Tweet

What is the Sales Value of my Small Business?

Written by: Greg Caruso

Article Overview: The first question most business owners ask me is “what is the value of my small business?” This article provides a simple way to value small businesses that are typically owner operated with revenues under $3,000,000.

What is the Sales Value of my Small Business?

Know the Sales Value of Your Business.

When you are anticipating selling your business you should obtain a valuation to plan appropriately and, in some cases, to use as a negotiating tool. For smaller businesses your broker should be able to prepare a simple valuation. For larger businesses it is worth having a valuation properly prepared by a valuation professional. This person may be independent, work with your accountant or be part of the broker’s firm.

Preparing a detailed valuation is beyond the scope of this article. Formal valuations often calculate values three or more ways. These valuation reports can be 50 pages or more.

What we cover here is a simplified valuation based on the market approach to valuing businesses. Do not use it for anything other than general planning without seeking the advice of your trusted advisors and an expert in business sales, mergers, and acquisitions.

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, 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 5 with between 2.3 to 2.7 being about average and above 3 rare 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.

With small businesses, you take the last three years’ tax returns and make these adjustments. Compare the three to identify the trend. If the trend is rising, select the average to high figure. If the trend is falling, select the average to low figure. If there is no trend then use the average against the multiplier.

Unfortunately, most small business owners are disappointed with the valuation of their business. Small businesses tend to be owner operated. This means that owners are getting paid for their labor and receiving a profit for their business risk. Only the profit portion of what has been earned is available to pay the purchase price of the business.

Unprofitable businesses are very difficult to sell. Obviously, the above formula results in a value of $0.00. They generally sell for asset value and asset value is usually not very much. Of course, superior locations that are owned or come with below market leases, grandfathered licenses, and other tangible or intangible assets have value and can be sold.

Because most owners view these resulting values as low, most business sales occur only when the owner needs to move on to something new. It is not because the price is something the Seller could not refuse. I recommend that you calculate your value every year as part of a planning session. Improve your profits and improve your value.

About the Author: Gregory Caruso, CPA, Attorney, and Certified Valuation Analyst, is a Principal at Harvest Associates in Baltimore and Bethesda, Maryland. He is author of the book, 11 Secrets to Selling Your Business. He is an expert in privately held business mergers and acquisitions with over 20 years of experience.

Related Articles
  Did Your Salespeople Choose to be In Sales?
  The Difference Between Winning the Deal & Losing the Deal
  Why Your Sales Approach Should Aim Small, Miss Small
  How to Make Sales and Marketing a Doable Strategy
  Growth In Sales Can Be Harmful!

Article Tags: accountant, amortization, business sales, cash flow, day tasks, depreciation, exotic travel, family member, general planning, heath insurance, independent work, market approach, mergers and acquisitions, normalizing, payroll, sde, selling your business, time charges, valuation reports, valuations



Related Forum Posts
New Small Business Topic - Hello everyone, I'm on the lookout for new topics to add to my site. We just launched a Franchising section and are planning Human Resources section. Do you have any thoughts for a new section? Here's a list of what we currently have: Angel Investors Branding Bank Loans Business Coaching Business Plan Franchises (New) Insurance Legal Marketing Public Relations Sales Small Biz Loans Venture Capital
My entry - 1. The Best Business Books Ever: The 100 Most Influential Business Books You'll Never Have Time to Read - this is a fascinating book about the history of Business theory, and I'd recommend it to anybody. 2. The Big Book of Small Business: You Don't Have to Run Your Business by the Seat of Your Pants, by Tom Gegax. Ditto. 3. PADI: The Business of Diving Book Okay, so this book won't be of use to anyone who doesn't want to start a scuba store, but I did, and this book was of course invaluable to me in reaching that goal.
These maybe the coldest franchises out there: - Here are the worst 15 performing franchises in regards to having the highest Small Business Administration (SBA) loan failure rates. The list is dotted with sub sandwich shops, fitness centers and car shops. WORST FRANCHISE LOAN FAILURES Failure % 1 OBEE'S SOUP SALAD SUBS 55.56% 2 LADY OF AMERICA 41.94% 3 COUNTRY CLUTTER (BED & BREAKFAST) 41.18% 4 COPY CLUB 36.36% 5 ALL TUNE AND LUBE 35.71% 6 PICKERMAN'S 35.71% 7 PHILLY CONNECTION 35.59% 8 ROLY POLY ROLLED SANDWICHES 34.78% 9 COTTMAN TRANSMISSION 34.48% 10 HAIR COLOR EXPRESS 33.33% 11 LEE MYLES AUTOMOTIVE TRANSMISSIONS 33.33% 12 GODFATHER'S PIZZA 33.33% 13 SMOOTHIE FACTORY 33.33% 14 BLIMPIE 31.39% 15 GOLF U.S.A. (RETAIL GOLF EQUIP.) 30.77% Source: Small Business Administration, SBA Loan Performance Within Franchise Code for the Period of FY 2001 - 2005
Exclusive: Interview with Results - Hi Forum Members, I'm helping start up a Business Coaching and Consulting company here in Toronto, Ontario, Canada (a Subsidiary of RSC Business in Los Angeles). As a Research and Development Intern I am required to practice my listening and interview skills by surveying Small and Medium Businesses on thier Business. This Survey is designed by RSC Business to also assist the Business being interviewed more insight into their own business. I am looking to interview about 30 businesses across North America over the span of 3 months. At the end of these interviews I will be publishing a report of the results and they will be made available for free to the Interviewees. The Report data will include responses from a minimum of 100 interviews. I would like to extend this opportunity to members of the Forum. If you would like to have this short 20-30 minute interview conducted on your Business and you reside in North America please send me an email or PM. Please contact me at andy[at]jvprosperity[dot]com to arrange our interview and to get free access to the results when they are published.
Re: Biz Plan Competition - i just wanted to say that posting Small Business Events on CanadaOne is a great resource. Thanks Julie!


Share this article with your friends. Fund someone's dream.

Leave a comment below or share on the left and you'll help support entrepreneurs in Africa through our partnership with Kiva. Over $50,000 raised and counting - Please keep sharing! Learn more.

Tweet

Newsletter

Get advice & tips from famous business
owners, new articles by entrepreneur
experts, my latest website updates, &
special sneak peaks at what's to come!

Name:
Email:

Popular Articles

Designing Employee-Enhancing Training Programs

ROSI Return on SUNK Investment

Paint A Word Picture - Excite Your Customer

Suggestions

Email us your ideas on how to make our
website more valuable! Thank you Sharon
from Toronto Salsa Lessons / Classes for
your suggestions to make the newsletter
look like the website and profile younger
entrepreneurs like Jennifer Lopez.