Some Pricing Basics

Defining the Earnings

Are the earnings just the bottom-line profits shown on the profit and loss statement? Are the earnings expressed as an EBIT (earnings before interest and taxes) figure? Are they expressed as an EBITDA (earnings before interest, taxes, depreciation and amortization) number? Or are they expressed as an SDE (seller’s discretionary earnings, which is EBITDA but with the seller’s salary or draw included) figure? How the earnings are expressed can make a big difference in the price from both the seller’s and buyer’s viewpoint, since the price is generally arrived at by a multiple of the earnings.

The much-used acronyms mentioned above seem simple enough, but there is one major ingredient missing, common to all of them. They should all have “after add backs” added to the definitions. Add backs are those expenditures considered “one-time” expenses, such as the purchase of a major piece of equipment, the cost of litigation, a move to new facilities, the cost associated with a fire or other unexpected closure, etc. The idea is that one-time expenditures should be added back to earnings since they won’t be repeated next year. The problem is that generally something else will happen and, in fact, many one-time expenditures do get repeated, but with a different title.

Add backs should only be added back when it is an extraordinary expense and one that can be defended to a prospective buyer. The basic principle behind these terms is that the price of a business should be based on the cash received from the business by the owner. It is this figure against which a multiple is applied to arrive at the price, or value, of the business. For example, SDE is the figure most often used in small businesses and the multiple is generally somewhere between 1 and 4 with 1.6 to 3 being a normal range.

Sellers should determine the lowest possible figure they are willing to accept; keeping in mind that the lower the down payment required, the higher the price, and the more cash demanded up front, the lower the full price. Also, the seller must be able to prove or verify the financial information. Just telling a prospective buyer what the business is making is not sufficient.

Here are some additional basic pricing questions to consider:

• What is actually for sale and included in the asking price? What about inventory, receivables, secret recipes, etc?
• How about the fixtures and equipment? Is some of it leased? How about the portrait of your favorite uncle –the company founder?
• How dependent is the business on the owner?
• Is the inventory current, or is it outdated or obsolete and therefore nor salable or usable?
• Is the current cash flow sufficient to cover all expenses as well as the new owner’s cash requirements, or will it require additional working capital?

The services of a professional business intermediary can help you answer these questions and also provide lots of information and data on pricing the business.

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Building the Value of your Business: How Does Your Business Stack Up?

The cover article provided some information about how the price of a business is determined. The multiple of SDE (seller’s discretionary earnings) was mentioned as being most often within a range from 1.6 to 3. As a quick quiz, how does your business stack up on the following important value indicators? Use 1 to 4 as a scoring system (with 4 for excellent) and see where your business falls on the scoreboard.

• Profitability
• Type of business
• History of business & industry
• Business growth
• Customers/Clients
• Market share
• Quality of financial statements
• Size
• Management
• Price & terms of sale

These are all important factors from a buyer’s vantage point. Obviously, the higher the figure for each item, the higher the score. Now divide the total by ten, the number of factors, and see where your business falls on the SDE scale.

Here is an additional question to consider:
Are your prices for products or services current, or are you charging yesterday’s prices? It might be time to take a second look and perhaps consider raising prices.

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Selling Your Business?Do-It-Yourself is Risky Business!

When the owner of a business makes the decision to sell, he or she is taking a giant step that involves the emotions as well as the marketplace, each with its own set of complexities. Those sellers who are tempted to undertake the transaction on their own should understand both the process and the emotional environment that this process is set against. The steps outlined below are just some of the items for a successful sale. While these might seem daunting to the do-it-yourselfer, by engaging the help of a business intermediary, the seller can feel confident about what is often one of the major decisions of a lifetime.

1. Set the stage.
What kind of impression will the business make on prospective buyers? The seller may be happy with a weathered sign (the rustic look) or weeds poking up through the pavement (the natural look), but the buyer might only think, “What a mess!” Equally problematic can be improvements planned by the seller that appeal to his or her sense of aesthetics but that will, in fact, do nothing to benefit the sale. Instead of guessing what might make a difference and what might not, sellers would be wise to seek the advice of a business broker -- a professional with experience in dealing regularly with buyers and with an eye experienced in properly setting the business scene.

2. Get the record(s) straight.
Although outward appearance does count, what’s inside the books is even more important. Ultimately, a business will sell according to the numbers. The business broker can offer the seller invaluable assistance in the presentation of the financials.

3. Weigh price against value.
All sellers naturally want to get the best possible price for their business. However, they also need to be realistic. To determine the best price, a business broker will use industry-tested pricing techniques that include ratios based on sales of similar businesses, as well as historical data on the type of business for sale.

4. Market professionally.
Engaging the services of a business broker is the key to the successful marketing of a business. The business broker will prepare a marketing strategy and offer advice about essential marketing tools--everything from a business description to media advertising. Through their professional networks and access to data on prospective buyers, business brokers can get the word out about the business far more effectively than any owner could manage on an individual basis.

Key Items Necessary for Selling a Business

  • Three years of profit and loss statements
  • Federal taxes for the same period
  • Current list of fixtures and equipment
  • The lease and related documents
  • Franchise agreement (if applicable)
  • List of encumbrances, loans, equipment leases, etc.
  • Approximate amount of inventory on hand
  • Names of outside advisors with contact information
  • Marketing materials, catalogs, promotional pieces, etc.
  • Operational Manual (if available)
  • Brief history of business

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How Unique is Your Business?

Most business owners think that their business is unique. There are obviously many different attributes that can make a business stand out from others. However, there are some key factors that make a business both unique and, at the same time, make it more valuable in the marketplace and more desirable by prospective purchasers. Just as importantly, they are also unique factors that are generally transferable to a new owner. Here are some key ones:

Intangible Assets
One example could be a long-term lease for a great location that is transferable to a new owner. Other examples include a mailing list of current and past customers, a popular franchise relationship, a well-known product line such as Hallmark, or a well-established mailing program designed to attract new customers or clients. Trademarks and copyrights are some other examples of intangible assets.

Difficulty of Replication
For example, in most jurisdictions, liquor licenses are doled out by population or on some other limited basis. One can not just decide to rent some space and open a liquor store. Franchises often limit the number of units in a geographical area. Selling Department 56 collectibles is a license not granted to just any store.

Proprietary Products, Services or Technology
A business owner may have developed or have had developed software unique to their business which is a key to its success. Or the proprietary item could be something as simple as a secret recipe for a food item, sauce or other food product unique to a restaurant.

Reputation
There is the pharmacy that is known all over town for delivering prescriptions or other medical needs. And there is the hardware store that will still sharpen knives or fix screens. Then there are the local businesses that have “just what you need” or that special something that makes them known all over town. While these characteristics make these businesses unique, it is up to a new owner to continue them.

When looking at businesses to buy, buyers should look beyond the numbers for the unique qualities that separate a particular business from the pack.

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