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Re: Selling my business....tips?
Old 02-25-2006, 08:47 AM   #21
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Re: Selling my business....tips?

nomo-aloha, the 5 to 8 multiple above is on the high side, as an internet business will not be a comp for yours.

I'm CFO for a company that buys about 10 dealerships each year.

All businesses are sold based upon their earnings ... EBITDA is the usual measure ... earnings before interest, taxes (i.e. income taxes), depreciation and amortization.* It is a rough approximation of cash flow.* A buyer will adjust your EBITDA to determine what it will look like under their ownership ... perhaps taking into account compensation for a general manager, for example.

That EBITDA number, usually on a TTM (trailing twelve months), is multiplied times a multiple.* Those multiples vary by industry, and investment bankers and other pros research industries to determine which multiples apply in the market.* For example, if a pro was valuing your business, they would look at comparable sales in the market, compare their TTM EBITDA to the sales price, and calculate the multiple.* That would provide a range of multiples for use in your business.* Multiples are a function of actual transactions in the marketplace ... they don't really set prices, per se, though most folks view them that way.

That data would likely be tough to find for your market, and all of this is obviously also subject to prospects for the business (e.g. higher multiple if high growth is expected), quality of the business assets, and circumstances of the seller.

That last item concerns me.* IF you can take care of your back so that you can function, then I would suggest you search for a solid GM to run the business.* Not a partner.* Give them an incentive comp plan that helps drive them to grow the business.* You handle client relations, accounting, "senior" management.* Check the candidates out very carefully, of course ... interviews, background checks, careful reference checking.* You manage the business carefully, and their comp plan is probably based upon EBITDA ... you can give them a % of EBITDA, a bonus for performance over a certain Plan number, etc.* The important point is that you don't have a partner, the business remains yours and yours alone, but you wisely share the profits with a GM who has great incentive to build your business.

The time to sell a business is when things never looked better, just came off of your best year, every prospect for great future success ... the exact time your gut tells you not to sell.* * The worst time to sell is when it is apparent the business has turned down, and a buyer may understand you're in a weakened state and must sell.

Last point.* Look at the multiples above as reciprocals of return percentages.* For example, if someone buys your business at a 5 multiple of EBITDA, then see this as 1/5 ... they are getting a 20% return on their money, assuming no changes in business.* Not bad compared to the S&P 500, but an investment in your business is not liquid, and much more risky.* Use the 8 multiple above ... it is 1/8, or a 12.5% return, roughly.* Why would someone pay this, when they can invest in the S&P 500 for slightly less return, but much less risk ... only reason would be if they thought they could take your business to great heights.

Also note that you should get capital gains treatment (for the most part, depending upon entity) for sale of your business ... that is a lower tax bite than the normal income taxes on your net profits. Thus, you can't directly compare the business values driven off of multiples to years of business profits.

We've paid 20 multiples, and even infinite multiples for businesses losing money.* We were only willing to do that to get the franchise rights and existing plant / equipment / personnel / customers.* We knew we could turn the business around, and it didn't cost much to take the current operator out.

Best of luck ... if possible, gin your business up before you sell.
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Re: Selling my business....tips?
Old 02-25-2006, 09:34 AM   #22
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Re: Selling my business....tips?

Here are some thoughts from my past life as a business broker and appraiser.

Earnings mean vastly different things depending on context. Brokers and appraisers working with businesses with gross sales under, say, $2-5 million will usually use multiples of a number that is called different things, but amounts to how much cash could the owner/manager take out next year if he wanted to maximize his take without impacting the business. This means restating the income statement and eliminating expenses that are owner perqs such as the board meeting in Hawaii (oops - you are in Hawaii -- so maybe the board meeting in Minnesota?), the company car that is mostly used for commuting to and from work, unusual one-time events, sponsoring Junior's little league team, etc. Also added back are costs of financing (unless financing costs are a typical part of the business, as they are in, say, car dealerships), tax credits for depreciation and amortization, and a zillion other things. Brokers are supposed to, but often do not, adjust DOWN for the "real" depreciation, i.e., the reserve for replacement of stuff that wears out.

Brokers vary in how aggressively they approach these adjustments, and the results can go all over the place. But in the end, a potential buyer needs to agree with the rationale for the adjustments.

Gross sales is far more objective, as no one has gone in and made adjustments -- they are what they are.

Multiples of the earnings described above and of gross sales are never used by buyers to decide what price they are willing to pay -- there are far too many other factors involved. They are just used in reality checks, and often in establishing a price when a sale is not contemplated, as in deciding on asset values in a divorce, etc.

Investors, contrasted with small business buyers, value businesses differently, using, for example, discounted cash flows and comparative investments -- but those are almost never used when the buyer will be taking a full time role in the business, and almost never when the books aren't fully audited, the business sales in the many millions of dollars, and so forth.

What small business buyers do is very simple. They look at (a) can they make a living in the business, and (b) can they afford it?

Simple example: Someone buying a business that will reliably produce $100,000 available for owner compensation and financing will likely try to keep their annual debt service costs down to no more than 30-35% of that amount.

The roughly $33,000 per year in loan payments will support a loan of somewhere between $100,000 and $200,000. (Rates are high and terms are short, especially when the business lacks hard collateral such as marketable real estate and machinery.)

That leaves something like $67,000 for the owner to live on.

What does that say about the purchase price? Well, if the borrowed amount is in the $150,000 range, then the rest of the purchase price has to come from the buyer as a down payment. So how much is someone likely to pay as a down payment for something that will let them take home $67,000?

In practice, between the likely amount of liquid savings available for a down payment plus cash reserve for initial operations and the psychological aspects of paying out a lot of money and taking on significant debt, buyers will typically pay between a year's "pay" for them ($67,000) to a year's total cash flow ($100,000) as a down payment.

So, add the likely loan amount of around $150,000 to the likely down payment of around $75,000 and you get a purchase price of around $225,000, or 2.25x the $100,000 "cash flow" (commonly used term for the amount that the business can pay out to an owner-manager, as I described above).

For a business to get this 2.25 multiple of cash flow, it needs to be reasonably attractive to a buyer, offer a real promise of growth potential, have clean books, and a track record that makes all these numbers look very real, not just wishes. If things aren't so clean, then a multiple of 1 is well within the boundaries of typical sales, and when things are fabulous, multiples of 3 - 3.5 are sometimes encountered.

(What makes a business "fabulous" in this context? Very low risk, very stable earnings, very low complexity, etc. An example that comes to mind is a local burglar alarm monitoring company we had, where many hundreds of customers paid by automatic credit card debit for monitoring, the labor was cheap, and customer turnover was minimal.)

So when you hear that a business will sell for around a little over 2x cash flow, that is really an expression of what the market will bear.

You said you are hearing that a business is worth around 1/3 of the gross sales. That's an easier number to understand. It is simply based on what has happened.

I am posting below a couple of scanned graphs from stuff I was able to dig up from my old days. The first is a graph plotting sales price against the "cash flow" (as defined above) for a bunch of actual business sales. As you can see, the sales seem to average around 2x cash flow. The diagonal lines show the 25-75% boundaries and the 10-90% boundaries, so you can see that only the best 25% of businesses sold for more than 2.4x and only the worst 25% sold for less than 1.1x cash flow.

The second is a similar plot, but using gross sales instead of cash flow. The average selling price is 41% of gross sales. Only the best 25% sold for more than 58% of gross, and only the worst 25% sold for less than 25% of gross.

Hope this info helps you at least see how this stuff works...

And by the way -- lots of this info at http://www.valuationresources.com/ if you are a glutton for this stuff.
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Re: Selling my business....tips?
Old 02-25-2006, 10:02 AM   #23
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Re: Selling my business....tips?

I know nothing about this subject compared to all the very knowledgeble folks who've posted, so I should just shut up. :

But: I think Charles point bears emphasizing: "The important point is that you don't have a partner, the business remains yours and yours alone, but you wisely share the profits with a GM who has great incentive to build your business."

I know of two absolute horror stories (family friends) who brought in "partners" and were essentially eaten for lunch and forced out of their own businesses for peanuts.

Keep it with a manager or sell it but don't partner with anyone you don't know well.

Just my 2 cents.
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Re: Selling my business....tips?
Old 02-25-2006, 12:05 PM   #24
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Re: Selling my business....tips?

Great Advice.
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Re: Selling my business....tips?
Old 02-25-2006, 01:20 PM   #25
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Re: Selling my business....tips?

Good advice above. Let me add this.

The OP should strip out the "discretionary spending" to come up with something that looks like a reasonable annual cash flow, before any draw in the form of salary or bonus. Then estimate what a skilled person would be paid in order to run the business. Above estimates run from the $50k the OP is taking - almost certainly low - to the $150k that Max estimated and deduct that. Deduct reasonable - not tax, reasonable - amortization of fixed assets. What you're left with is an estimate of the economic profit.

Any sane buyer will pay a multiple of that economic profit. The multiple varies by industry and by size of business, but with small private businesses, it's not going to double digits and there are lots of times that it's low single digits.

The biggest single mistake that business owners make when trying to value a business they want to sell is to imagine that any buyer will apply the multiple to their own draw. I've seen this over and over.

"My business makes $100k a year when I run it. I pull out about $80k a year to live on and, if I weren't running it, I'd have to pay somebody $80k a year to run it for me. "

If such businesses go for 5x "earnings" as a matter of course, that business is worth $100k to a buyer, not $500k. Nobody is going to pay an extra $400k to buy themselves a job, which is what "running the business" really is.
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Re: Selling my business....tips?
Old 02-28-2006, 11:05 AM   #26
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Re: Selling my business....tips?

....Sorry for the slow response in thanking the latest contributers to this thread. I have (un-expected) family in town...enough said.

I just logged on, thought I'd have a look and WOW. It is clear to me that I must devote some un-interupted time in order to fully comprehend / digest your graphs, advice and other contributions.

In the meantime, just wanted to drop this note of thanks as I do not want to appear ungrateful. I am grateful, humble and beginning to see the bigger picture. Thanks again!
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Re: Selling my business....tips?
Old 03-01-2006, 06:55 AM   #27
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Re: Selling my business....tips?

all of the advice above is great, detailed, specific advice and I agree with 99.9% having just come off selling my business. One thing I will note is to be a bit careful when using the methodologies decribed above. Generally this is the accepted way to value and purchase a business, but since your business is fairly small, I would say that you may be able to sell it to a less sophisticated buyer who may value it in a completely different way. And contrary to what someone said above, less sophisticated investors will pay for a job, just look at how many folks are starting their first subway or mcdonalds.

All I'm saying, is that if you can find someone who is genuinely interested, it can definitely change the multiple, or the valuation method. Obviously this can also work in reverse.

Just make sure to disclose absolutely everything. Would be nothing worse than to sell it, and then get sued a year later.
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Re: Selling my business....tips?
Old 03-05-2006, 06:28 PM   #28
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Re: Selling my business....tips?

Quote:
Originally Posted by CybrMike
all of the advice above is great, detailed, specific advice and I agree with 99.9% having just come off selling my business. One thing I will note is to be a bit careful when using the methodologies decribed above. Generally this is the accepted way to value and purchase a business, but since your business is fairly small, I would say that you may be able to sell it to a less sophisticated buyer who may value it in a completely different way. And contrary to what someone said above, less sophisticated investors will pay for a job, just look at how many folks are starting their first subway or mcdonalds.

All I'm saying, is that if you can find someone who is genuinely interested, it can definitely change the multiple, or the valuation method. Obviously this can also work in reverse.

Just make sure to disclose absolutely everything. Would be nothing worse than to sell it, and then get sued a year later.

SUPER Mike, Thanks for the info. I've been playing tour guide for the past several days and only found your post today. I really appreciate the information and hope your particular transaction was a great success!
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