How to Value a Small Business for Sale or Purchase
Selling a business is not an easy task. You have to find a buyer, fill out tons of paperwork, and make sure your business keeps running. One of the hardest parts of selling is picking the right asking price. Ask for too much money and it’s likely nobody is going to seriously look at your business; asking for too little money means you may lose out on profit.
Figuring out how to value your small business for sale requires understanding what assets you will be including, how much money you are currently making, and the amount of profitability the new owners could get in the future.
The easiest and quickest way is to use a business broker familiar with your industry. They can help pick the right way to value your business so you can get the most money out of the deal. The downside of using a broker, though, is that they will take a percentage of the sale.
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How to Value a Business Yourself
In order to find out the value of a business, you will need to gather up how much money it makes yearly and how much different assets are worth. That way, you can determine how much money a buyer can expect and what kinds of assets they will be purchasing with the business, and get paid for all of it.
A good way to figure out a business’ value is to figure out how profitable it is (Seller’s Discretionary Earnings or SDE) then multiply it by how valuable the company will be in the future (SDE multiplier), and then add in any assets that will be purchased. You subtract any liabilities or debts that will accompany the business, and the result is a good total business value.
By looking at a company’s financials, you can determine how much money they are currently earning, how much of that translates to profits, and in turn figure out how much money you can make in a single year. By analyzing those numbers, it becomes possible to place a price on a business and give financial reasons on why somebody should make the investment in purchasing it.
A company’s cash flow shows how much money they have coming in, and also what kind of expenses they have to pay. It’s good to start with cash flow as it will be the base for figuring out the company’s SDE.
Seller’s Discretionary Earnings (SDE) and SDE Multiplier
One of the best places to start when figuring out a business is to look at the seller’s discretionary earnings (SDE). SDE is calculated by looking at the business’ pre-tax earnings before taking out certain kinds of expenses including: owner salaries, company perks like company car or travel fare, one-time expenses, charitable donations, and leisure activities.
Basically, a SDE gives a buyer a snapshot of how much money the company pulls in and what kind of regular expenses they would have if they took over the business tomorrow. Find a flat rate by looking at a company’s SDE on a yearly base to start.
Then, utilize a SDE multiplier to find out of how to buy or sell the business for. The buyer isn’t just purchasing the business for a year, but for the long term, and the multiplier makes sure the seller gets paid for that future revenue.
Businesses typically sell for one to four times their SDE depending on a variety of factors. Major influencers on how many times you multiply your SDE are:
- What industry your business is in
- Company size
- Tangible and Intangible assets
- Geographic and industry trends
- Company’s independence from owner
The better off your business is in these areas, the higher SDE multiplier you can have, and the more money your business is worth. If the future of your company looks bright and the owner can walk away without ruining the business, the multiplier is higher.
ROI and Potential Profitability
A buyer is going to want to know how much money they can expect back on the investment from buying a business. It’s understandable, especially if they are dropping hundreds of thousands, or even millions, of dollars on your business.
First, look at the last few years of ROI (return on investment) for the current owner of the business. How much profit did they earn and has it grown from year to year? If it’s an upward trending graph, continue that trend at the same rate and see how much profit you can earn in the next five to ten years.
It’s also important to analyze the future of the industry as well. If there is money to be earned, you can expect increased competition, which can lead to decreased demand. If other similar businesses are going out of business, that potential profitability might be lower.
Calculate the Business Assets and Liabilities
There is more to your business than simply money coming in and out though. Assets and liabilities can play a major part in the worth of a business and much be considered. Assets add to the overall value, while liabilities lower it.
Depending on the size and type of business being sold, assets can play a major role in the value of a business. For example, a company that utilizes heavy machinery to make their products highly value these assets, as they couldn’t operate without them.
For each piece of asset that will be sold as part of the business, find a proper value for it. A good way to do this is to take the purchase price and find out how long that asset is expected to work. Then, break up the purchase price with how many years it’s been in use and find a current value for it.
For example, say the original purchase price for an asset was $1000, and it is expected to function for five years. Broken up, that is $200 per year. Then say the asset has been working for three years, equaling $600 of value for the machine has been used. That would make the current sale value for the asset $400.
Some assets can’t be valued this way, though. Some assets, like effective marketing strategies or employees, don’t have a purchase value you can use to add to your company’s value. In these situations, it’s smart to figure out the ROI from these assets and use that as part of your company’s value.
Liabilities and Debts
While running a business, it’s common to pick up liabilities, in the forms of debt or other regular expenses that must be paid. Often, a sale won’t go through unless the liabilities is handled by the seller, as the buyer doesn’t want to take over that debt. Some liabilities, like payments to suppliers, are unavoidable liabilities that accompany a purchase.
Buying or selling a business is hard work, but if you do it at the right time, it can mean a lot of money for the future. If you are finding it hard to get the right value, consider getting a business broker involved. They’ll be better equipped to find the right price and help connect you with a buyer. A broker can help you figure out things like your company’s SDE, SDE multiplier, assets and liabilities.
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Ben Allen is a freelance content creator and digital marketer who believes in helping small businesses succeed. He spends his free time bragging about his two daughters, eating stuffed crust pizza, and playing video games.
This post was updated March 8, 2018. It was originally published February 21, 2018.