Small Business – Business Valuation Formula and Example

Business valuation for M&A or other purposes such as divorce, partner disputes, IRS and estate planning purposes are complex formal processes.  What is provided here is a basic rule of thumb business valuation approach useful for preliminary planning for companies with revenues between $50,000 and $5,000,000 and/or owner profit plus owner salary of $75,000 to $500,000 range. 

Do not use the provided business valuation formula for formal final uses such as going to market in a sale situation or legal proceedings etc. without review and approval of a valuation professional.  Many businesses such as contractors, engineering firms, sub-contractors, specialty contractors such as electrical contractors, plumbing contractors, HVAC contractors, landscape contractors, suppliers, retailers, business services, manufacturers and the like can use this business valuation formula.

Want to know more?  Please click here for the downloadable e-book. “7 Things You Must Know Before You Order a Business Valuation” 

A small, owner-operated businesses with an active working owner who performs day-to-day tasks such as sales, production, direct management etc., can be valued using the following formula: 

Owner’s salary plus profits plus expenses benefiting the owner (such as underemployed family member on the payroll; exotic travel to conventions; auto; heath insurance; pension to owner etc.)  plus one-time charges (perhaps a large legal bill in one year only) plus interest plus depreciation and amortization equals the Seller’s discretionary earnings or SDE. 

If you are an absentee owner in a business that is usually owner run,  then you can add your manager’s salary back to the cash flow.  If you have cost advantages your Buyer will not have, subtract these.  Those often involve rent where you own the building the business occupies.  Most Sellers adjust the rent to market cost at the time of the sale so that should be factored into the formula.                         

Some people call this “normalizing” the cash flow.  The idea is to show a Buyer what her normal discretionary earnings will be.  They are called discretionary earnings because the owner decides what to reinvest and how to pay herself.  You can pull many of these figures directly from the company income tax return.  The total is then multiplied by a value called a multiplier.  In most cases the multiplier is 1.5 to 6 with between 2.3 to 2.7 being about average for small businesses. 

 Example of Calculating Value:

Consider this example of Bob Smith who owns Smith Electric.  Bob has a steady base of service work with some new construction mixed in.  Bob has four service crews and still often performs remodeling jobs himself.  Bob makes about $100,000 in salary.  His wife makes $35,000 working one day a week as the bookkeeper.  Bob drives a company truck all the time.  He has health insurance through the company.  He spent $12,000 last year on interest and had $35,000 in depreciation.  Bob runs the business from an office warehouse which he owns.  The business does not pay rent to Bob for Smith Electric’s 2500 square feet of space.   

The valuation math would work like this:

 Salary $100,000 plus excess salary to wife estimated at $20,000.  Plus personal use of truck estimated at $5,000 plus health insurance at $11,000 plus interest at $12,000 plus depreciation at $35,000 minus $24,000 estimated rent.  This totals $159,000.  Assuming Bob has a high percentage of service work which tends to be predictable then his multiplier might be around three.  That would put the value of his business at about $477,000.  If Bob mainly performed new construction work obtained from competitive bids, his multiplier would be around two because of the risk involved in obtaining future work. 

Please note that this is a useful formula for preliminary planning or tracking your progress but is not a substitute for a proper valuation when selling your business.  NEVER go to market or enter into important negotiations or legal proceedings based on a rule of thumb formula such as this.  Get proper valuation assistance.  (Call us).

Gregory R. Caruso, JD, CPA, CVA
Harvest Business Advisors
609-664-7955

gcaruso@harvestbusiness.com
www.harvestbusiness.com

 


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Construction Contractors, Sub-contractors, Engineering, Specialty Trade Firms Growing Fast, Work On Succession Plan or Exit Strategy Now

Construction, Sub-contracting, contracting, engineering, specialty trade contractors etc. are again the fastest growing small businesses.  Owners of these cyclical businesses should start planning for their succession plans and exit strategies while the economy is supporting growth. A time of growth is a great time for mergers and acquisitions, M&A – as either a buyer or a seller.  After the difficulties of the last four or more years now is the time for construction contractors and related engineers, specialty trades, supply houses and the like to both grow and work on their succession plans, exit strategies, and begin the M&A or business sale process.

Cat Clifford, small business expert at Entreprenuer Magazine, says that Sageworks did a study and found the below list to be the fastest-growth industries.

She writes, “Past performance is no guarantee of future results, as the old business truism says. But you also may have heard that you can’t know where you’re going without knowing where you have been.”

Time to Sell Your Construction Business? Please click here to download the e-book, “A Contractor’s Guide to Succession Planning”.

Fastest-Growth Industries for U.S. Small Businesses in 2012

1. Residential building construction: 14.77 percent
2. Building custom software and servers for businesses: 14.29 percent
3. Machinery, equipment, and supplies merchant wholesalers: 13.75 percent
4. Management, scientific, and technical consulting services: 12.31 percent
5. Architectural, engineering, and related services: 11.40 percent
6. Foundation, structure, and building exterior contractors: 11.37 percent
7. Building finishing contractors who make additions, alterations, maintenance and repairs: 11.32 percent
8. General freight trucking: 10.41 percent
9. Services to buildings and dwellings, including pest exterminators, janitorial services, and landscaping: 10.11 percent
10. Other specialty trade contractors, including site preparation activities and other specialized trades: 10.04 percent

To see Cat’s article, Click here

Connect with Harvest Business Advisors today – email info@harvestbusinessadvisors.com or call 443.334.8000

 

Business Exit Strategies or Business Succession Planning for Retirement

Fact – Most small business owners don’t make nearly enough money from the sale of their business to survive the thirty to forty years they may live after the sale.  This must be realistically considered in your business exit strategy or your business succession plan.  You must start saving for retirement early and consistently.  Consider a tax assisted retirement savings program.  Another business exit strategy or business succession plan is to buy the real estate where your business is located.

In all events find a financial planner you trust and start today.  There is nothing worse than being physically or mentally exhausted and having to leave the business but  resisting it because your business succession and retirement plan did not generate the necessary downstream financial resources.

Considering Selling Your Business? Please click here for a downloadable e-book, “ 10 Ways to Increase the Value of Your Business“.

Many owners we work with intend to augment their savings by seeking employment in the future.  They just want to get the weight of owning a business off their shoulders.  If the income expectations and time requirements are realistic this is a good component of the business exit strategy or business succession plan.  Limited future employment is becoming a normal component of many business owners’ strategic plans.

If you are not in a position to properly develop these types of business plans yourself meet with a competent financial planner early.  Find a way to save.  Make it a priority because your future depends on it.

 Tip:  Every year you should assess your succession plan and exit strategy.  This would include updating the buy-sell agreement and related insurances if you have partners, developing a management plan specifying plans during your disability or your death, tracking your outside investments, and working on an exit strategy. 

Connect with Harvest Business Advisors today – email info@harvestbusinessadvisors.com or call 443.334.8000

 

How to Prepare Your Business Succession Plan or Business Sale

Sooner or later every business is sold, shut down, or given away.  Most of us didn’t think about that when we started our new and exciting venture. Yet, at some point our interests start to change and our enthusiasm and energy for the business wane.  At this point developing a succession plan or exit strategy for your business is key.  The business succession plan might include M&A, business valuation, business acquisition or other strategies

Considering Selling Your Business? Please click here for a downloadable e-book, “ 10 Ways to Increase the Value of Your Business“.

If you are reading this article, you are at least starting to think about the possibility of your life going on without your business.  Keep thinking about that.  When you started your business you had a plan.  It may not have been written down, but it existed.  This plan probably did not spill over to, or include, your personal life because the entire focus was on getting the business going and then growing it.  At this point, you should try to develop a plan that looks at what you want to do next and how you will get there.  A few critical questions you need to answer are:

  • Where are my interests now and where will they be in five years?
  • What do I get enthusiastic about?
  • What are my priorities regarding my family (or families in many cases), key employees and other people I am close to?
  • How long can I, or will I be willing to, continue to put forth the energy to lead my business?
  • Am I looking to sell because times have been tough?  If the market for my product turned tomorrow would I reconsider selling?
  • Besides the highest price and lowest taxes what do I want from the Buyers?
  • Do I want the business name to live on?
  • Do I want the real estate renovated?
  • Do I want the employees treated well?
  • Do I want future involvement?
  • Do I want my children or other family members to stay involved?
  • How do I handle fairly one child who is active and another who is inactive in the business?
  • Financially, what do I need to survive?
  • Who can best help me answer these questions?

These are not easy questions.  The correct answers may take quite a while to arrive.  And, by correct answers, we mean the answers that are correct for you.  These will vary greatly from one owner to another.  It often helps to talk it out with people you trust such as your spouse, CPA, attorney, business coach, clergy, therapist, life-long friend…..or a combination of these.   Quiet reflection also helps.

Gregory R. Caruso, JD, CPA, CVA
Harvest Business Advisors
609-664-7955

gcaruso@harvestbusiness.com
www.harvestbusiness.com

Revisit, Rethink, Recharge, Restart

Teamwork … it is the fuel that allows common people to attain uncommon results” 

                                                                                                         —  Andrew Carnegie

Good news – no more daily updates about the “fiscal cliff”.  It’s over, done, finished. What drama!

Back to the business of sales and acquisitions.  A study* was published last year that rated the challenges buyers and their advisors face when working on an acquisition. The findings were based on input from 70 participants who were experienced, motivated and wanted to do deals. Conclusion: there is no “silver bullet” in getting deals done, but the study emphasized several good learning points.

We’ve summarized the results below in the following format:

Challenge topic
Rated: two ratings – buyer followed by advisor
Comments

          Note: the ratings range from 1-5 (1=very easy, 5=very difficult).

We hope this helps you, buyers and sellers as you revisit, rethink, recharge and restart your own exit planning goals.

Considering Selling Your Business? Please click here for a downloadable e-book, “ 10 Ways to Increase the Value of Your Business“.

Study Results:

Acquisition Strategy
Rated: 3.7 and 3.8
Comments: key driver of alignment between buyers and advisors; if unrealistic, the plan is too general and not enough emphasis on action-related tasks.  Post-closing success begins with good strategy and planning.

Deal Flow 
Rated: 3.6 and 3.7
Comments: access to deal flow is a conscious effort combining communication and networking skills, strategy articulation and identification of real opportunities.  Prospecting and follow-up are very time consuming.

Team Formation
Rated: 3.3and 3.7
Comments: teams must rise to times that demand intensity, coordination, trust and candor. Find external advisors you can trust, not those just trying to get any deal done.

Engaging Sellers
Rated 3.3 and 3.6
Comments: key to the deal, knowing the sellers and their advisors motivations: i.e. the key sellers’ “drivers”; “Staying in constant contact until the moment is right”.  Sellers tend to over-value their business and are not prepared for requests during due diligence.

Business Valuation
Rated: 3.8 and 3.5
Comments: sellers place less reliance on market comparables then do lenders and advisors. The challenge is how the comparable being used relates to today’s market. Understand the 2 or 3 key value drivers and test them during due diligence.

Financing
Rated: 3.8 and 3.7
Comments: banks focus on projections, track record, relationships, a clear understanding of the opportunity given the level of risk, management team and experience, the strategy behind the deal and the integration plan.  No company should start the acquisition process until they have financing to affect the acquisition strategy.

Negotiation
Rated: 3.7 and 3.6
Comments: it;s one thing to agree on a price (“hand shake”); the potential for the deal to derail is real during this process. The absence of experienced advisors is a common source of deals that fail.  Most targets retain less experienced advisors,making the negotiation and documentation process very painful at times.

Due Diligence
Rated: 3.6 and 3.6
Comments: due diligence needs to focus on valuation of the target and how uncertainties can best be handled in the final purchase contract.  The challenge is not with the information; it’s the lack of information the target does not have.

Post Sale Integration
Rated: 4.2 and 4.0
Comments: this item received the highest rating by a significant margin. Integration plans should begin at the very beginning of the acquisition process. Misplaced optimism, overconfidence in the deal and confusion with senior management surface.  Acquisitions often involve competitors who add to he mistrust and anxiety. 82% of participants rated this as “challenging” to “very challenging”.

Final thoughts and comments from the participants

“Acquisitions are difficult – finding the right acquisition targets, managing egos and continuing to run a business during the acquisition process…”

 “Plan on more details and value the experience of your team and advisors. Successful acquirers are those who have made multiple acquisitions.”

 “The use of politeness, graciousness (towards the other side) and humor are greatly undervalued in acquisition settings.  Relax and be polite.”

 “It would be valuable for a soup-to-nuts service from strategy through integration.”

 *Study: Joseph Feldman, Feldman Associates 2012

Clients choose Harvest Business Advisors for our accurate business valuations and our consistent ability to deliver the highest price in the smoothest sale transaction possible. Harvest provides business brokerage, business valuation, and business succession planning services. We have extensive experience in the information technology and professional services, manufacturing, distribution, and contracting fields. We maintain offices in Maryland, New Jersey and Virginia. Connect with us at info@harvestbusiness.com or 443.334.8000 to discuss selling your business, ordering a business valuation or buying a business.

 by Ed Davis, Partner

 

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