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Before You Buy — Recognizing Small Business Value Drivers

By The BizBuySell Team

Small Business Value Goes Beyond the Financials

When it comes to determining small business value, one of the most common question buyers ask is, ‘If I buy this business, how much money can I make?’ Yet, it’s important to look beyond the financial records when determining small business value. Oftentimes, financial records can be inaccurate or incomplete. Furthermore, they are intended to help minimize taxes, not show how well the business is doing.

Beyond the financials, here are some key value drivers to consider when buying a small business:

1. The Business Has Been Providing a Steady Income for Several Years
A business that has been operating for at least 3-5 years is worth recognizing. This means the owner has been able to make some sort of living, plus pay business expenses, rent, vendors, and employee payroll.

It also means gross sales are providing enough cash flow to keep the business running smoothly. Sales drive value. This is because the real bottom line of earnings (seller’s discretionary earnings or SDE) comes out of the top line of earnings (gross sales).

A general rule of thumb for a small business that has been operating for at least three years and earns less than one million dollars in gross sales is that the owner’s benefit (SDE) could be anywhere from 10 to 20 percent of gross sales. Once a business earns over one million in gross sales, the owner’s benefit (SDE) goes down to 10 percent or less.

2. There is Potential to Grow and Expand the Business
A business is more valuable if there is potential to grow post-sale. When evaluating a business, 30 percent of your focus should be on what the owner has done and 70 percent should be what you could do with the business.

For example, it would be hard to scale if the owner is the backbone of the company as the business relies heavily on one person. For you to scale that business, you may need to put in a lot of upfront work to create process and systems to ensure it runs smoothly in your absence.

Other initial filters include:

  • A strong company brand — A business with a great reputation is more valuable than one that has been damaged by a crisis or poor service. A strong brand within the industry will be more scalable.
  • Market position — A business that is well positioned from its competitors has a better chance of a strong market position. These companies have products and services that are well differentiated within the marketplace.
  • Quality employees — A strong business has trustworthy and highly skilled employees. Those who remain with the company long term could impact the quality of the business.
  • Business revenue model — A recurring revenue model could provide steady sales throughout the year versus ones that only make sales seasonally.
  • Strong and loyal customer base — An established customer base is more valuable as they are most likely to stay put after the business has sold.

3. Running the Business Works With Your Desired Lifestyle
Purchasing a business is an emotional decision as much as a financial one. If you don’t like the business or it doesn’t work with your lifestyle, then it will never be a good fit no matter how valuable the business is.

Questions to ask include:

  • Do I have the skills to manage the business?
  • Is it in a location that I want?
  • How often do I need to be physically present at the location?
  • Will I need to travel often to meet buyers and suppliers?
  • Do I prefer a wholesale or retail business?
  • Is it the size I want (e.g. managing a lot of employees)?

Take the Time to Understand Small Business Value Drivers

Understanding the value a small business can offer for your income and lifestyle is paramount in determining what to look for when making a purchase. Once you’ve assessed the initial filters, take time to go visit the business and investigate further. You never know; the next business you visit could be a winner.

Loren Schmerler No Comments

Questions Business Owners Ask Me and the Answers I Give Them

bbpLoren Marc Schmerler, President and Founder of Bottom Line Management, Inc. contributed “Questions Business Owners Ask Me and the Answers I Give Them” article for Business Broker Press, an organization dedicated to support the business brokerage industry.

 

  1. How much is my business worth?
    The correct answer is the price a Buyer offers you that you are willing to accept. It makes no difference whether you are making money or losing money. It makes no difference whether sales are increasing, declining or flat. It makes no difference how much blood, sweat and tears you have put into your business. It makes no difference how much money you have invested in the business. It makes no difference how much money you owe to the bank or to yourself. It makes no difference what a business valuation or appraisal says. It makes no difference what your hard assets are. It makes no difference what your customer list or client list contains. It makes no difference what your patents or service marks cost you. It makes no difference whether you are a Franchiser, Franchisee, Licensor, Licensee, Distributor or Independent Contractor. The bottom line is that what you finally accept is what your business is worth.
  2. How long will it take to sell my business?
    The correct answer is no one knows for sure. But I tell my clients that the average time is seven months from listing to closing. For companies that sell for $1 million or more, the average is nine to twelve months. But I also explain that the quickest I ever sold a business was one week, and the longest it ever took me to sell a business was six years. Additionally, I explain that price and terms sell a business. The lower the price the more affordable the business will be. The lower the down payment, the more people will be able to consider it. The greater the amount of owner financing, the easier the business will be to sell.
  3. Is there anything I can do to make my business more desirable?
    The answer is yes. The most important thing you can do is to put your ego aside and not make the business dependent upon you. Ideally, the goodwill of the business should be at the lowest level that interfaces with customers or clients. This means that you want to hire and keep employees that make your customers happy with high quality work and excellent customer service.
  4. Is there anything I should not due during the listing period?
    The answer is that you should not slack off in any way. You need to stay focused and operate your business as if it will never sell. You need to work as hard or harder no matter how burned out you feel. Do not make any major changes during the listing period. Try to retain all good and excellent employees and remove those that are not contributing as they should. Try to keep your inventory fresh and eliminate any obsolete items. Keep your equipment and machinery well maintained and properly functioning.
  5. What is due diligence?
    It is the process where the Buyer examines all your books and records , gets approved by the Landlord, gets approved (if applicable) by the Franchiser, Licenser, Distributor, bank, etc. Your books and records need to be current and “bullet proof.” Your tax returns for payroll taxes, sales tax, state income tax, federal income tax, county income tax, city income tax and any other municipality taxes are 100% current. Your various licenses need to be current whether or not the buyer will have to apply for their own. You want to fully disclose everything and not leave any skeletons in the closet.
  6. What else do you suggest I do to impress a Buyer?
    Have a job description for each employee. Put together a Policies and Procedures Manual. This will make the corporate buyer feel more comfortable about taking over the reins. Make sure all your employee reviews are current. The last thing a new owner wants to do is to sit down in a vacuum with an employee who is expecting a raise. Make sure you clean everything that is dirty. Make sure you fix anything that is broken. You do not want the Buyer to wonder what else might be a potential problem. Prepare a business plan and/or marketing plan to show the Buyer how he or she can grow the business. Put together a transition plan that shows the Buyer how you will assist them daily for a period of 28 days. The Buyer may not want you for the full transition period, but at least you are showing that you have thought it through and are willing to make yourself available.
  7. What happens if I agree to do some owner financing and the Buyer misses a payment?
    The way the closing attorney prepares the paperwork, if a Buyer misses a rent payment or a note payment, it is considered an event of default under the note. This will allow you to take back the business in a worst-case scenario or enter into serious discussions to protect your financial interests. While the best outcome is a Seller getting paid all their money and a Buyer being successful, you must plan for the worst and hope for the best. But I also tell my clients that they should never sell their business to a person they feel will not treat their employees, customers, clients or vendors properly. If you ever get a knot in your stomach during the negotiation that is the time to throw in the towel and let me gently explain to the Buyer that you do not feel it is a good fit.

I hope this list of questions and answers has been helpful. I offer a free no obligation consultation 7 days/7 nights should you wish to discuss the sale of your business or the purchase of another business. Loren Marc Schmerler, CPC, APC, President, Bottom Line Management, Inc., 404-550-1417 www.BOTLINE.com.