The 3 Most Critical Issues in Buying or Selling a Business

Critical issues in buying or selling a business.As a business broker with offices in Fairhope, Alabama and Baton Rouge, Louisiana,  I’m often asked what the top critical issues are in buying or selling a business.  If the top three issues discussed below in the sale or purchase of a business are not properly addressed, then there is a good chance the transaction will fail.

So to get to the core of the question, these are in my opinion the top three issues involved in buying or selling a business:

1. Critical Issue #1: Confidentiality

Confidentiality is critical to the successful transfer of a business.  If word gets out that a business is for sale, several things start happening and none of them are good for the seller or buyer of the business.  First, key employees start looking for other jobs, fearing that a new owner may not retain them.  In the uncertainty, customers may begin shopping elsewhere.  Suppliers get nervous.  Competitors can take advantage of the situation.

This is why a prospective business buyer will be asked to sign a non-disclosure confidentiality agreement early in the process of looking at a possible business acquisition. In this agreement, the potential buyer confirms that he/she will not disclose the fact that the business is for sale except to professional advisors.

If you show that you take the need for confidentiality seriously, you will be regarded as the professional that you are.

2. Critical Issue #2: Valuation

Nothing causes the buyers and sellers of businesses more anxiety than the issue of valuation. The question of selling price haunts both parties. The seller doesn’t want to price his business too low and “leave money on the table.”  On the other hand, the buyer of the business is afraid he’ll pay too much and not get the best possible price.

Formal, fully documented business appraisals are now readily available.  In addition, there are rules of thumb guidelines that can be used to quickly estimate the value of a business.  As just one example, we know that a full service restaurant with a liquor license is worth about 30% of its annual gross revenue as an ongoing business.  This assumes – big assumption – that the business is earning the average bottom line profit for its peer group.

There are rules of thumb guidelines for almost all categories of business from ice cream stands to manufacturing plants.  But again, these guidelines provide only quick estimates.  And written, fully documented business appraisals are now done by several respected national firms at a cost similar to real estate appraisals.

3. Critical Issue #3: Financing

Financing is always a concern, as hardly any business buyer has the financial capacity to write a check for the purchase price of a business.  If they did, they would most likely be living off of investment income rather than buying a business.

These are five possible sources for business acquisition loans:

BANKS – Although most people seeking a loan to buy a business will think first of a traditional bank loan, I can tell you from years of business brokerage experience that banks generally do not make business acquisition loans.  There are exceptions but they’re rare.

SBA – The SBA, through its approved lenders, provides business acquisition loans.  The SBA does not make direct loans, but rather guarantees a portion of the loan that is made by the approved lender.   It’s known as the SBA 7(a) program.  Wells Fargo Bank is currently the top volume SBA lender nationally.

The SBA route for a business acquisition loan is sometimes frustrating because of the time and detail that is involved.  However, keep in mind that the SBA will approve loans that others have turned down and will usually approve them with a smaller down payment.  In most cases, it’s worth the wait.

FAMILY – Many times the older generation in a family will loan the down payment or the entire amount needed to a promising member of the family’s younger generation.  If your family is willing to loan you the money, one word of advice is in order.  Have a very clear understanding as to how the debt is to be handled and put it in writing in the form of a legal note.

THE SELLER – In a significant percentage of the business transfers that I handle as a business broker, the owner of the business finances a portion of the purchase price for the buyer.  Some sellers cannot offer owner financing for a variety of reasons, but when they can, it conveniently solves the problem of financing.

The fact that the business owner is willing to finance the sale of his company provides more than a convenient finance plan.  More importantly, it provides a strong validation of the owner’s belief that the business will support the owner and earn enough cash to pay back the loan.  You can’t get any better recommendation on the business than this.

The normal down payment for owner financing ranges generally from around 30% to 50% of the purchase price of the business.  Interest rates are generally market driven but there is more flexibility here than in other forms of financing.

401(K) FUNDS AND IRA ACCOUNTS – The use of these funds to buy a business, without tax penalty, is a fairly recent development.  Several national CPA and attorney groups have developed a plan, approved by the IRS, which allows you to use your funds for business acquisition.  There are legal and accounting fees involved, but they are a small fraction of the tax penalty that would be assessed for cashing in these accounts early.

 The above ­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­five sources of financing are not exclusive to each other.  I recently handled a transaction in which three of the five sources were used to buy the business.

It’s called creativity!

To order our complimentary 62-page booklet entitled “How to Buy a Business in a Safe and Organized Way,” please see the ordering information on the upper right area of this page.

If I can assist you with any considerations involved in the valuation and transfer of ownership, please don’t hesitate to email or call me.

For further reading, here are additional related articles:

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   With offices in Fairhope, Alabama and Baton Rouge, Louisiana, he may be reached at (251) 990-5934 (Fairhope), 225-465-5799 (Baton Rouge) or by email at Will@WilliamBruce.org. 

 
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Help Is On the Way for Restaurant Owners

Help is on way for restaurant owners

Help is on the way for hard-hit restaurant owners.

Help is on the way for beleaguered restaurant owners who have been among the hardest hit business proprietors during the pandemic.

The Program

The help for restaurant owners comes via the Restaurant Revitalization Fund.  The American Rescue Plan Act, recently enacted by Congress, established the Restaurant Revitalization Fund with a balance of $28 billion to provide financial assistance to restaurants and other eligible businesses.  

The program, administered by the Small Business Administration (SBA), will provide restaurants with funding equal to their pandemic-related revenue loss up to $10 million per business and no more than $5 million per physical location.

Business owners are not required to repay the funding as long as funds are used for eligible uses no later than March 11, 2023.  In other words, if you play by the rules, it’s a grant, not a loan!

Businesses that received a PPP loan are still eligible.

Who Can Apply

Eligible entities that have experienced pandemic-related revenue loss include:

  • Restaurants
  • Food stands, food trucks, food carts
  • Caterers
  • Bars, saloons, lounges, taverns
  • Snack and nonalcoholic beverage bars
  • Bakeries (onsite sales to the public comprise at least 33% of gross receipts)
  • Brewpubs, tasting rooms, taprooms (onsite sales to the public comprise at least 33% of gross receipts)
  • Breweries and/or microbreweries (onsite sales to the public comprise at least 33% of gross receipts)
  • Wineries and distilleries (onsite sales to the public comprise at least 33% of gross receipts)
  • Inns (onsite sales of food and beverage to the public comprise at least 33% of gross receipts)
  • Licensed facilities or premises of a beverage alcohol producer where the public may taste, sample, or purchase products

The Application and Filing Instructions

Complete details on this financial help for restaurant owners can be found on this SBA website: https://www.sba.gov/funding-programs/loans/covid-19-relief-options/restaurant-revitalization-fund?utm_medium=email&utm_source=govdelivery.

The SBA will begin accepting applications via the application portal on Monday, May 3. The application portal will remain open to any eligible establishment until all funds are exhausted. 

If We Can Help

Our firm specializes in business valuations, sales, mergers, and acquisitions.  If we can assist during these strange times, please don’t hesitate to call or email.  For our article on restaurant valuation, please click here.  

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   With offices in Fairhope, Alabama and Baton Rouge, Louisiana, he may be reached at (251) 990-5934 (Fairhope), 225-465-5799 (Baton Rouge) or by email at Will@WilliamBruce.org. 

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What is Bitcoin? Here’s the Skinny.

Small Business Weekly explains BitcoinThe latest issue of “Small Business Weekly” is out and contains an article that explains Bitcoin.  Other articles included are:

  • Trump hotels removed from top luxury network.
  • 4 best practices for scheduling a virtual event.
  • What are business brokers and what do they do?

To read the newsletter, please visit Small Business Weekly.  To subscribe, click the button at the bottom of the newsletter to have it delivered to your inbox each Monday morning.  We will not spam you!

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   With offices in Fairhope, Alabama and Baton Rouge, Louisiana, he may be reached at (251) 990-5934 (Fairhope), 225-465-5799 (Baton Rouge) or by email at Will@WilliamBruce.org. 

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America’s Premiere – and Free – Small Business Consulting Service

Small Business Development Centers offer valuable and free assistance

America’s Small Business Development Centers offer valuable – and free – advice.

“You have the best coach, business advisor, analyst and mentor I’ve ever had in any business,” says businessman Reed Rogers Of Lillian, Alabama, when talking about the assistance he received from the local Small Business Development Center.

And the good news for aspiring and current business owners is that there is probably a Small Business Development Center (SBDC) near you.  In partnership with the U.S. Small Business Administration, there are nearly 1,000 Centers across the country.

However, less than half the funding of the Centers comes from the SBA.  The balance comes from a variety of sources including donations from successful businesses.

SBDC advisors provide current and future small business owners a variety of free business consulting and low-cost training services including business plan development, manufacturing assistance, technology development, funding assistance, exporting and importing support, disaster recovery assistance, procurement and contracting aid, market research help and more.

Nationwide, small businesses employ 60 million people, which is nearly half of all American workers. With deep roots in their communities, small firms and their employees are the engines driving the American economy. Small Business Development Centers provide these local businesses and entrepreneurs with the resources they need to thrive, compete, and succeed.

Lest you think this is another wasteful government program, ponder this: In my home state, for every federal dollar invested in the Alabama SBDC program, $2.35 is
returned to the state, and $3.79 is returned to the federal government in tax revenue.

In other words, this dog will definitely hunt!

A common thread running through the accolades from clients of the SBDC is that the assistance received is real-world and spot-on.  Maria Richard, a client of the Mobile, Alabama SBDC related, “My business advisor, Mel Washington, has been the most supportive, encouraging, and innovative person I’ve spoken with about my business. He has helped me fine tune my processes and identify my company’s position in the marketplace.”

Often located on college campuses, SBDC offices successfully combine private sector know-how with the educational background of universities in order to provide entrepreneurs with the resources they need to feel confident in starting and running a business.

For additional information on the services available, please click here.  And to find the Small Business Development Center near you, visit this SBDC office locator.

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

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The Latest Issue of “Small Business Weekly” Has an Article Ranking Franchise Investments Best to Worst

Small Business Weekly

The latest issue of “Small Business Weekly” is out and contains an article ranking franchise opportunities from best to worst based on SBA loan defaults.

Other articles include:Best and worst franchises

  • Learning from Abraham Lincoln’s failures.
  • What to know when applying for a new PPP loan by March 31 deadline.
  • Google ranking factors: What’s the secret sauce.
  • The easiest way to achieve email inbox zero.

To read the newsletter, please visit Small Business Weekly.  To subscribe, click the button at the bottom of the newsletter.

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   With offices in Fairhope, Alabama and Baton Rouge, Louisiana, he may be reached at (251) 990-5934 (Fairhope), 225-465-5799 (Baton Rouge) or by email at Will@WilliamBruce.org. 

 

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SBA Extends Deadline for COVID-19 Disaster Loan Applications

SBA COVID-19 Disaster Loans explained by William Bruce

SBA COVID-19 disaster loan application deadline extended.

Just recently, the SBA announced that the deadline to apply for a COVID-19 pandemic Economic Injury Disaster Loan has been extended to December 31, 2021.

To date, SBA has approved $197 billion in low-interest loans, which provide U.S. small businesses, non-profits, and agricultural businesses working capital funds. Economic Injury Disaster Loan applications will continue to be accepted through December 2021, pending the availability of funds.

Loans are offered at affordable terms, including a 3.75% interest rate for small businesses and 2.75% for non-profit organizations, a 30-year maturity, and an automatic deferment of one year before monthly payments begin.

The SBA Economic Injury Disaster Loan program is separate from the Payroll Protection Plan (PPP) loans and requires a different application.

For details and an application, please click here.

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

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The New Stimulus Package Explained

New stimulus act explained

Here’s a quick summary of the new stimulus package.

The new stimulus bill signed by the president Sunday night contains these items according to Forbes.  To read the full Forbes article, please click here.

Stimulus Checks: The new stimulus package will provide a one-time stimulus check of $600 for each eligible individual based on the same income limitations for the first stimulus check, which is a 2019 income less than $75,000 for each individual and $150,000 for each married or joint filer. Eligible dependents 16 and younger can qualify for $600 stimulus checks, while married and joint filers can get $1,200.

Unemployment Insurance: The new stimulus package includes $300 a week for enhanced unemployment insurance.

Rental Assistance: The stimulus package includes $25 billion of rental assistance to protect vulnerable Americans who are at risk of losing their home. There is also a one-month extension of the federal eviction moratorium.

Additional Benefits: The stimulus package also includes funding for the Paycheck Protection Program ($284 billion), education ($82 billion), child care ($10 billion), clean energy and fossil fuels, and vaccine distribution, among other benefits.

What’s Missing: Student loan relief was dropped from the stimulus package. There is also no Covid-19 liability protection for businesses or any state or local aid.

Our research here in the William Bruce office confirms that the act reauthorizes loans under the expired Payroll Protection Plan to certain businesses that have already received a PPP loan.

The act offers a second loan to businesses that meet certain eligibility requirements. Specifically, companies applying for a second loan must show that they employ no more than 300 employees.  Additionally, businesses are eligible only if they have used or will use the full amount of their initial loan and have lost at least 25 percent of their revenue in any quarter of 2020.

Business owners interested in applying for a first or second PPP loan should promptly contact their professional advisors.

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

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Should You Sell Your Business Now or Wait?

Sell business now or wait

Should you sell your business now or wait.

We’re living in strange times with the pandemic, a record number of hurricanes and a change of residents in the White House.  So if you’re considering exiting your business, it’s natural to wonder if you should sell your business now or wait a while.

Among the many issues you must weigh, probably the most important consideration in making the decision to sell your business now or wait for a while longer is the question of valuation.  In short, business owners are wondering what effect the pandemic has had on the valuation of small to medium size businesses?

The answer is, “It depends.”

It depends almost entirely on the type of business, with bars and restaurants suffering the most. I’m advising my restaurant and bar clients who are considering selling their businesses to wait.  Valuations are down critically in the category because earnings have been so dramatically reduced.  If these owners can survive until the country is vaccinated — big “if” —  then they will realize more from their years of hard work.

Other categories of businesses are more fortunate.  In most other categories, valuation specialists, myself included, are not penalizing the business for a dip in earnings if experienced during the pandemic, realizing that it’s not a trend.  And any dip is likely to be dramatically less than in the restaurant/bar sector and easier for business buyers to overlook.

In addition, there are at least three other issues for a business owner to consider when trying to decide whether to sell the business now or wait.  These are (1) market availability, (2) the accessibility of buyer financing and (3) the time frame from the decision to sell until you get to the closing table.

By market availability, I mean what businesses are on the market and available for a business buyer to consider.  A lot of businesses on the market favor the buyer; fewer options favor the seller. Right now, there is a scarcity nationally of businesses posted to the business-for-sale websites compared to normal times.  I’m in touch weekly with business brokers around the country and almost to a person, they tell me they have fewer offerings in their portfolios now than they have had in a long time.  Some say the fewest ever.

Regarding buyer financing, banks with the federal government’s encouragement are now aggressively making loans, especially under the SBA 7(a) business acquisition loan program.  I have bankers calling me frequently soliciting referrals of business buyers seeking financing.

The last consideration I’ll discuss is the time it takes to sell a business.  It’s not an overnight process.  Selling a business versus selling a home is more complicated and it takes longer.  Four to eight months is a reasonable time frame.

Because of this, a business seller should start planning ahead.  There is more seasonality to business sales than most folks would realize, with January through April being the busiest months. It’s not dramatically busier, but in my 34 years of business brokerage, I’ve noticed it.

No doubt, you as the business owner, have more issues to consider than just those discussed above. After all, you have successfully operated your business over many years and you are the ultimate decision maker.

You’ve seen, haven’t you, photos of President Truman seated in the Oval Office behind the desk plaque, “The Buck Stops Here.”  It also applies to you, the business owner.

If you think I might be of assistance with your business planning, please don’t hesitate to call or email.  All communications are strictly confidential.  If you would like to have it, I can email you a digital copy of my 40-page booklet, “How to Sell Your Business While Avoiding Costly Mistakes.”

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

 

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Considering Buying a Business? Here’s How to Analyze It.

How to analyze a business to purchaseBy William Bruce

Are you considering buying a business but are not quite sure how to analyze it?  Here’s how to do it.

First, The Need for Confidentiality

Confidentiality is critical to the successful transfer of a business.  If word gets out that a business is for sale, several things start happening and none of them are beneficial to a prospective buyer.  First, key employees start looking for other jobs, fearing that a new owner may not retain them.  In the uncertainty, customers start looking around and begin shopping elsewhere.  Suppliers get nervous.

This is why a seller or business broker will ask you to sign a non-disclosure agreement.  In this agreement, you confirm that you will not disclose the fact that the business is for sale — except to your professional advisors.  And yes, your spouse is considered a professional advisor.  After all, he/she consults with you often on a professional basis, right?  Just caution your advisors on the need for extreme confidentiality.

If you show that you take the need for confidentiality seriously, you will be regarded as the professional that you are.

The Anonymous Customer

If you’re working with a business broker, he will probably have furnished you with a summary profile on the businesses.  The profile will contain the salient points of the business including gross revenue and earnings.  The first step in analyzing the business might be an anonymous visit posing as a customer.  We call this a reconnaissance run.

As you visit, first, note the location.  Is it appropriately located for the type of business?  As you’re driving into the parking lot, what does the business look like from the street?  What about signage and street identification?  Then as you walk to the entrance, what kind of an impression do you receive?

Once you’re inside, take a close look around.  If it’s a retail establishment, are the shelves full?  Is it clean and neat  Are there customers there?  Are the employees helpful?

What is the general feeling you received from your visit?  If you decide this is a business you want to follow up on, make a list of questions for the owner.  Make this list while your visit is fresh on your mind.  Include anything and everything you’re curious about.

It’s great if the image is good, but don’t despair if it’s not.  As one of my astute clients reminded me recently as I was lamenting the poor street image of one of my offerings, “It’s an opportunity for a new owner to make a difference.”

A word of caution:  While on this visit, don’t talk to anyone in the business about the fact that the company is for sale.  Chances are the employees don’t know it’s for sale.  And even the owner would not be free to talk about it at this point within earshot of customers and employees.  Chat pleasantly about the weather … or college football!  (‘Tis the season, you know.)

The Meeting With the Owner

The next step in this logical sequence will be a meeting with the owner.  If you’re working with a business broker, he will set up the meeting at a time convenient for both parties.  He will attend the meeting with you and facilitate the exchange of information.

Be sure to bring your list of questions.  Ask anything you want to.  However, it’s usually best, at this point, not to discuss the asking price of the business or the possibility of owner financing.  That comes later.  But ask anything else that comes to mind.  Nobody knows the business better than the owner.  If you’re meeting at the business, ask for a tour of the facility.

It’s important that this meeting remains informal and cordial.  Remember, you are both checking each other out.  If the owner is going to finance a portion of the selling price, he’s looking at you as much as you’re looking at the business.  It’s a two-way street.

At the end of the meeting, you don’t have to express any commitment.  Simply say something like:  “Well this has been very informative.  Thanks for your time.  Let me consider this new information.”  It might also be a good idea to convey to the owner that the information will be kept in the strictest of confidence.  He’ll appreciate your sensitivity to that issue.

Computing Discretionary Earnings

The next step is to determine the owner’s discretionary earnings.  After all is said and done, what you will be buying is the ability of the business to produce profits.

So first let’s define discretionary earnings.  Some professionals refer to it as adjusted cash flow.  Discretionary earnings are defined as that amount of cash left over after only the necessary operating expenses have been paid that is available for (1) owner’s remuneration, (2) return on investment, and (3) debt service, if any.

Another way to express it is that discretionary earnings are the total owner’s benefit from owning the business regardless of how the owner takes the money out of the business.

Discretionary earnings are not the same as net profit shown on the business tax return.  It’s not the same because of the bookkeeping practices of most business owners.  Simply stated, most business owners make strenuous efforts to reduce any taxable income by running some expenses through the business that are not really necessary to the operation of the business.  This practice reduces tax liability but it also oftentimes masks the true earnings record of a business.

In considering a business, your challenge is to determine its true discretionary earnings.  CPAs sometimes refer to this exercise as the recasting or normalizing of the financial statements.  If you are using a business broker, he has probably already prepared a recasting worksheet on the business.

Here’s an article explaining more about the computation of discretionary earnings.

To Pursue or Not to Pursue

After computing the discretionary earnings of the business, the next step is to determine if the cash flow is enough for you.

To do this, you need a fairly close approximation of what your debt service, if any, will be on the amount borrowed to buy the business.  After all, it’s the amount left over after debt service that will be available for you and your family to live on.

Your broker will have amortization tables available for debt calculation.  Business loans without real estate generally run seven to 10 years.  With real estate, the term of the loan can be up to 20 years.

The arithmetic from this point is fairly simple.  Just take the yearly bottom line discretionary earnings of the business and subtract the annual debt service.  If the remaining balance is enough to support you and your family, then this business might be one that you would want to pursue.

It probably should be mentioned that the above calculations do not consider any increases in revenue and earnings resulting from new ownership.  Historically, a business will experience a revenue increase of between ten and fifteen percent due solely to a change in ownership.  Nor does this calculation account for any new products and services or other changes that a new owner may plan to introduce.

Now it’s decision time.  If the business is of interest to you, and if it returns the amount of cash flow you need (or can be made to do so), and if you can envision yourself successfully running the business, then you may be ready to move on to the next logical step.

If you’re ready to pursue this business, my next blog post will outline an important step: The Contingent Offer.

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

Follow William on LinkedIn.

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Here’s How to Value an HVAC Business

how to value an HVAC business

Here’s how to quickly estimate the value of an HVAC business.

The valuation of privately held businesses is sometimes confusing.  But fortunately for heating, ventilation and air conditioning – HVAC – businesses, we have valuation formulas that will yield a pretty close approximation of value.  In determining how to value an HVAC business, let’s take a look at two valuation formulas.

Two frequently used formulas that professionals use to value an HVAC business involve (1) a percentage of gross annual revenue, and (2) a multiple of discretionary earnings.

First, let’s consider the formula that uses a percentage of gross annual revenue.  One widely respected reference source says that HVAC companies are worth somewhere in the range of 35 to 50 percent of annual revenue plus inventory stocked for resale at cost.  Where within this range a particular business falls depends on several factors discussed below.

The other formula maintains that HVAC businesses can be valued by using a multiple of yearly discretionary earnings.  What are discretionary earnings?  The number is sometimes also sometimes referred to as adjusted cash flow.

One easy way to define discretionary earnings is to explain that it is the total financial benefit to the business owner from his/her ownership of the business, regardless of how he/she takes that benefit out of the business.  For a more detailed description of the term, take a look at this article.

So with the term defined, let’s again quote a respected industry source which asserts that HVAV businesses are valued at 2 to 3.5 times discretionary earnings plus inventory for resale at cost.  This valuation based on a multiple of discretionary earnings is generally considered more accurate than the formula that uses a percentage of revenue.  After all, earnings are more important to value than revenue.

The formulas do not include the value of any real estate.  Any realty included in the transaction should be added to the final formula result, and as stated above, the cost of any inventory which is on hand for resale should also be added.

So where in the two ranges quoted above would a particular business fall?  Listed below are some of the factors to consider:

  • Location in a growing area with a strong local economy adds value.
  • A clean set of books and tax returns bring value to the company.
  • A trend of growing revenue and profits definitely creates value.
  • A good staff including a general manager and well-trained technicians adds value.
  • Conversely, an overreliance on the owner for management lower value.
  • A large number of annual maintenance contracts for recurring revenue adds value.
  • A significant portion of income derived from new construction lowers value.
  • Higher revenue and profits command higher multiples of discretionary earnings for valuation purposes.

However, an HVAC company, like any business, is worth what a willing seller and a willing buyer, with no undue pressure on either party, are able to agree upon as the market value of the company.

If my firm can assist you with your valuation or transfer of ownership processes, please don’t hesitate to contact me.  My office is 251-990-5934 and my email is Will@WilliamBruce.org.

Here are three additional articles that might be of assistance:

Using Rules-of-Thumb to Quickly Estimate Business Value

The Top 3 Critical Issues in Buying or Selling a Business

The Critical Question of Price When Selling a Business

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

 

 

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What Are the Differences Between EBITDA and Seller’s Discretionary Earnings (SDE)?

What are differences between EBIDTA and Seller's Discretionary Earnings

There are important differences in EBITDA and Seller’s Discretionary Earnings (SDE).

The differences between EBITDA and Seller’s Discretionary Earnings (SDE) cause confusion.  Sometimes the two terms are incorrectly viewed as interchangeable, but there are important differences.

First, some definitions.  Both are business performance benchmarks that are widely used in valuing a business for sale or acquisition.  However, there are critical differences in EBITDA and Seller’s Discretionary Earnings, and if you use the wrong one in valuing the company under consideration, you could calculate a grossly inaccurate appraisal of the business.

EBITDA

EBITDA is defined as earnings before interest, taxes, depreciation and amortization.  In other words, to compute EBITDA you take the net profit of the business as shown on the company’s tax return or P&L and add back the interest, taxes, depreciation and amortization.  Only these four items are allowed to be added back.  The resulting number of this calculation is EBITDA.  It’s by far the easiest benchmark to compute because the adjustments to net profit or loss are limited and well defined.

Seller’s Discretionary Earnings (SDE)

In computing Seller’s Discretionary Earnings (SDE), you again start with the net profit or loss of the business and add the items listed above for EBITDA.  Then for SDE, you also add back some other items.  Those additional items are the business owner’s salary and perks, any one-time expenses not likely to recur (ie: a major remodeling expense), and any expenses that will disappear for the new business owner.

As just one example, let me tell you about the sale of a restaurant that I handled as a business broker several years ago.  The profit and loss statement from the business was actually showing a small loss.

However, the owner’s wife drove a Lincoln Navigator which was listed on the books of the business as a company vehicle. The company also paid for all her gas and maintenance on the Navigator although she had no role in the operation of the restaurant.  Same for the daughter’s Honda which she drove back and forth to college. The daughter was also on the payroll as an employee of the restaurant which furnished her with spending money at college, although she never actually worked at the restaurant.

The family’s week-long ski vacation to Colorado was charged to the business because the owner attended a business meeting for a few hours while in Aspen. You see where I’m heading here, don’t you? By the time all these items plus any non-cash expenses (eg: depreciation) were accounted for, the restaurant was actually producing a nice yearly discretionary income for the family.

DISCLAIMER: Hey, I’m not with the IRS and don’t render an opinion on these sorts of things!

Simply put, the calculation of Seller’s Discretionary Earnings is an attempt to determine the business owner’s total financial benefit derived from owning the business.

With the differences between EBITDA and Seller’s Discretionary Earnings, which one to use?

So with the differences, which one of these benchmarks do you use when buying or selling a business?  More than anything else, it depends on the size of the business.

For large businesses, usually with a professional non-family CEO running the company, EBITDA will yield a more applicable result.  These businesses are usually the ones being sought by private equity groups or considered by publically traded firms as a merger candidate.

But for smaller businesses, usually run by an owner-operator and with annual revenues below, say, $5 million, the calculation of Seller’s Discretionary Earnings will be much more meaningful.

More Information

For additional information on related topics, these articles may be helpful:

Please don’t hesitate to call or email if my office can be of assistance.

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

 
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