I see the carnage every day. Someone who wants to sell his/her business will call me after the business broker they hired hasn’t delivered. In almost every one of these calls, the business owner will tell me something like: “I paid the broker for an evaluation of my business, but now he’s telling me all the potential buyers think the valuation is too high.”
If the business owner is still under a contract with their broker, I’ll politely end the call right then because I won’t ever interfere with an existing contractural relationship. But if the business owner has no remaining contractual relationship, I will continue the conversation with hopes I can triage the mess.
There are two problems evident in the business owner’s call. First, the business owner has paid money to a business broker for something that should have been free (the valuation), and second, the valuation was wrong. Now in fairness, there are lots of bad business valuations floating around out there, here are at least three reasons why:
THERE ARE NO RELIABLE COMPS FOR BUSINESSES. My wife and I are considering building a new home so we’ve been meeting with real estate brokers to value our present home. A real estate broker has tons of reliable, current and local data to assist in their valuation of our home. There is no similar database of comparable local business sales from which to derive probable market valuations.
BUSINESS BROKERS ARE NOTORIOUS FOR OVER-STATING THE VALUE OF A BUSINESS JUST TO GET THE ENGAGEMENT. I’ve been there, done that. It’s hard to tell a business owner that they’re valuation expectation is inflated. Sometimes it just seems easier to tell them what they want to hear, take the engagement and hope for the best. But I’ve learned, hope is a lousy strategy.
THERE ARE NO QUALIFICATIONS IN MOST STATES TO CALL YOURSELF A BUSINESS BROKER, SO THERE ARE SOME WHO JUST DON’T KNOW. It’s shocking to realize you need a license from the state of Tennessee to operate a barber shop, but you need no training, expertise or education to call yourself a business broker. Obviously therefore, there are men and women out there trying to do their thing who just plain don’t know any better.
So as you consider selling your business, how can you know what your valuation might be? Here’s a three minute formula to figure it out.
FIRST 15 SECONDS. Remind yourself you don’t need to pay anybody to tell you this. If your financial records are basically sound, you can do this yourself. If your records aren’t in good shape, you might consider an auction of your assets, or waiting two to three years while you get your records in good shape.
NEXT 30 SECONDS. Gather your financial statements for the current year and past three years. For the current year, do a projection for the full year based on a straight proportion of the year to date (take monthly average NOI and multiply by 12; don’t worry, we can be more granular later, we’re long for big picture assessment at this point). So now you should have NOI for four years.
NEXT 45 SECONDS. For each of those four years start with NOI then add back interest you’ve paid that year, plus any non-cash expenses like depreciation, plus any one-time us unusual expenses, plus any compensation you’ve taken that is above and beyond what would normally be required to run your business. You should now have four years of what we call “seller’s discretionary earnings (a/k/a, SDE).
NEXT 15 SECONDS. Take your four years of SDE, multiply the current year by 50%, the most recent full year by 25%, the next year by 15%, and the last year by 10%, then add them all together to get your “weighted average SDE.”
FINAL 15 SECONDS. Multiply your “weighted average SDE” by 2 if your business is growing at 5% per year or less, or by 3 if your business is growing more than 5% per year. The resulting number is your market valuation, +/- 15%. We can talk later how to value current assets, but for now realize the number you’ve just calculated is indeed very close to what you can get for your business.
If you don’t believe that my three minute exercise will work, here’s what you do. Pay someone a bunch of money to do all sorts of complicated and impressive ratios and compile a big thick book of stuff pulled off Wikipedia. The resulting number will likely be within 15% of the exercise I just took you through. If not, be suspicious.
Yes, I know, you probably think your situation is different, and indeed a few are, but most aren’t. But when you call a business broker about selling your business, if you don’t hear advice generally like you’ve just read, realize it might be time to reconsider with whom you should be talking.
Tennessee Valley Group
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