How To Value A Business For Sale

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1 A Special Publication From TheBizSeller.com The Simplified Small Business Valuation Guide An Easy To Understand System For Pricing Your Small Business That Eliminates All The Jargon And Theory So You Can Sell Your Business FAST Summary: When it comes to pricing a business for sale, too much of the information on the Internet is theoretical, technical or academic meaning it is IRRELEVANT when it comes to you pricing your business. So in this special report we are not going to go into theoretical discussions or academic exercises. This report is written EXCLUSIVELY for the small business owner ($1 million in sales or less) who also happens to manage the business (meaning it is the owner's main source of income, not just a passive investment) and wants to learn how to arrive at the best possible asking price so that the business can be sold for the most money. After reading this report you will not have earned an MBA but you will know how to price your business. And just as importantly: you will know how to show the buyer why your business is worth the price you are asking. Bonus Section I've also included an extra section at the end of this report to help you effectively negotiate the best financing terms. If you and your buyer can focus your negotiations on the terms of the sale instead of just the price it will mean more money in your pocket, so make sure you read this bonus section! 1

2 Dear Friend: Let's begin this report with some good news small business valuation is not as hard as everyone tries to make it sound. At least not when it comes to smaller (under $1 million in sales) businesses that are owner managed. And not when it comes to performing a valuation in order to price and sell a business. If you have been intimidated by the words "business valuation", don't be! By the end of this special report you should have enough knowledge to confidently place an asking price on your business. I'll admit, I didn't always feel that placing a value on a business could be so easily achieved. In fact, when I first started to learn about selling a business, it was the valuation that I found to be the most difficult, even intimidating, aspect of the whole process. Then I started TheBizSeller.com in 1999 and I quickly realized I was not alone. What makes business valuation seem so complicated is that there is no universally accepted formula for determining value. It's often been said that business valuation is an art not a science. Well, it might be easier if it was a science, at least with science there are laws that can be proven to be correct. For example, Einstein's Theory of Relativity, (E=mc2) provides a framework for understanding an extremely complicated subject with one short equation. And every 2

3 scientist in that field agrees the equation is correct. And if you read some of the stuff on the Internet by the so called valuation "Experts", you may think that you have to be Einstein to value a business correctly. :) Since there is no equivalent in business valuation to E=mc2, we are left with dozens of options, techniques, formulas, theories and opinions. Sorting through the options and understanding all the jargon can be a full time job. In fact, some people business appraisers, college professors and other experts with initials after their names do make a career doing just that. The other problem with all the theoretical material on the Internet about business valuation is that it never mentions the buyer or the selling/negotiation process! Since the buyer is the person who has your money (or at least it will be your money once you give him your business!) it might be a good idea to factor in their impact on the value of your business. So, if your research to this point has only made you more confused than when you started don't worry. I'm not a professor or a mathematician... But I do know how to sell small businesses. And one thing I know with absolute certainty is that to successfully sell your business you must be able to explain to the buyer the true worth of your business. If you can't do that, he won't give you his money. But if you can, you will be able to sell your business in short order. But it all starts with the valuation. If you don't know how to place a price on your business (and you just pick a number out of thin air which is what a lot of sellers do!) you won't be able to explain the valuation to the buyer. And then the buyer won't buy. The key is that you have to understand how you arrived at your asking price so that you can explain the value of the business in very clear terms to the buyer. 3

4 So let's talk about how to do just that. 2 Basic Facts About The Value Of Your Business Here are 2 facts, that if you keep them in mind, will help to simplify things and make the entire process easier. Fact #1 The only purpose of doing a business valuation is to develop an appropriate Asking Price Range for your business. You then advertise your business at the high end of that range. Ultimately, the prospects who are interested in your business will decide what the business is worth to them, they will make you an offer based on that and the negotiation process will begin from there. Sidebar And trust me there is always a negotiation process. So don't start with a rock bottom price thinking it will lead to a quick sale it won't. Starting with your lowest price will only leave you with nowhere to go. Buyers will try to negotiate a lower price no matter what because it is their only way to test the market to see if they are getting a fair price. Remember valuation is an art not a science. If they were buying a used car they could look up the "Blue Book" value on the Internet in seconds. But with small businesses, there is no pricing guide the buyer can go to. So they "Test" your price by making counter offers. Here's a fact to keep in mind when setting your price: Historically the final selling price for a small business usually winds up being about 80 85% of the original asking price. Valuing your business for sale is not like taking a math test in school where there is one correct answer and your professor is going to penalize you if you don't get it exactly 4

5 right. It's really not all that complicated or intimidating when you realize that you don't have to perfectly calculate the value of your business because that perfect calculation doesn't exist. So forget about trying to find a single value for your business All you have to do is determine a reasonable ( and aggressive!!) price range, get your business out on the market and let the buyers decide what it is is worth to them. There seems to be some perverse human characteristic that likes to make easy things difficult. Warren Buffett Fact #2 The person who will be giving you money for your business is doing so for only one reason they want to enjoy the income and other benefits the business will provide for it's owner in the future. The "income and other benefits" are all derived from the earnings the business produces, so the earnings should be the basis of any valuation that will be used to establish a price range. (Basing the price on sales or on a "rule of thumb' is common and in some cases may be useful as a way of making comparisons so I will discuss that later in this report). So as we go forward with pricing our business we need to keep in mind that we want to develop a price range, not a single number and that price range needs to be derived from the businesses profits because the profits are ultimately what will motivate the buyer to actually buy. Sidebar Many uninformed sellers think they can price their business based on what they have invested in the business or how much debt they have. Or worst of all, how much they want to have at retirement. Don't be one of these poor, misguided sellers it will only set you up for disappointment and frustration. The reality is buyers don't care 5

6 about your situation or desires. They are scared to death because in most cases they are about to sink their life savings into your business. In order to motivate them to take that huge leap of faith you are going to have to motivate them, and justify your price, with money. The Multiple Of Earnings Method The "Multiple Of Earnings" method is one of the simpler ways to value a business you take a company's profits and multiply it by a number (called a "multiple") to arrive at an asking price. The "multiple" can be viewed as a measure of ROI or "return on investment". When you use the multiple of earnings method you can explain your asking price (the buyer's investment) simply by talking about the company's proven profits and the return the buyer can make on the money he is investing. Use the multiple of earnings method to price your business and you will be talking the buyer's language the entire time most other pricing methods are overly complicated, theoretical or they are based on what other businesses have sold for in the past all of which is meaningless to your buyer. But even with this simple method, there are endless ways to vary the outcome: do you use past profits or projected future profits?... Before or after taxes?... Come to think of it, how do you even define the word "profits"?... Does it mean the same thing as cash flow? Let's discuss all of these questions. The first key question to address is whether to use historical profits or future, projected profits. If you are going to convince a buyer to choose your business over all the other 6

7 businesses on the market that they can buy, you have to appeal to her motives. Setting your price range based on your actual proven profits (as opposed to speculating about future profits) makes the most sense to buyers. It directly addresses their main concern how much money the business actually makes! In the business world, the rear view mirror is always clearer than the windshield. Warren Buffett Now for the key question: How do we define "profits"? Do we use cash flow? Or do we use something called EBITDA (Earnings Before Interest,Taxes, Depreciation and Amortization)? The best, most logical number to base your valuation on is called "Owner's Benefit". Accountant types like to call this "Seller's Discretionary Income" or "Seller's Discretionary Cash Flow". I prefer the term "Owner's Benefit" because it sounds less like jargon and it speaks directly to the buyer's interests. The formula for determining the owner's benefit is: The Company's Annual Pre Tax Profit + Owner's Salary + Owner's Perks/Benefits + Interest + Depreciation This number will tell the buyer how much money the business actually has been generating for you as it's owner. Since the buyer's interest and tax payments will be different than yours, you want to include tax and interest payments in the total owner's benefit number. From there the buyer can make their own estimates of what their interest and tax payments will be. "Perks and Benefits" include things such as automobile leases, travel expenses that are optional and salaries for family members that are over and above the marker rate for the work they perform (only the amount that is above market rate should be added to the Owner's Benefit total). Any of the good stuff that you get in addition to your salary that the business pays for should be included in the "Owner's Benefit". But the key concept here is that the Owner's Benefit is the amount of money plus other benefits the business generates for the owner. And since the prospect is buying the 7

8 business in order to get that money and benefits, that is where any valuation must start. I suggest you use an average of your last 3 years owner's benefit as the basis of your valuation. You could simply take the owners benefit total for the last 3 years and divide by 3. But since your most recent performance is the most important I suggest you use a "Weighted Average". You can take 70% of your most recent year plus 20% of the prior year plus 10% of the year before that. If last year was a really good one, you may be tempted to use just the owner's benefit from the most recent year instead of the last three. I recommend you use three years because that creates more credibility with the buyer. Especially if your most recent year has been significantly better than any previous year, the buyer may regard it as a fluke or even worse they may suspect you have manipulated the numbers. Here is what we have established so far: 1.) Using a multiple of profits is the best method to value a business that is for sale because buyers are buying the business for it's profits. 2.) Using historical, proven profits is better than speculating about future projected (potential) profits because buyers can believe in them. 3.) "Owner's Benefit" is the best definition of profits because it accurately represents the money that the business provides for the owner. 4.) A weighted average of the last 3 years' Owner's Benefit is best because it emphasizes the most recent performance (which is the most important) but also protects against a skewed number if the most recent year was unusually good. In other words, buyers trust a number based on 3 years more than they do a number based on one year. A weighted average of 70% of year % of year % of year 3 is recommended. What Multiple Do I Use? So, the next obvious question is: by what number do you multiply your owner's benefit 8

9 figure? Much of what has been written on this subject states that most businesses are sold with a multiple that ranges from 1 5. But in truth, businesses that sell for 4 or 5 time their owner's benefit are rare at least when it comes to smaller owner managed businesses. In smaller businesses with an owner's benefit of $50,000 to about $250,000, the owner will usually also manage the business on a day to day basis. The buyer is in truth "buying a job". Their total return on investment is much lower because they are investing not just their money but their time. In larger businesses, where there is enough cash flow to hire a full time, professional manager, the owner can make a return on his investment without a full time commitment so that business will be valued at a much higher level. That's not to say you can't sell your business for a multiple of 4 or 5, but in my experience the vast majority of smaller businesses sell for a figure much closer to 1 to 2.5. And numerous surveys over the years in all sorts of industries show that most smaller businesses sell for somewhere between 1.8 and 2.2 times the owner's benefit. In keeping with our theme of finding a range of prices, I suggest determining a range of multiples. Start with 2.0 And use the list of factors below to adjust the multiple up and down based on your specific situation. This is just a partial list, there are bound to be unique factors that affect your business that are not listed here. Positive Factors That Can Increase the Multiple... Sales and profits have risen consistently each year for at least 3 years. A significant amount of sales come from repeat customers. Even better is revenue that comes from automatically recurring charges. Web hosting, alarm monitoring and self storage are few examples of business that may have reliable repeat revenue each month. Proprietary products, patents and/or trademarks. Exclusive rights to a territory. 9

10 Less warranty exposure than is typical in your industry. Management and/or employees will stay on after the sale. The more experienced or uniquely talented these people are, the better. The business is a franchise of a well established and well known company. For many buyers, the support and training they get from the franchiser is a major plus one they are willing to pay for. You are offering seller financing with attractive terms. Important ratios such as profit margin and cost of sales are above average for your industry. Your industry is growing and the future appears bright. For these last two items you should check with any trade associations that serve your industry. They may be able to provide you with facts and statistics that can help you show the buyer that your business is part of a growing industry or trend. Negative Factors That Can Decrease The Multiple Sales and profits have been trending down recently. Sale and profits have been inconsistent or unpredictable in the recent past. Sales from your most important product have been down or stagnant. One customer accounts for a large portion of your sales more than 20%. There are many businesses similar to yours that are also for sale. Or your products are widely available at many places a "Me Too" product a line. The business relies heavily on location for its success but the lease is not transferable or is about to expire. If this applies to your business, try to get an extension on your lease before you start to sell. Pending legal or government issues such as lawsuits or environmental concerns. Important ratios such as profit margin and cost of sales are below average for you industry. A large amount of obsolete inventory. 10

11 The business is part of a weak franchise or one with a bad reputation. Too many old and uncollectible accounts receivable. You are not offering any financing Neutral Factors That May Not Affect The Multiple These are features of your business that may be positive but are not special. In other words, these are things you would expect to find in the average business similar to yours. It s likely that other businesses that are for sale will have many of these same features, so they may not allow you to gain a premium multiple. But they can definitely help you present your business in a positive light and should not be ignored. The business is not overly dependent on you for its success and none of your customers buy simply because of their personal relationship with you. The business is not overly dependent on one customer no one customer should account for more than 10% 15% of your sales. The business is not overly dependent on one single product. The facilities warehouse, factory or retail location are in good shape and will allow the company to grow without a major investment. No pending legal issues. It is not a seasonal business and sales are fairly consistent throughout the year. How Do These Factors Affect The Price Sellers tend to focus mainly on the positive factors when talking to buyers. Buyers, however, tend to zero in on the negatives or what they perceive to be negative. They are averse to risk and so they will always be on the lookout for problems. If any of the negative factors listed above exist in your business you are not alone. 11

12 Almost every business has some problems and they should not stop you from successfully selling. That these problems exist isn t the issue, how you deal with them is. You have several choices when it comes to the weak points of your business. You can lower your price accordingly and show the buyer how and why you have discounted your price by lowering the multiple, you can ignore the issues and wait for the buyer to point them out, and you can fix the things that are fixable. Or you can do a combination of all the above. If you have old or obsolete inventory, get rid of it and take the lose. The same holds true for uncollectible receivables. The buyer will not pay you any money for these things and they will only help to create a negative overall impression of the health of your business. Other factors such as a decline in sales in recent years or one customer accounting for much of your revenue can t be fixed so easily in the short term. If you don t have the option of holding on to the business for another year or two so you can improve these things than you will have to adjust the price accordingly. Finally, there are those items that you don t control such as the fact that there are many similar businesses on the market or you are part of a franchise that is struggling. I would suggest that you not lower your original asking price because of these items. But be aware that the buyer will probably bring them up at some point so be prepared to deal with them. Before lowering your price, try first to offset any of these negatives with some of the positives features of your business. Maybe there are many businesses similar to yours on the market, but if your profits have steadily increased over the last few years or if you have a favorable lease in place that is transferable, you can show the buyer how your business is worth the price you are asking. 12

13 Future Profits, Sales & Rules Of Thumb Why We Don't Use Them In The Valuation Using A Multiple Of Future Earnings Buyers are paying for the opportunity to benefit from your company's future profits, so basing your valuation of projected future earnings can make sense. Of course, the future is impossible to predict perfectly so buyers are hesitant to pay based on unproved future earnings. If your profits have been trending up for the past 3 5 years, projecting that same rate of growth into the future and then applying a multiple to that projected profit may seem like a valid way to go. Here's the problem: Once you have your owner's benefit number you are going to apply a multiple to come up with your asking price. Impressive growth the past few years will definitely allow you to justify a higher than average multiple. So your recent growth and bright prospects for the future will be reflected in your asking price through a higher multiple. If you project your growth rate into the future and then also apply an above average multiple to those projected future profits, you have given yourself credit twice for the same positive feature. Expect a lot of resistance from the buyer. 13

14 The future ain't what it used to be. Yogi Berra Also, the best negotiating strategy is to be aggressive when setting your multiple and be more conservative with determining your profits. (And by "conservative " I simply mean using historical, proven profits instead of projected future profits). The buyer can't argue with you over the facts, but they can and will when it comes to future projections. Increasing your multiple just slightly can have a dramatic effect on the overall selling price. If you can justify to the buyer a multiple of 4 instead of 3 it will mean a 33% increase in your selling price. That's a lot easier than proving that profits will increase in the future by 33%. Side Bar: You will definitely be in a stronger negotiation position if you focus your negotiations on the multiple instead of trying to justify future projected profits. But, the best way to maximize your total income from the sale is to focus the negotiations on the terms down payment, interest rate etc. Obviously you must be willing to finance part of the selling price to do this. I strongly suggest you offer the buyer some type of financing instead of demanding all cash up front. One study after another has shown that about 80% of smaller business sales include some type of seller financing. At the end of this report I've included a Bonus Article on how to maximize your total income from the sale by negotiating the financing terms of the sale. It's not exactly related to "Valuation" but it is actually more important than the valuation when it comes to closing the sale and it is required reading if you want to most money possible out of the sale. Industry Rules Of Thumb A "Rule Of Thumb" is the most general way to ballpark the price of a business. They are so general in fact that the may be of no help at all in your particular case. Add to that the fact that most industries have more than one rule of thumb that is used. In the hair salon industry for instance, I came across these 4 different rules of thumb on just one industry web site: 1 times annual adjusted earnings. 14

15 4 times monthly gross sales PLUS inventory % of annual gross revenues PLUS fixtures, equipment & inventory % of annual adjusted earnings PLUS $2000 per station. If you own a salon and apply all 4 of these rules to your business you may come up with 4 wildly different values for your business. If your industry has one widely accepted rule of thumb you may want to use it as a starting point. But as you can see, none of the hair salon examples take into account any of the factors that are unique to a business such as the lease, the quality of the employees or recent trends in earnings. Factors that could be included in a multiple of owner's benefit calculation. So the rule of thumb is just a starting point and you will have to adjust the price up or down based on your unique circumstances and how you compare to other hair salons. Knowing your industry's rules of thumb can be helpful though. Applying them to your business will at least let you know how realistic you are being in your pricing. Also, they can be helpful in instructing unreasonable (or uneducated) buyers who make unrealistically low offers on your business. If you can show them how your pricing is in line with industry standards it can help them to move off of their low ball offer. What About A Multiple Of Sales? Basing the asking price on sales is common in some industries. Most of the rules of thumb in the restaurant industry, for example, are based on a multiple of sales. Businesses with few assets and service or sales based businesses like insurance agencies or PR firms will often use a multiple of sales. While using a multiple of sales may be standard practice in your field, it doesn't directly address the concerns of the buyer who wants to make money. Two similar types of businesses with exactly the same amount of sales may have nothing in common when it comes to profits. 15

16 So if you use a sales based valuation because that is the norm in your industry, the buyer will still evaluate your business and your asking price based on profits (i.e. owner's benefit). Here's why: Even if you are one of the lucky ones who gets an all cash deal, your buyer is probably borrowing money from someone so it's not an all cash deal for the buyer. Also, in most small businesses the owner will also manage the company they are in one sense "buying a job". Therefore, they will be paying themselves a salary (even if they don't officially set a salary for themselves, they will be living off money generated by the business). Before they buy your company they will need to know that the business generates enough earnings that they can: 1.) Make payments on their debt 2.) Pay themselves a reasonable salary to live on 3.) Have some money left over to reinvest in growing the business. If they can t accomplish these three things than either they can t buy your business or you will have to lower the price or you will have to offer your own financing terms that will allow them to accomplish these three goals. So you can t sell your business unless you can justify the selling price with the earnings of the company. I see no problem with you applying your industry's rules of thumb to your business to see what you come up with. But the buyer will only say "Yes" to buying your business when it makes sense from an earnings based perspective. More Questions & Answers 16

17 What is the difference between what you call "Owner's Benefit" and EBITDA? EBITDA (Earnings Before Interest Taxes Depreciation and Amortization) is an earnings figure used to value larger companies. The Owners Benefit figure is used to value small, owner managed companies. The main difference between EBITDA and Owner's Benefit is that the earnings in the EBITDA figure does not include the salary paid to the manager of the business. The "Owner's Benefit" does include the salary paid to the manager because the owner (or business buyer) also manages the company so that salary is a benefit enjoyed by the owner. How does the value of items on the balance sheet inventory, equipment, cash, accounts etc. affect the valuation if you are using a multiple of earnings? Some of the items on the balance sheet such as machinery, vehicles and equipment are required in order for the business to produce its earnings. So the value of those assets is already reflected in the earnings figure you are multiplying. The cash and receivables are usually kept by the owner after the sale so they wouldn t affect the price. If the buyer is going to take over the receivables than you and the buyer will have to agree on a fair value for them. Your receivables represent money you have already earned so the buyer would have to pay extra for them. Exactly what your receivables are worth today and just how collectible each account is may be something you and the buyer don t agree on. That s why it s simpler for the seller to just retain the receivables. In most cases, the inventory is valued at its replacement cost. Not at what the seller paid for it or what it can be retailed for, but what it would cost the new owner to go out and replace the inventory. Where do "Rules Of Thumb" come from? Most are derived from surveys that industries do with their members. Other information comes from surveys of business brokers about deals they have closed. It's important to note that these rule of thumb calculations are based on the actual selling price, not the asking price. These same surveys show that most businesses sell for an average of 17

18 80 85% of the original asking price. So no matter how you arrive at your asking price, make sure that it includes a cushion of up to 20% above what you actually hope to sell for. So don't make the mistake of advertising a rock bottom price hoping it will attract more buyers. No matter how low you set your initial asking price, buyers will always test it by asking for a lower price. If you don't budge at all off your initial asking price buyer's will not feel like they are getting a good deal and it will be much harder for you to sell. So always begin with an asking price at the very top of the price range. Multiplying The Profits Times A Number (The Multiple) Seems Arbitrary. Where Does This Multiple Come From And What Does It Represent? The multiple in the valuation calculation is a representation of ROI (return on invest). Lets take a business with $100,000 in owner s benefit. And Let s say that the business has a lot going for it solid customer base, good reputation, good lease and little competition. If the owner were to sell the business for $300,000 ( meaning a multiple of 3 which again, would be exceptionally high) that would mean the buyer could expect a 33% return on his investment if the business saw no increase in performance. The buyer would invest $300,000 up front and one year later would have made $100,000 and would own a business that is still worth $300,000. If the business wasn t as solid and the future earnings were not as certain, the buyer would be taking on more risk. Thus the seller may only have been able to justify a selling price of $200,000. If the business just maintained it s current performance the new owner would have invested $200,000 up front and in one year would have made $100,000 plus they would own a business worth $200,000. That means a 50% return on investment. The less stable and attractive the business, the higher the return on investment a buyer will demand. 18

19 So always look at the multiple as a measure of return on investment for the buyer. In one sense these may seem like unusually high returns for the buyer. If you compare them to the stock market they are. But remember, the typical multiples we talked about earlier ( on average they are ) are for owner managed businesses. The buyer of the business must come in each day and work the business in order to get this type of return. So comparing the purchase of a business to a real estate or stock investment is truly and apples to oranges comparison. This brings up one of the big problems owners of very small businesses encounter when they use the Internet to do research about selling a business. Most of what you will come across on the Internet is geared toward larger businesses. When you read about merger and acquisitions of mid market companies, you're reading about $20 million and $50 million businesses. Every day it seems I come across comments on blogs and in discussion groups about how such & such a business could easily sell for 6 8 time earnings. Of course it s not easy to sell a small business for 8 X earnings. (But it is easy to say things like this in Internet forums). So summing up. The multiple in your earnings X multiple equation is a representation of return on investment. In very small businesses buyers expect to get a higher ROI on their money because they are also investing their time to manage the business. Much larger companies(though still referred to as small businesses throughout the media) have more money and manpower to expand the businesses they buy so they can afford to pay much higher multiples even as high as 6 or 8 times earnings. The individual buying your smaller business will be investing not just their money but also their personal energy full time in the business. In addition to that, they will have to be able to live on the money that is left over after they have serviced the debt they took on in order to buy the company. Therefore the market for very small businesses simply can t bear a multiple of 6 or 8. And your business, like everything else that is for sale, will sell for what the market will bear. Your Next Step 19

20 Still to come in this Special Report is our discussion of Asset Based Valuations and your bonus report on Negotiating The Financing. But for many of you, the information already covered will be enough to get you started. And if it is... Then Get Started! 90% of success is showing up! Woody Allen Ultimately, the price you get for your business will be determined by business buyers. It won't be you or me that determines that number. It won't be some formula. So the key to selling sooner rather than later is to start looking for buyers now. If you've learned nothing else from this report, I hope you now see that you don't have to worry about getting your valuation exactly right up front. Just develop a price range you can explain to buyers... The go find some buyers. Until you get your business in front of buyers and get their feedback on your business and your asking price you really don't know anything for sure. The market will determine the ultimate value of your business so get it out on the market. TheBizSeller.com has two resources to help you as you go forward from this point one of them is free, the other is a paid service. How To Sell Your Business is our free question & answer section. You can read questions submitted by our actual business owners along with our answers to them. There is even a form where you can submit a question about your own business and your specific challenges in selling. Click Here to go there now. 20

21 Our paid service allows you to sell your business quickly and without using a broker by reaching our large audience of buyers. It's confidential and you never pay a commission just one low monthly fee. And you can cancel at any time. Click Here to read all about our services. Asset Based Valuations Unfortunately, there are a lot of business that can't use an earnings based valuation because they don't have any. So today I want to talk about the "Asset Based Valuation" method. If you are selling a new business that doesn't have a track record, a business that has been losing money or a business where the owner has recently died this is the method you should use to value the company. Using this method will probably result in the lowest valuation of your business what is often referred to as the liquidation value. Even if you own a successful, highly profitable business, you should still conduct an asset based valuation as a way of establishing a baseline to compare with other valuation methods you will use. Conducting An Asset Based Valuation The first thing you must do is make a complete list of the tangible assets owned by your business. Examples of tangible assets include: accounts receivable, furniture and fixtures, 21

22 equipment, inventory, customer contracts, vehicles, leasehold improvements, prepaid expenses( paid insurance premiums for example), franchise agreements. If you own the real estate that your business occupies you may be better off selling it separately from the business, which means it won't be part of this valuation. But if the business is dependent on the current location, than add the value of the real estate in this step. Next assign a price to each tangible asset based on it's fair market value. Fair market value is what the item can be sold for on the open market. It may take some research to determine this. Unless prices have changed drastically, inventory should be valued at your cost. Sometimes an owner will attempt to value the company's assets based on book value ( the non depreciated value of the item as it is currently valued on your balance sheet). It is the rare buyer who will pay you book value they can buy brand new equipment and vehicles for nearly the same price as the book value. So do your best to assign a value to each item based on what it can realistically be sold for on the open market. And make sure to note next to the price why it is worth that amount. Finally, make a comprehensive list of the intangible assets owned by the company. Examples of intangible assets: Customer lists, proprietary information and software, trained and experienced employees and patents, copyrights trademarks etc. Come up with what you consider to be a fair value for each item. Next, clearly describe the item and explain why you believe it is worth the amount you're asking. An intangible asset that gets a lot of attention is "goodwill". But Goodwill, in actuality, is just the sum total of all of your intangible assets. 22

23 Adding the total of your tangible assets plus the total for your intangible assets will give you a good idea of what your asking price will be. How To Negotiate The Sale When Using An Asset Based Valuation The reality is that you may not find a buyer who is willing to pay for all your tangible and intangible assets. She likely will want to pick and choose between them. Also, it is unlikely that that a buyer will agree to all of the prices you've assigned to your assets no matter how conservative you are. You should be prepared to negotiate, not just the selling price of certain assets, but which assets will actually be part of the sale This is why it is so important to take the time to describe your intangible assets and provide an explanation on all your pricing. It allows you to set the highest justifiable asking price you can. Then, when the buyer wants to negotiate and no matter how low you set your asking price the buyer will want to negotiate you will have room to maneuver. Your business is worth only what someone will pay for it. The asset based valuation method is just a way to arrive a reasonable starting point once you have a living, breathing buyer in front of you some negotiating on price will always need to be done. By following the process I've described here, you will set yourself up to sell your business for the best possible price even if that turns out to be less than the amount you arrived at in your original calculations. Bonus Section 23

24 How To Negotiate The Terms So You Can Get The Maximum Amount Of Money From Your Business Many business sales fall through because the buyer and seller make two key mistakes: 1.) They focus the negotiations almost entirely on price 2.) They negotiate one issue at a time When you first look at the process of selling a business the sheer number of details that need to be agreed upon can make a sale seem impossible. In addition to price these are just some of the possible items that can be negotiated: legal structure of the sale, the assets to be included, how to handle accounts receivable, non complete and employment contracts, due diligence, as well as down payment and other financing terms. The good news is that the more the negotiations can focus on a give and take regarding all these issues simultaneously, the better your chances of getting your asking price (or something very close to it). No area offers more opportunities to negotiate successfully than when it comes to the details of the financing. Always keep in mind that when it comes to discussing the details of the financing arrangements: You want to lower your risk by getting paid ASAP while keeping the payments low enough that the buyer can make payments to you out of the business' monthly cash flow. Let's look at some ways you can arrange the financing in order to make a deal more likely and how to do it without lowering the price: Present The Buyer With Multiple Financing Options 24

25 Let's use the example of a business with a selling price of $200,000 where the buyer and seller agree that the buyer will pay $100,000 down and the seller will finance the rest. Below are a combination of different interest rates and time periods that could be used along with the corresponding monthly payments: 5 Years Interest rate Payment Total Of Payments 6% $1,933 $115,980 7% $1,980 $118,800 8% $2,027 $121,620 9% $2,075 $124,500 10% $2,124 $127,440 4 Years Interest rate Payment Total Of Payments 6% $2,348 $112,704 7% $2,394 $114,912 8% $2,441 $117,168 9% $2,488 $119,424 10% $2,536 $121,728 3 Years Interest rate Payment Total Of Payments 6% $3,042 $109,512 7% $3,087 $111,132 8% $3,133 $112,788 9% $3,179 $114,444 10% $3,226 $116,136 Of course, you want to get paid as soon as possible and if you are like many sellers you will offer a 3 year repayment plan. But what if the buyer has determined that after he pays himself a livable wage there is only $2,000 left from the business' cash flow each month. The lowest payment in the three year plan is $3,042 at a rate of 6%. If this is the only offer you make to the buyer and he can take it or leave it, he will most likely leave it. But what if instead of a "take it or leave it" approach, you gave the buyer 3 choices and 25

26 let him choose one. For example you could offer the buyer one of these three options: Option 1 Option 2 Option 3 Principle $100,000 $100,000 $100,000 Term 36 months 48 months 60 months % Rate 6% 7% 8% Payment $3,042 $2,394 $2,027 Total Payments $109,512 $114,912 $121,620 If you present the buyer with just the first option (because it suits your wants) it's likely that the buyer will respond by asking for a price reduction to get the payments in line with his budget. But if you give the buyers all 3 options and let him pick one, you accomplish several things: 1.) You get the focus off of price (the principle remains $100,000 in all 3 options) 2.) You give the buyer an option that meets his stated requirements thereby increasing the chances that, instead of asking for a price concession or making a counteroffer, he will just pick the 3rd option. 3.) You are improving the tone of the entire negotiation process by offering a "concession" by allowing the buyer to pay you back over a longer period of time. (Any time you make a concession you always want it to be acknowledged by the buyer. You should say something along the lines of: "Bill, when I planned my retirement I was counting on having all my money out of the business in three years, but if it's what it takes to make the deal, I'm willing to give you up to two more years to pay me off") 4.) You are getting compensated for making this concession because you will be paid a higher rate of interest if the buyer pays you back over a longer time period. You will receive an extra $12,108 in this example if the buyer picks option #3 over option #1. Any Issues Regarding The Financing Can Be Bart Of The Choices You Present The options don't need to be limited just to rate and number of months either. 26

27 For example, if the buyer pays you back in 36 months you may want to require that the loan be secured with 30% of his personal assets and the remaining 70% will be secured by the business' assets. As the term lengthens, so does the amount of the buyer's personal assets he must put up to secure the loan a 48 month term could require the buyer to put up 50% of personal assets and a 60 month term 70%. Another element you may want to include is an acceleration clause, but you may choose to require it only if the buyer opts for a longer repayment period. Using the example of the $100,000 loan from above, the options you present to the buyer may become more detailed: Option 1 Option 2 Option 3 Principle $100,000 $100,000 $100,000 Term 36 months 48 months 60 months % Rate 6% 7% 8% Payment $3,042 $2,394 $2,027 Total $109,512 $114,912 $121,620 Payments Acceleration No Yes Yes Clause Amount Of Personal Security 30% 50% 70% The buyer may come back and say he likes Option #3, but wants the interest rate from Option #1. In fact, that type of response is likely. But if you can come to an agreement on that one issue (either justify the 8% rate or settle on some type of compromise) you've settled an entire group of details at once. One thing you want to avoid is presenting the buyer with options that bring into play things that have already been agreed upon in previous negotiations. In the example above, the buyer and seller have already agreed on a price of $200,000 with a down payment of $100,000. If, when trying to work out the other details such as interest rate, the seller proposed an option with a different price and/or lower down payment, that would not be good for the negotiation process. 27

28 It would create a sense of uncertainty between the negotiators: "Are the things we have already agreed to solid or are they going to change tomorrow?" Be creative as you need to be when negotiating, but don't reopen issues that have already been settled. Bring Non Financing Issues Into The Mix There is no reason why the discussion about the financing should be separated from all the other agreements that make up the sale that have yet to be settled. If it's appropriate in your situation, you can offer to lower the interest rate by one point in exchange for a more lucrative consulting agreement. Or you may agree to extend the payment term from 48 months to 60 months in exchange for the buyer giving you a less restrictive non compete clause. In Closing If you have made it this far... Congratulations! You are obviously serious about selling your business. If you have any questions or feedback about this report, you can always me at: pat@thebizseller.com Also, don't forget you can find more information and help at TheBizSeller.com by following one of these links: How To Sell Your Business is our free question & answer section. You can read questions submitted by our actual business owners along with our answers to them. There is even a form where you can submit a question about your own business and your specific challenges in selling. Click Here to go there now. 28

29 Our paid service allows you to sell your business quickly and without using a broker by reaching our large audience of buyers. It's confidential and you never pay a commission just one low monthly fee. And you can cancel at any time. Click Here to read all about our services. TheBizSeller.com home page 29