Unfortunately, probably not as much as the owner thinks it is. According to B2B CFO®’s The Exit Strategy Handbook, business owners often feel:
- Buyers and appraisers are intentionally undervaluing the business
- The prospective buyer does not really understand the true value of the business
- The various valuation methods are not realistic ways to calculate value
- Not enough value is given to intangibles, such as employees, customers, etc.
There are 10 different valuation methods outlined in the book, Private Capital Markets, Valuation, Capitalization, and Transfer of Private Business Interests. They showed how one company’s value, using the same financial information, could have a value ranging from $2.4mm to $18.2mm. That’s a very wide range for a business to be valued at – most owners want to know what their business is worth in a fairly tight range. For most small to mid-sized businesses, they will be valued at a multiple of EBITDA, less any debt assumed by the buyer.
EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. This information can easily gleaned from a company’s financial statements. There are typically several adjustments made to increase or decrease EBITDA. The Success TeamTM needs to spend time evaluating your business in order to identify any possible adjustments before any discussions with prospective buyers. Different types of buyers will pay more than others. ESOPs and management buyers are on the lower end, financial buyers in the middle, and strategic buyers usually willing to pay the most for a business. While multiples can range from 3x to 10x EBITDA, most are in the range of multiple of 4-6 times EBTIDA for most small to mid-sized businesses. Consequently, increasing EBITDA by $100,000 could net easily another $500,000 for the owner. Adjustments typically many of the following:
- Excessive compensation or below market compensation to owners
- Personal expenses passed through the business
- Excessive personal travel
- Related party transactions that are not a market value, such as building or equipment leases
- Write-offs of unproductive or obsolete assets
- One time litigation costs
- Catastrophe losses such as fires, tornado damage, etc.,
- Opening a new facility
So, if the owner thinks his business is worth $5mm, but The Success TeamTM thinks it’s only worth $3mm, what are the next steps? Stay tuned for my next post on how to increase the value of your business.