Using an “earnings multiple” is the most popular way to value small businesses that are for sale.
But that raises a tough question: What number do you multiply your winnings by?
Much of what has been written about multiple valuation states that most companies are sold at a multiple ranging from 1 to 5.
But in truth, smaller businesses selling for 4 or 5 times their profits are rare, at least when it comes to owner-managed businesses.
In smaller businesses with an owner profit of $50,000 to around $250,000, the owner will usually also run the business on a day-to-day basis. The buyer is actually “buying a job.” Their return on investment is much lower because they are not only investing money, but also time.
In larger businesses, where there is enough cash flow to hire a full-time professional manager, the owner can get a return on his investment without a full-time commitment, so the business will be valued at a much higher level. tall. That’s not to say you can’t sell your business for a multiple of 4 or 5, but in my experience the vast majority of smaller businesses sell for much closer to 1 to 3.
So I suggest you start with a multiple of 2.0 and use the list of factors below to adjust the multiple up and down based on your specific situation and your company’s performance.
This is only a partial list to get you started, there are sure to be unique factors affecting your business that are not listed here.
Positive factors that can increase the multiple
*Sales and profits have been steadily increasing each year for at least 3 years.
*A significant amount of sales come from repeat customers. Even better is the income that comes from automatic recurring charges. Web hosting, alarm monitoring, and self-storage are some examples of businesses that can have reliable repeat income each month.
*Products, patents and/or registered trademarks.
*Exclusive rights over a territory.
*Less warranty exposure than is typical in your industry.
*Management and/or employees will remain after sale. The more experienced or exceptionally talented these people are, the better.
*The business is a franchise of a well-established and well-known company. For many buyers, the support and training they receive from the franchisor is a huge advantage, something they are willing to pay for.
*Your industry is growing and the future looks promising.
*Important ratios such as profit margin and cost of sales are above their industry average.
*You are offering above-average financing conditions
For these last two items, you should check with any trade association that serves your industry. They may be able to provide you with data and statistics that can help show the buyer that your business is part of a growing industry or trend.
Negative factors that can decrease the multiple
* Sales and earnings have been trending down recently.
*Sales and earnings have been inconsistent or unpredictable in the recent past.
*Sales of your most important product have decreased or stagnated.
*A customer represents a large part of your sales, more than 20%.
*There are many businesses similar to yours that are also for sale. Or their products are widely available in many places: a “Me To” line of products.
*Business relies heavily on location for success, but lease is non-transferable or about to expire. If this applies to your business, try to get an extension on your lease before you start selling.
*Pending legal or government issues, such as lawsuits or environmental concerns.
*Important ratios such as profit margin and cost of sales are below their industry average.
* A large amount of obsolete inventory.
*The business is part of a weak or disreputable franchise.
* Too many old receivables that will never be collected.
*You are not offering any financing
How do these factors affect the price?
Sellers tend to focus primarily on the positives when talking to buyers.
Buyers, however, tend to focus on the negatives, or what they perceive to be negatives. They are risk averse, so they will always be on the lookout for trouble.
If any of the negative factors listed above exist in your business, you are not alone. Almost every business has some problems and they shouldn’t stop you from selling successfully.
That these problems exist is not the problem, but how you deal with them.
You have several options when it comes to the pain points of your business.
You can lower your price accordingly and show the buyer how and why you’ve discounted your price by lowering the multiple, you can ignore problems and wait for the buyer to point them out, and you can fix things that are fixable.
Or you can do a combination of all of the above.
If you have old or obsolete inventory, get rid of it and take advantage of the loss. The same applies to old accounts receivable. The buyer will not pay you money for these things and they will only help create an overall negative impression of the health of your business.
Other factors, such as a decline in sales in recent years or a customer that represents a large part of your income, are not so easily fixed in the short term. If you don’t have the option of staying in business for another year or two so you can improve these things, you’ll have to adjust the price accordingly.
Finally, there are those elements that you do not control, such as the fact that there are many similar businesses in the market or that you are part of a franchise that is struggling.
I suggest you do not lower your original selling price because of these items. But keep in mind that the buyer will probably mention them at some point, so be prepared to deal with them.
Before lowering your price, first try to offset any of these negatives with some of the positive features of your business. There may be many businesses similar to yours on the market, but if your profits have risen steadily over the last few years or you have a favorable lease that is transferable, you can show the buyer how your business is worth the price you pay. are asking.