of the major considerations business owners will have as they give serious consideration to their exit strategy.

This post should be helpful for those thinking 'long-term' towards the ultimate selling of their business.

Thank you in advance for your comments and for sharing this with those in your circle of contacts. We invite you now to enjoy this guest blog post. 

What is Your Business Worth 

Provided by Dale Alton as Part I of 2

Notes: Excepted from “INSIDER TIPS ON SELLING A BUSINESS IN CANADA” by Greg Kells.

This is Part 1 of a 2 part installment on “What is Your Business Worth”. This is a key concern for the business owner and often not well understood. This first installment addresses the importance of a broker’s role in determining the value of your business. Future installments will add a specific business example.

If beauty is in the eye of the beholder, then the worth of a business lies in the eye of the market. The market is really what decides how much an owner will get for their business when they go to sell.

Determining that value, the Most Probably Selling Price (MPSP), is an art that goes beyond straight valuation. You’ll benefit by engaging an accredited business broker with expertise in both. Obtaining a brokers opinion of value before you are ready to sell can help build a roadmap for increasing value and minimizing taxes. The end result is more money in your pocket. A formal business appraisal can also provide the necessary valuation to buy out a partner or split assets in a divorce, for estate planning, an asset freeze for tax planning, or roll over into a family trust.

At Sunbelt, we start by determining Fair Market Value (FMV), using methodology of the International Business Brokers Association (IBBA), the Institute of Business Appraisers (IBA) and the National Equipment and Business Brokers Institute (NEBB).

From the FMV, we determine the MPSP. This calculation represents a reasonable price, factoring the true (recast) earnings past and future, what the market is willing to pay, and the seller’s motivation. With this knowledge in hand, the seller can then negotiate on an informed basis.

• Value is: seen in current dollars, risk-adjusted, not negotiated, but arrived at objectively based on determined value.
• Price is: not time-sensitive and not risk-adjusted, derived from value and may be negotiated.
• Deriving the MPSP: recasting financial statements

The seller’s expectations of price needs to be in line with market reality. Often though, financial statements of small businesses do not reflect the business operations. They are often prepared to minimize the tax burden for the company and its owners. A first step in valuing the business is to recast, or normalize, line by line, the most recent balance sheet and three to five years income (profit and loss) statements. Recasting the financials provides a realistic value of the assets and liabilities, and shows the true earning capacity of the business.

For an owner-operated small-to-medium-sized business, metrics based on income — Seller Discretionary Earnings* (SDE) and Earnings Before Interest Taxes Depreciation and Amortization (EBITDA)—are important factors in determining value.

Benchmarking
Valuations also weigh the fair market value of tangible and intangible assets, and comparable ratios of sold businesses. Working with a business broker who has access to specialized databases and brokerage archives is of great advantage in benchmarking a business against the industry, marketplace and other like businesses.

Business patterns, systems, competition, markets, quality of service or product, staff and operational factors are all predictors of future earnings and need to be taken into account. But first, we need to normalize the company’s earnings starting with the true cash flow from operations, "adding back" expenses considered discretionary, extraordinary, non-recurring, or non-cash.

Discretionary means not necessary to support the revenue of the business; extraordinary means excessive, above normal levels; non-recurring means a one-time expense; and non-cash is usually tied to depreciation.

We also add back interest expense as this is the cost of capital and may be different for the new owner. We do the same with income tax.

Recasting requires rethinking
Although recasting is a standard practice in business valuation, it can take buyer and seller a while to adjust to the concept. A fair representation of the business is essential to both parties.

Sellers need to understand that these are valuation, not tax-deriving documents, and that all things being equal, a better bottom line will lead to a higher business valuation. Without recasting, an owner may understate cash flow from operations, arriving at an asking price that is too low.

A buyer needs confirmation that the adjustments to earnings are real, and validation that the cash flow is sufficient to pay their salary, service the debt incurred to buy the business, build or reinvest in the business, and provide a reasonable return on their invested capital. All must be substantiated to the satisfaction of both parties, their lawyers and accountants at due diligence.

* Note - SDE is net income less: interest; taxes; depreciation and amortization; owner’s compensation (including salary and discretionary expenditures.

In our next instalment we will explore how recasting can find the true value of a business and other factors that affect what your Business is worth.

Sunbelt Business Brokers Edmonton

Sunbelt’s team of brokers, operating at local and regional levels, have experience selling small to medium sized businesses. 

Sunbelt is the world’s 

largest business brokerage firm with approximately 300 licensed offices located throughout the world, 

and 33 offices across 

Canada alone.

More than 1,400 Sunbelt brokers annually coordinate an estimated 4,000 Main Street and Middle Market business transactions.

A variety of strategies are required to sell businesses from different industries, of different sizes, and in different economic climates. Many Sunbelt brokers have specific industry experience and cooperate with their counterparts to identify the buyer and create the right framework for the sale.

Your Local Sunbelt Business brokers sell a diverse mix of main street businesses valued under $3 Million. Mergers and Acquisitions of larger and more complex business transactions of up to $30 Million are managed out of the Ottawa Head Office. We would like to help you plan and look forward to retirement, expansion or an exciting new business opportunity. 

Have you ever thought about selling your Business?

Sunbelt represents clients who may be interested in buying a business like yours. If you are thinking of selling a business now or in the next 3 years, discover what your next steps should be. Feel free to contact our Sunbelt Business Brokers Edmonton office if you have any questions or would like a free confidential consultation. Give me a call. Dale Alton – 780-878-8787 

Sunbelt - The Place to Buy or Sell a Business.

Thank you once again Michael and Dale for closer look at valuing a business!  We'll be posting part 2 for this series next month.

As a reminder, we invite you to consider Pro-Vision Solutions Inc. as a part of your TEAM of business professionals. We bring over 30 years of experience in helping entrepreneurs and specialize in aspects relate to business plan development - particularly for start-up, growth and expansion, as well as funding requirements.. Let us know if that's something you may require, and let's have a conversation! 

Together, we can help you Build your Business Dream, starting with your Business PLAN.

NOTE: For more information on the services provided by Pro-Vision Solutions Inc. and how we can assist ... please visit our Website: www.pvs4u.ca