Each year approximately 4 million businesses are sold in the United States. The majority of these transactions involve small businesses, more commonly know as "main street businesses." Examples would include florists, pizzeria, liquor store, dry cleaners, convenience stores, etc. In many cases a business broker facilitates these transactions. It's estimated that there are less than 4 thousand business brokers in the country, a small number when compared to the aforementioned number of transactions.
According to surveys conducted by the Independent Business Brokers Press
The breakdown of businesses sold by size would be as follows:
- 10 or fewer employees with annual revenues of less than $750,000 annually represent 80 % of the transactions
- 100 or fewer employees with annual revenues between $750,000 and $1,000,000 represent 11% of the transactions
When people ask what a business broker does my initial response is: "Compare their role to that of a real estate broker, but instead of selling homes they sell a business."
Some of the more important responsibilities of a business broker include:
- Listing the business for sale
- Establishing a sales price
- Locating qualified buyers
- Maintaining the confidentiality of the business sale
- Conducting a buyer search and presenting the business with minimal disruption
- Facilitating the sale between seller and buyer
One of the most important roles of a business broker is to place a value on the business and establish the sales price.
In order to understand how a small business is valued you need to have a basic knowledge of the following:
EBITDA, which represents "earnings before interest, taxes, depreciation and amortization." An accounting term frequently used in the business world.
SDE, which is, know as "owners cash flow or sellers discretionary earnings."
By taking EBITDA and adding owner's salary you arrive at SDE. Owner's salary should include any perks such as benefits, company vehicles, etc.
This is the basis used for valuing most small businesses. Once SDE is identified a multiple is then applied which can range from 1.5 to 2.5 not including real estate or inventory. If owned real estate is involved a value will be established based upon existing market factors. In the case of inventory the process typically involves a count of the inventory and that value or amount is added to the sales price. According to Tom West, publisher of the IBBP, franchised business, usually command a selling price 10% higher versus a comparable business that is not franchised. This could be due to the strong "branding" of a franchise and the fact that a franchise is part of a network.
Returning to the pricing format, consider a business with an SDE of $100,000; its selling price excluding real estate and/or inventory will range from $150,000 to $250,000. Typically the seller retains accounts receivable so that number will not be included in the sales price. If there is any debt that the buyer will assumes that amount needs to be deducted from the selling price. Many sellers will finance some portion of the sales price. The lower the sales price the less willing a seller would be to offer financing. Financing is an opportunity for a seller to earn a greater return on the sale due to the added interest.
In the case of larger businesses, valuation becomes more complex and multiples will vary from industry to industry. Transactions can be based upon asset value, percentage of revenues or pre-tax income multiplied by the industry multiple. Commissions for businesses that sell well over $1million dollars are usually calculated based upon the Double Lehman formula. Under this method the commissions are based upon the first million at 10%, the second million at 8%, the third at 6%, the fourth at 3% and the fifth million and above at 2%.
When valuing small businesses, issues can include poor record keeping, family members on the payroll but not fully productive and incomplete financial reports. This is a major benefit of the SDE approach, since the valuation is based upon what the owner(s) actually earns. The business broker will meet with the owner and develop a business profile based upon each element of the business.
Some of the advantages to be gained from a business broker include:
- Locating qualified buyers and insulating the seller from business interruptions
- Allows the seller to focus on their operation of their business
- An intermediary who can facilitate the transaction without emotion
- Experience in business valuations and sales transactions
- Access to an inventory of buyers
For those business owners who look to sell their business it's important to remember that the buyer will be far less emotional regarding the sale than the seller. The other point to keep in mind is that buyers won't pay for potential. Put another way, buyers don't want the seller to profit from the buyers future hard work and investment.