What Are the Seller’s Discretionary Earnings of a Business?

Posted on March 23, 2020 by William Bruce
discretionary earnings of a business

Seller’s discretionary earnings are simply the total net benefit to the business owner.

What are a business seller’s discretionary earnings?

It is NOT the profit or loss that a business owner shows Uncle Sam on the tax return. To put it delicately, almost all business owners run some expenses through the business that are not — a’hem – absolutely necessary to the operation of the business.

Seller’s discretionary earnings (SDE) are the total cash that the business generates in a year that is available to the owner after deductions for only the necessary operating expenses.  Another way to define discretionary earnings is that it is the “total owner’s benefit” derived from owning the business, regardless of how the owner takes the money out of the business.

More formally, seller’s discretionary earnings (SDE) is the amount of cash left over after paying only the necessary operating expenses that is available for (1) owner’s salary and benefits, (2) return on investment and (3) debt service, if any.

To illustrate, 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 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 cash flow for the family.

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

In addition to the owner perks discussed above, non cash deductions like depreciation are added back to the net profit shown Uncle Sam, as are one time expenses not likely to recur (eg: an air conditioning system being replaced).

CPAs and business brokers often refer to the computation of discretionary cash flow as normalizing or recasting the company’s profit and loss statement.

Why is the computation of discretionary cash flow important?

It provides an accurate picture of the true cash producing ability of the business.  In effect, it uncamouflages the bookkeeping practices of most business owners.

And since many business appraisals are done based on the seller’s discretionary earnings, it’s important to be able to accurately compute the number.

Here’s an article explaining the differences between seller’s discretionary earnings (SDE) and earnings before interest, taxes, depreciation, and amortization (EBITDA).  It’s an important difference that often causes confusion.

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If I can help with any questions or computations on this subject, don’t hesitate to contact me.

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William Bruce Business Broker

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 Is a Business Broker and What Do They Do? Here’s a Business Broker Definition.

Posted on March 5, 2020 by William Bruce

by William Bruce

What is a business broker

What is a business broker and what does a business broker do? A professional business broker handles many important responsibilities.

What is a business broker and what do they do?  And what is the definition of a business broker?  Very few people know what business brokers do, as the profession usually operates under the radar to maintain the seller’s required confidentiality.

To determine what a business broker is and the resulting business broker definition, let’s first generally define the profession.  Business brokers are intermediaries who facilitate the sale of small to medium-sized privately held businesses by working with both buyers and sellers.  There are important differences, but in some respects, business brokers operate similarly to real estate agents; however, their practice is limited to business entities.

Licensing of Business Brokers

Currently, there are 17 states requiring business brokers to be licensed by their state’s real estate commission.  All states require a real estate license if the business broker is handling real estate along with the sale of the business entity.  However, the majority of small to medium size businesses are in leased locations with no real property as part of the sale.

Who Do Business Brokers Represent?

Business brokers can represent either the buyer or seller in a sale.  Historically, the broker has traditionally represented the seller, but buyer representation is becoming more common.  The representation of one party in a transaction usually creates a fiduciary duty between the broker and the party represented.  Some states allow dual agency representation of both buyer and seller if all parties agree to the arrangement.

In some states, brokers can choose to act as transaction brokers, representing neither party as an agent but working to facilitate the transaction.  In this situation, there is no fiduciary duty created and the broker deals with both parties on the same level.

Training and Qualifications to Become a Business Broker

A business background from experience and/or education is essential to a successful business brokerage practice.

Training specific to business brokerage can be obtained from several professional associations or other organizations.  The American Business Brokers Association, as one example, conducts a 2-day training seminar several times each year.  A quick Google of “business broker training” will return many options.

Credentials

Both national associations of business brokers in the U.S. offer credentials to brokers who have completed a level of education and experience in the profession.

The American Business Broker Association awards the Accredited Business Intermediary (ABI) credential.  The International Business Brokers Association offers the Certified Business Intermediary (CBI) designation.

In addition, several state associations, such as Texas and California, offer their own credentials to qualified members.

What Do Business Brokers Do?

Business brokers perform many duties including:

  • Pricing the business with a professional valuation.
  • Drafting an offering summary, sometimes called a confidential business review. This piece becomes one of the most important marketing tools for the offering, and is provided to prospects only after they have signed a confidentiality agreement and been qualified by the broker.
  • Marketing the business to the widest possible audience while maintaining strict confidentiality.  This is one of the important distinguishing differences between business brokers and real estate agents.  Real estate agents put a sign in front of their properties and typically without the need for confidentiality, advertise widely the specific location.  Business brokers are trained to maintain strict confidentiality.
  • Introducing prospective buyers to the business after insuring confidentiality agreements have been executed.
  • Facilitating meetings between the seller and potential buyers.
  • Writing offers to purchase the business.
  • Handling negotiations between the parties after an offer has been made.
  • Facilitating the due diligence investigation.  Offers to purchase are almost always made contingent upon a further due diligence investigation.
  • Assisting the buyer in obtaining business acquisition financing.
  • Scheduling and facilitating the closing of the transaction.

Compensation

Business brokers have traditionally been compensated by the seller with a commission only fee arrangement which is detailed in a listing agreement and paid at closing.  However, in recent years some brokers have moved to a partial up front fee which may be credited to commission at closing.  This helps the broker defray the initial expenses involved in marketing the business, and according to some brokers, also serves to identify serious sellers as opposed to those who just want “to test the waters,” which many brokers regard as a waste of their time.

The customary commission rate ranges from 8 to 12 percent, with 10 percent being the most prevalent.  In a recent survey of the profession, 59 percent of brokers reported using a 10 percent commission rate.  Generally, the smaller the business, the higher the percentage rate of commission.

Top 3 Issues Involved in a Business Transfer

Many business brokers agree that the top three issues involved in the transfer of business ownership are:

  1. Confidentiality. Confidentiality is critical to the successful transfer of a business.  If it becomes known that a business is for sale, several things start happening and none of them are beneficial for either the seller or buyer of the business.  Business brokers are keenly aware of this and are experts at maintaining confidentiality.
  2. Valuation.  The issue of valuation is of critical concern to both buyers and sellers of businesses.  Business brokers are professionals in determining the most probable selling price of a business.
  3. Financing. Business acquisition loans were difficult to obtain in the recession of a few years ago.  Currently, however, banks and the SBA are again loaning money for business acquisitions.  Business brokers stay informed as to the type and source of loans that are available from various lenders and assist buyers in arranging financing.

Asset Sale Versus Corporate Stock Sale

Most transfers of privately held businesses handled by business brokers are asset sales rather than corporate stock sales.  The selling entity (whether sole proprietorship, partnership, corporation or LLC) sells selected assets to the acquiring entity.  The selected assets are usually all assets of the business, including trade name, with the exception of cash in the bank and the accounts receivable which are usually retained by the seller.

Number of Business Brokers

Because there is no national registration or licensing of business brokers, there is not an accurate count of the total number of brokers.  Estimates run from a low of 2,500 brokers to a high of 5,000 individuals in the U.S. in the profession.  The LinkedIn discussion group of the American Business Brokers Association, which is the largest LinkedIn Group of business brokers, has a membership of over 7,200 brokers and affiliated professionals.

Additional Information

For further reading, here are additional related websites and 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.   He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

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The Two Dramatically Different Definitions of “Amortization.”

Posted on February 13, 2018 by William Bruce

The two distinctly different definitions of “amortization” explained.

The term amortization has two distinctly different meanings.  And both definitions are used in the financial world, adding to the confusion.

Most folks will think of amortization as a loan repayment table for a car or home loan, and that is the most frequent usage of the term.

If you’ve bought a car or home with an installment or mortgage loan, you’ve most likely got somewhere in your files an amortization schedule which breaks down each monthly payments between interest expense and the amount applied to the loan principal.  The amounts allocated to interest and loan principal vary each month as the principal balance due on the loan declines.

The other usage of the term amortization has no relation to the above.

Before moving into a discussion of the other meaning of the word amortization, let’s back up a moment and talk about the term depreciation.  Depreciation is the yearly write-down on financial statements of tangible business assets, usually buildings, furniture, fixtures and equipment.  This write-down of tangible assets is allowed by the IRS as an expense deduction on the profit and loss statement.

Now, let’s move back to the term amortization.  Amortization in this second meaning is a first cousin to depreciation.  It’s the write-down of intangible assets as opposed to the depreciation of tangible assets.  Intangible assets can be the value of a patent, a trademark, a copyright or business goodwill.  Intangible business assets are sometimes referred to as intellectual property.

If you see amortization listed on a profit and loss statement or tax return as an expense line item, you know that it’s this second meaning and therefore a write-down of intangible assets.  If you see a chart or table filled with columns and rows of numbers, it’s an amortization table breaking down a loan repayment schedule into the amounts allocated monthly to principal and interest.

It’s confusing to have such distinctly different meanings attributed to the same word, with both being used in the financial world.  We hope this article helps a bit to clear up the misunderstanding we frequently encounter in our mergers and acquisitions practice.

For further reading, here are additional articles that may be of interest:

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William Bruce is an Accredited Business Broker and Appraiser assisting buyers and sellers of privately held businesses in the transfer of ownership.  His practice includes consulting services nationally on issues of business valuation and transfer.  He currently serves as president of the American Business Brokers Association.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org.  His business brokerage website may be viewed at www.WilliamBruce.net.
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What is Intellectual Property? How Do You Value It?

Posted on July 3, 2017 by William Bruce

Valuing intellectual propertyAs a business appraiser and intermediary in the sale, merger and acquisition of privately held companies, I’m often asked about how to value intellectual property.

Intellectual property is something originally created in the mind.  Among other things, it can be an invention, a  written manuscript, a piece of art or a company logo including words, phrases and images used in business.

Some experts in intellectual property break it down into four categories: copyrights, trademarks, patents and trade secrets.

A copyright is a person’s or company’s exclusive right to reproduce, publish, or sell his or her original work of authorship (as a literary, musical, dramatic, artistic, or architectural work).  The ownership right is protected by law.

A trademark is a distinctive design, graphics, logo, symbols, words, or any combination of these that uniquely identifies a company and gives the owner the legal rights to prevent its unauthorized use.

A patent is a right granted to an inventor by the federal government that permits the inventor to exclude others from making, selling or using the invention for a period of time.

In general, a trade secret is any confidential business information that gives a company a competitive edge.  Legal protection for owners of trade secrets is available but murkier than for the other categories.

How do you place a value on intellectual property?

It’s not easy but I’ll tell you how I do it to get fairly close.  When I’m appraising an on-going business entity, I’ll determine the total market value of the business by using industry-specific valuation formulas, sold comparables and other methods.  Then I’ll subtract from that total market value the (1) inventory at cost, (2) the furniture, fixtures and equipment at used replacement value, and (3) the value of any other tangible assets.

The remaining balance is the company’s goodwill value which may include intellectual property.  However, be aware that goodwill can include other items in addition to the intellectual property.  Such things as company reputation, trained employees and a loyal customer base are also part of the goodwill of the business.  For an article explaining goodwill in more detail, please see “What is Business Goodwill.”

For further reading, here are additional articles that may be of interest:

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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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Family Businesses Are Now Less Likely to be Passed on to the Next Generation

Posted on June 6, 2017 by William Bruce

Family businesses ownership trends are changing.

A recent survey reports some interesting results including changes in current owners’ intentions regarding ownership transfers.  The survey was done by PricewaterhouseCoopers.  The full results can be reviewed at 2017 US Family Business Survey.

According to the survey, 83 percent of family firms do not plan to change hands in the next five years.  However, the most surprising result of the survey is that among family-owned businesses contemplating a transfer of ownership within the next five years, only about half of the owners plan to pass the business on to the next generation of the family. This is down from 74 percent two years ago and is the lowest percentage in 17 years.

One possible explanation for the dramatic drop addressed in the survey is the increasing difficulty of formulating a succession plan for small to medium-sized family businesses.

The longevity of family firms depends on sound succession planning.  Companies that have made it to the third generation are much more likely to have a succession plan than younger firms.  In fact, the survey reports that 75 percent of third generation and beyond ownership have a plan for succession.

Other survey results:

  • 11 percent of family firms plan to diversify
  • 29 percent plan to expand internationally
  • 21 percent say innovation is a priority
  • 64 percent of family firms say they are more entrepreneurial than other type firms
  • 52 percent of firms say they reinvent themselves with each generation
  • 75 percent of first and second generation firms say they will give men and women equal opportunity for leadership.  With third generation and beyond, the result is 57 percent.

Our office specializes in services to family firms and offers assistance in succession planning.  Please contact us if we might 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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Selling a Business: Here’s How to Successfully Meet with a Prospective Buyer.

Posted on March 6, 2017 by William Bruce

business-meetingPrevious articles have discussed the importance of having a good reason for selling your business, getting the business ready for sale, setting the right asking price, taking your business to market and buyer acquisition financing.  In this article, we will share some advice on how to successfully hold the first face-to-face meeting with a prospective buyer of the business.

The meeting with a prospect is extremely important.  It’s your chance to put the prospect at ease and show off the business in its best light.

You will probably want to schedule the visit after hours so as not to arouse any suspicions among your employees.  Or, you can schedule the meeting in your broker’s office if for some reason you don’t want to host it in your business.  However, I think it best, if possible, to hold the meeting at your location.  It gives the prospect a better feel for your operation.  If you are using a business broker, he will arrive with the prospect, make the introductions and facilitate the meeting.

The first meeting is sort of a “look see” for both parties.  The prospect is checking out you and the business while you are sizing him up.  It’s important to remain cordial and open.

The ideal meeting will go something like this:

  • First, you welcome the prospect into your office and make sure everyone has a chair and is comfortable. (Of course, it goes without saying that you have cleaned up the place and thrown away all of the old Dominoes Pizza lunch boxes!)
  • It’s usually best after the initial get acquainted chitchat, to give the prospect a brief history of your business and a succinct description of your current operation. (You might want to even practice this presentation to make sure you cover the important points without rambling.  If you’re using a broker, he will be with you and will help guide the meeting.)
  • Remain friendly and informal, call the prospect by name often, and ask periodically if the prospect has any questions. Answer any questions openly and honestly.
  • Be enthusiastic. Point out how much fun you’ve had running the business.  Let the prospect hear and feel how he could experience the same enjoyment you have.
  • As the meeting in your office winds down, offer the prospect a tour of your facility. Give this tour some thought beforehand, so that you can address the points that you want to during the walk-thru.  Point out anything that will help clarify any points you make in the meeting in your office.
  • As the meeting ends, you say something like this, “Well thanks for coming out and taking a look. You’ll probably have some additional questions, so don’t hesitate to get back in touch with me (or Mr. Broker if you’re using one).  I know this will be a big decision for you and we have nothing to hide, so just let me know what I can do to assist you with the process.”   Put these thoughts into your own words and they will leave a favorable impression in the prospect’s mind.

From the “school of hard knocks,” I can also give you some advice on things you DON’T want to do in the initial meeting with a prospect:

  • Don’t overcomplicate your business. Simplify it.  Don’t make it sound like the management of the company is so specialized that only a brain surgeon can do it.  I’m being facetious of course, but be careful not to scare off the prospect by planting the doubt in his mind that he would not be capable of running your business.
  • Don’t hide any problems. If there are any problems with the business, get them out up front.  There is never a better time to get any problems out on the table than in the meeting.  (See discussion below.)
  • In the initial meeting, it’s usually best to stay away from price and terms. If the prospect brings it up, just say, “My broker here has all of that information and if your will, get with him on that later.”

The importance of getting any problems out in the open up front cannot be overemphasized.  It’s partly a psychological issue.  If you bring up a problem in the beginning and discuss it openly, the importance of that problem is minimized in the prospect’s mind, compared to having it pop up unexpectedly later in the process.

For example, let’s say there is a tax lien against your business for unpaid payroll withholding taxes.  If you bring it up initially by saying something like, “By the way, I do want to mention for the sake of being completely open and honest that we have a tax lien against the business which is being taken care of (or which will be taken care of at closing) so that you will buy all of the assets of the business free and clear without any liens or other encumbrances.”

When you mention it like this, you win points for honesty and openness and it minimizes the problem.  I’ve seen many transactions fall apart when such problems are not disclosed and are later discovered by the prospect.  When discovered later – as they always are – the problem will usually “torpedo” the transaction.

This is such an important point that it bears repeating: DON’T HIDE ANY PROBLEMS.  TALK ABOUT THEM IN THE BEGINNING!

Now that I’ve been overly redundant, let’s move on.  The next article will discuss how to handle written offers to purchase the business.

For further reading, here are additional related articles:

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William Bruce is an Accredited Business Broker and Appraiser assisting buyers and sellers of privately held businesses in the transfer of ownership.  His practice includes consulting services nationally on issues of business valuation and transfer.  He currently serves as president of the American Business Brokers Association.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 
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The 3 Financial Benchmarks All Small Business Owners Should Monitor.

Posted on September 11, 2015 by William Bruce

Updated February 14, 2017.

Easy to calculate key small business financial ratios

These 3 key financial ratios should be calculated by every small business owner.

Many small to medium size business owners, including this author, get wrapped up in day to day management of their businesses to the exclusion of some important aspects of oversight.

The ultimate business benchmark is, of course, bottom-line net profit.  However, the three financial ratios discussed here don’t take long to calculate and will keep you on track for a healthy bottom line number.  These are the three that should be checked frequently to monitor the ongoing health and viability of your business:

Gross Profit Margin

Gross profit is simply your total sales (less sales tax) minus the cost of products sold.  Other expenses like rent, payroll, etc. are not considered in this calculation.  The gross profit margin is usually expressed as a percentage by dividing the gross profit by total sales.

For example, if your gross sales for last year (exclusive of sales tax) were $500,000 and the cost of the products you sold was $220,000, then your gross profit was $280,000.  Dividing your gross profit by total sales, we can calculate that your gross profit margin was 56 percent.  The rest of your expenses come out of this gross profit to compute your net profit.

Most industries have benchmarks for gross profit margins.  If yours is above your peer group, you’re doing a good job.  If lower, look for ways to improve.

Current Asset Ratio

This ratio is a measure of your company’s ability to pay its bills as they become due.  It is calculated by dividing your company’s current assets by its current liabilities.

Current assets are cash in the bank, accounts receivables and any other assets you expect to be converted into cash within the next 12 months.  Current liabilities are those obligations that will become due and payable during the next 12 months.

A ratio of two or better is considered by most analysts to be a comfortable situation.  If it’s one or lower, you’ll be waking up in the middle of the night!

Inventory Turn

This calculation measures how fast you’re selling and replacing your inventory.  Inventory turn is particularly important in retail and wholesale operations, but has application in all business categories.  It’s calculated by dividing the average inventory for the time frame being analyzed by the cost of goods sold.

Again, consult your industry benchmark for what is average in your niche.  The higher the turn, the better job you’re doing in managing your inventory level.  A low number most likely means you’re carrying too much inventory for your level of sales.

In summary, don’t be intimidated by the idea of periodically calculating these benchmarks.  It’s pretty easy.  And if you need help, ask your accountant.

Here are related articles you might find interesting.

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William Bruce is a business broker, an Accredited Business Intermediary and a business appraiser.  His practice includes consultations nationally on matters involving business valuations and transfers.  He currently serves as president of the American Business Brokers Association.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org.

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The Best and Worst Franchise Investments as Listed by Forbes

Posted on June 26, 2015 by William Bruce
Brightway Insrance is Forbes Magazine top pick for franchises costing less than $150,000.

Brightway Insrance is Forbes Magazine top pick for franchises costing less than $150,000.

As a business broker and appraiser, I’m often asked what are the best and worst franchise investments, which is why I noticed the following article.

Forbes Magazine writer Emily Inverso has just penned an interesting list of the best and worst franchises to buy.  Her rankings are based on data gathered over a five year time frame from 2009 through 2013.  Inverso’s article can be reviewed here.

The franchise offerings are ranked on several metrics including entry cost, 5-year growth rate and 5-year franchise continuity.  Franchise continuity as shown in the rankings is the percentage of franchises opened that are still in business at the end of the five year period.

The franchises are divided into three categories according to entry cost: up to $150,000, $150,000 to $500,000 and over $500,000.

The top ten in Forbes’ ranking for the under $150,000 entry cost were:

  • Brightway Insurance – sells personal and business insurance policies.
  • Maid Pro – provides residential cleaning service.
  • Right at Home – home care to seniors and disabled.
  • Discovery Map – curates quirky maps and travel guides.
  • Just Between Friends – provides consignment events for children’s and maternity clothes.
  • Seniors Helping Seniors – non-medical home care by seniors
  • BrightStar Care – homecare
  • Pop-A-Lock – locksmith services
  • Mathnasium – math tutoring
  • Weed Man – lawn care

As ranked by Forbes, the worst 10 franchises in the under $150,000 investment category were:

  • American Express Travel Services – 57% continuity for 5-year period
  • Gardsman Furniture Professionals – 47 % continuity
  • ERA Real Estate – 48% continuity
  • All Tune and Lube – 31% continuity
  • United Country – 52% continuity
  • WSI – 43% continuity
  • Handyman Connection – 31% continuity
  • Curves – 37% continuity
  • Computer Trouble Shooters – 42% continuity
  • Realty World – 29% continuity

In the mid sized investment range of $150,000 to $500,000, these were Forbes’ top 10 ranking franchises:

  • Jimmy Johns – fast food
  • Jet’s Pizza – deep dish pizza in a square pan
  • Marco’s Pizza – “authentic Italian” pizza
  • Plato’s Closet – young adult clothing
  • Dutch Bros. – drive-thru coffee shops
  • Wingstop – wings restaurants
  • Sports Clips – sports themed barber shops
  • Batteries Plus Bulbs – replacement batteries
  • Anytime Fitness – 24 hour gyms
  • Auntie Ann’s – pretzels in mall food courts

In the same size category ($150,000 to $500,00) these were Forbes worst 10 franchises to buy:

  • It’s a Grind Coffeehouse – 36 locations
  • Econo Lube N’ Brakes – 33 locations
  • Mr. Payroll – 88 locations
  • Cottman Transmissions – 67 locations
  • Chock Full o’ Nuts – 31 locations
  • Quiznos – 1,439 locations
  • Great Steak & Potato Company – 90 locations
  • Epcon Communities – 86 locations
  • Fitness Together – 207 locations
  • The Athlete’s Foot – 54 locations

For details on the above franchises and to review the ranking of franchises requiring an investment of greater than $500,000, please visit the Forbes article here.

For additional article by William Bruce on franchise risks and opportunities, please see:

Best & Worst Franchises Listed by SBA Loan Default Rates

List of Franchises Not Qualified for SBA Loans

What is a Franchise Really Worth. How to Value any Franchise.

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William Bruce is an Accredited Business Broker and Appraiser assisting buyers and sellers of privately held businesses in the transfer of ownership.  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 WilliamBruceOnline@gmail.com.  His business brokerage website may be viewed at www.WilliamBruce.net.
 
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Types of businesses most and least likely to be approved for SBA loan

Posted on April 20, 2015 by William Bruce
SBA loans by type of business

SBA loans by type of business

By William Bruce

It’s well known that some types of small to medium size businesses are more likely to receive SBA loans than others.

We are indebted to George Heaslip, “The Loan Professor” for the following ranking.  George is an independent SBA loan originator of many years experience.  George is based in South Florida and can be reached at (561) 329-1315 or by email at gbh7@mac.com.

Based on his experience and opinion, George periodically issues a ranking of business categories most and least likely to receive SBA loan application approval.  It’s a star rating method with five stars being the most likely to receive loan approval.

The list is updated quarterly and is the only one of its kind in the U.S.  This ranking is as of April 2015.

*** A/C & Heating

** Advertising and Promotion

Zero Adult Merchandise

*** Agricultural Products and Plantings

** Aircraft Maintenance

**** Aircraft Flight Schools, with real estate

* Air Duct Cleaning

** Alarm Systems, Residential and Industrial

** Amusement/Theme Parks established with real estate

**** Animal Care & Grooming, with real estate

**1/2 Animal Grooming, no real estate

** Antiques Dealer

Zero Apartment Houses, Strip Malls, all investor properties

*** Appliance Sales and Repairs

** Art Gallery/Dealer

** Arts and Crafts

** Art Framing

****1/2 Assisted Living Facilities with real estate

**** Auto Body & Repair Shop with real estate

**1/2 Auto Body & Repair, leased facility

*** Auto Car Wash, with real estate

** Auto Broker

Zero Auto Car Wash, no real estate

**** Auto Car Wash with real estate

** Auto Salvage

Zero Auto Used Car Lots

* Awards/Prizes/Engraving

***1/2 Beauty/Spa One Stop Centers, with real estate

** Beauty/Spa One Stop, leased

*1/2 Bed & Breakfast, with real estate

**1/2 Bagel Restaurant, leased

*** Bagel Restaurant, with real estate

** Barber/Styling Shop, franchise

Zero Barber/Styling Shop, leased

***1/2 Bakery, Neighborhood, with real estate

** Barges, Sea Transport

* Billiard Parlor

**** Biohazard Cleanup Services, Per Event

****1/2 Biohazard Cleanup Services with government accounts

***1/2 Boat/Marine Manufacturer with real estate

*** Boat Storage Facilities with real estate

Zero Boat Tours

* Book Store

*1/2 Bookkeeping Services

*1/2 Boutique and Bridal Shops

***1/2 Bowling with bar & restaurant and real estate

** Bridal/Baby Shops

**** Building Component Suppliers and Installers

**1/2 Building Supplies

**1/2 Building Renovators

*1/2 Business Brokerage Companies

* Greeting Card/Gift Shop

** Carpet Cleaning Franchise

**** Car Wash, with real estate

Zero Car Wash, no real estate

Zero Printer Cartridge Refil

Zero Casino, Gambling

***1/2 Catering with real estate

** Catering, Business & Residential, no real estate

*** Cement Product Manufacturers with real estate

***1/2 Cemeteries

Zero Charter Schools

**** Child Care Centers with real estate

** Child Care Centers, no real estate

**** Children Party Center, franchise, with real estate

* Children Party Services

*1/2 Chiropractic Services

***1/2 Chropractic Services seeking a building, as opposed to current lease

Zero Churches

Zero Cigar Store

** Cleaning, Clothing

*** Cleaning Janitorial

*** Closet Interior Manufacturers

** Clothing Stores, Leased, Franchised

** Club Houses

***1/2 Cold Storage Facilities

** Coin Laundry

Zero Collection Agency

***** Commercial Building/Condo For Business Expansion

* Computer Supplies

** Construction/General Contractor

**** Consulting Companies with fine tax returns (Legal, Accounting,

*** Consignment Shops with real estate

*1/2 Consignment Shops, leased facility

*** Contractors, established with government accounts

* Contractors, other

Zero Convenience Store

* Costume Shop

*** Crane Services

***1/2 CPA Practice

** Damage Restoration

** Dance Studios, children and/or adults

Zero Data Management

*** Delis with real estate

** Delivery Services

***** Dentists/Dental Practices

**** Dental Lab

***** Distribution Centers with real estate

*** Distribution Centers, leased facility

***** Doctors

**** Doctors With Patented Product

** Document Shredding

****1/2 Dog and Cat Kennels with real estate

*** Dry Cleaners, franchised

** Dry Cleaners, not franchised

** Dry Cleaners with real estate

** Educational Schools

** Embroidery Services with commercial accounts

*** Electrical Contractors, with fine business records

Insurance, Immigration, other professional)

** Employment Placement Companies

***1/2 Environmental Cleanup

* Electronics/Computers

** Equipment Sales, Services, leased facility

*** Equipment Sales, Services, with real estate

**** Equipment Suppliers/Installers, established

* Event Planning

***** Export Products Manufacturers

**** Exterminating Companies, franchise

****1/2 Farm/Ranch Facilities and Equipment

***** Fabrication Companies with real estate

***** Factories/Manufacturing

*** Farm Equipment Sales/Servicing

**** Fast Food Franchises, with real estate, and on the Franchise Directory

* Fencing Companies

1⁄2 Film Production Companies, Independent

* Financial Services

** Firearms

*** Fireplace and Furniture Manufacturers

** Fish Farm

Zero Fishing Vessels

*** Fitness Health Club, expansion to new facility, not leased

**** Fitness Centers, franchised with trainer(s) and real estate

*** Flooring Contractor

***1/2 Floral Centers with real estate

** Flowers

**1/2 Food Business, Retail

***** Franchises with 100 or more locations, on the Franchise

***1/2 Franchises, like above, no real estate

** Franchises other with real estate

Zero Franchise, New

Zero Franchises not on the Franchise Directory

*** Freight, with real estate

Zero Fund Raising

***** Funeral Homes with real estate

*** Furniture, Retail with real estate

Zero Game Room

***1/2 Garden Centers, growing sales, with real estate

***1/2 Gas Stations/Truck Stops, with real estate

**1/2 Gas Station/Convenience Store, with real estate

Directory, and with real estate

Zero Gift Shop

*** Glass Company, Auto, Home, Industrial

**1/2 Golf Courses, established, historic sales growth

* Golf Store

** Gourmet Catering

***1/2 Gravel Pits and Dredge

*** Grocery Store with real estate

*1/2 Grocery Store, leased

* Group Transportation

** Guard Company, Security

* Guided Tour

* Gyms, not franchised

Zero Hair Salon

***** Hardware Stores, with real estate, established, no big

** Hazmat Cleanup Services

**1/2 Health Products, franchise and on the Directory

* Hobby Shops

**** Home Health Care Services

***1/2 Home Health Care Staffing Services

** Home/Condo Owners Association Management Companies

*** Home Heating Fuel distributor

***1/2 Hostels with growing rent rolls

**** Hotels, Flagship

**1/2 Hotels/Motels, other

**** Hydraulic Systems and Services, with real estate

* Ice Cream/Yogurt

Zero Import Companies

Zero Investment Properties, like strip malls, apartments

**** Industrial Buildings/Condos, 51% owner occupied

*** Injection Mold, with real estate

** Insurance Agencies, franchise

**** Interior Design Units Manufacturers

* Internet Related

** Irrigation

*** Janitorial Services, commercial accounts

Zero Jet Ski Rent

** Jewelry, Retail

**1/2 Kitchen and Bath Retail

***1/2 Kitchen and Bath Products Manufacturer

** Land for business expansion and construction to start immediately.

***1/2 Landscaping with commercial accounts

*1/2 Landscaping, residential

box competition

**** Law Firm, business expansion/new facility

Zero Limo Business

*** Liquor Store with real estate

** Liquor Store, no real estate

** Locksmith

*** Lounge/Liquor, growing business with real estate

**** Machine shop, historical growth, with real estate

** Mail Packaging/Mail Order Services

***** Manufacturing Facilities with real estate

***** Manufacturing Facilities that export

*** Marinas with real estate

***1/2 Marinas/Restaurant, with real estate

** Marine Related Sales

* Marketing Company

*1/2 Massage, body, back and feet

***** Medical Related, except chiropractic

Zero Medical Billing Software and Services

***** Medical Product Distributers, with warehouse real

***1/2 Medical Product Distributers, leased facility

***1/2 Metal Fabricator, with real estate, good track record

Zero Micro Breweries

***1/2 Millwrights, with real estate

**1/2 Mines

*1/2 Miniature Golf

Zero Mobile Homes

**** Motel for conversion to an ALF, re-hab center, or nursing complex

***** Motel, Flagship, with real estate, otherwise ***

** Moving Companies

* Movie Theaters

** Mulch Products

** Museums, for profit

** Music

***** New Building or Upgrade/Expansion

Zero Not For Profit Organizations

Zero Nail Salons

**1/2 Nursery/Plants

****1/2 Nursing Home, with real estate

*** Nursing Home, no real estate

** Nutritional Stores, if on the registry and a franchise

Zero Office Building, not 51% business owner occupied

estate

***** Office Building/Office Condo, 51% business occupied

* Oil Wells

** Painters

Zero Parasailing

*** Parking Lot Cleaning and Maintenance

* Party Goods

**** Pawn Shop with real estate, otherwise **

*1/2 Personal Services

Zero Personnel Staffing, non-medical

**** Personnel Staffing – medical

**** Pest Control, established and franchised, otherwise *1/2

**** Pet Centers, with real estate, franchise, fine reviews

**** Pharmacies, no compounding

***** Pharmacies, compounding

** Photography services

* Pizza Shop

Zero Pressure Cleaning

Zero Phone Sales

** Pool Supplies, leased site

***1/2 Pool Supplies, establishes, with real estate

**** Pre-School with real estate, otherwise **

* Printer Cartridge Refil

* Printing and Typesetting

**** Professional Service Companies (Accounting, Legal, etc.) seeking a

***1/2 Plumbing Supply

***1/2 Pool and Supplies, no real estate

***** ` Pool and Supplies, with real estate, franchise

Zero Pool Cleaning/Maintenance

** Publishing

* Residential Realtors

****1/2 Pet Kennels and Supplies

***1/2 Recreational Facilities and Clubs, with real estate, fine records

**** Recycling Facilities

*** Restoration Services, franchise

***** Recycling Facilities with real estate

* Rental Businesses

** Repair Services, Licensed

****1/2 Restaurants, solid historical records, with real estate

*** Restaurants, franchised

** Restaurants, other

*** Retail, with real estate, solid historical records

larger facility

** Retail, no real estate

*** Roofing Contractor

**** Roofing Maintenance

* Roof Cleaners, independent, pressure washing

* Routes

* Sanitary Landfills

Zero Satellite Dishes (TV)

** Security Systems

***** Self-Storage Facilities

Zero Seven-Eleven Franchises

**** Sign Companies with real estate

*** Sign Companies without real estate

** Sight Preparation, for construction

Zero Skin & Massage

* Security Related

** Shoes/Repairs

*** Skating Rinks with real estate, food services

** Sod Distribution

*** Software Services, with three years of documented growth

***1/2 Sports Arenas

* Startups, unless customers are lined up

*** Sports Bar, established, clean records

***1/2 Sports Bar, established, clean records, with real estate

****1/2 Sports Sales Related, long business history, with real estate

*** Sports Sales Related, franchise and on the Franchise Directory

* Start Up Businesses, difficult, requires solid business plan high cash

Zero Strip Malls (considered as investment property)

** Sub (Sandwich) shops, franchise

*** Supermarkets, flag

* Surf and Active Wear

* Tailoring

Zero Tanning Salons

Zero Taxi Business

* Tax Preparation

* Teeth Whitening, non-dentist

Zero Telemarketing

* Telephone Sales

*** Tennis Clubs with real estate

***** Therapy Centers and Therapy In-Home Services

* Tobacco Related

*** Towing Services, Autos

**** Towing/Repair Services/Trucks

injection and collateral backup

*** Trade Contractors

**** Training Schools, for profit, established, with real estate

** Training Schools, other

** Transportation Services

Zero Travel Agencies

**1/2 Tree Farm, with real estate

**** Truck Repairs and towing

**** Truck and Car Washes, with real estate

***** Truck Stop, Full Service/Repair, with fuel, food, on site

* Tutoring

Zero Vacant Commercial Land

*** Vacant Commercial Land for business relocation/construction within a

Zero Valet Parking

** Variety Store, non-franchise

***1/2 Variety Store, franchise, with real estate

Zero Vending Machine Routes

***** Veterinarian

Zero Video Related

**** Uniforms Manufacturing, United States, with real estate

Zero Used Car Dealerships

***** Warehouses, for an expanding business that will occupy

** Water/Smoke Damage Restoration

** Water Purification

* Web Development and Hosting

* Wedding Planning/Gowns

** Well Drilling

*1/2 Wineries

***1/2 Wholesale Distributors, with real estate

** Wholesale Distributors, no real estate

** Yogurt Store

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William Bruce is an Accredited Business Broker and Appraiser assisting buyers and sellers of privately held businesses in the transfer of ownership.  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 WilliamBruceOnline@gmail.com.  His business brokerage website may be viewed at www.WilliamBruce.net.

 

 

Posted in Business Valuation & Appraisal, Valuing, Buying or Selling a Business | Tagged , , , , , , , | Leave a comment

Selling a Business: Buyer Acquisition Financing

Posted on February 1, 2015 by William Bruce

Business acquisition loan financingPrevious articles have discussed the importance of having a good reason for selling your business, getting the business ready for sale, setting the right asking price, and taking your business to market.  In this article, we will talk about the question of business acquisition financing for a business buyer.

Whether you want to our not, you’re going to get involved to one degree or another in the financial arrangements for business acquisition financing of your buyer.

Acquisition financing is always an issue in selling a business.  Almost all business buyers will need some amount of financing to complete the transaction.  Of all the business sales that I’ve seen, over 90% involved financing of some description.

Very few business buyers are sitting on enough cash to buy a business without financing.  People with that much money are usually “clipping coupons” and not interested in jumping into the challenges of daily business management.

So where do business buyers get the necessary financing?  There are three sources, aside from family member of the buyer who sometimes enter the situation.  Let’s discuss each:

Banks

Although most people seeking a loan to buy a business will think first of banks, I can tell you from years of business brokerage experience that banks generally do not make business acquisition loans.

That statement will surprise most people.  Once you’re in business, banks will compete for your patronage, but most will not stick their necks out in the beginning to make you a business acquisition loan.  Bank advertising would lead you to believe they would do so, but in more than 90% of the cases, they will find some reason to decline the business acquisition loan application.

The exception might be if you have a strong, years-long relationship with a bank and you can offer some other collateral such as Certificates of Deposits.  Or if the bank participates in the SBA loan program, they might be able to approve a SBA guaranteed loan (see below).

So don’t be surprised if a bank turns down your buyer.  And don’t take it as a reflection on your business or the buyer.  It’s just the way things are.

Now this is the humorous part of the situation.  It’s ironic but it has happened more than just a few times.  After your business buyer been in business for a number of months or a year or so, the same bank that turned him down for a loan to buy the business may come calling on him soliciting his banking business.  One of my buyers in this situation responded to the banker by assuming a serious air and in a somber tone, said, “Well now Mr. Banker, we’ll be happy to consider your application for our business.  Let’s see, we’ll need your financial statement and a list of references and your business plan for five years into the future.  Once we have your completed application, I’ll be glad to take it before my committee and let you know of our decision.”

The banker was taken aback.

SBA

The Small Business Administration (SBA), an agency of the federal government, provides for business acquisition loans through its approved lenders.  The SBA generally does not make direct loans, but rather the agency partially guarantees the loan that is made by the approved lender.   It’s known as the SBA 7(a) program.

The SBA list of approved lenders includes many banks with the largest lender currently being Wells Fargo.  But some community banks also make a significant volume of SBA guaranteed loans.  Some of these lenders will include in the loan total an amount for working capital in addition to the price of the business, after down payment.  Down payment requirements range from 20% to 35% plus there are usually up-front fees paid by the buyer for various requirements.  Interest rates are competitive with the marketplace.

Your business must be growing and profitable to be approved by the SBA.  A downward trend in gross revenue or profits will usually disqualify a business.  And another disqualifier of the SBA, is the requirement that the business buyer have experience in your industry.  This requirement pretty severely limits the pool of prospective buyers for your business who can use SBA financing.

The SBA route for a business acquisition loan is sometimes frustrating because of the time, detail and documentation that are involved.  If your buyer goes this route, be patient.  And stay on top of the SBA requests for information.  The quicker you can get the information and documentation to the SBA underwriter, the quicker your loan will close.

The Seller

In the majority of the business transfers that I handle, the owner of the business finances a portion of the purchase price for the buyer.  Some sellers are initially reluctant to offer financing.  However, with a strong down payment from a buyer who has a good credit bureau report and personal financial statement, the advantages to a business seller can be significant.

Not only is the tax bite usually lower for a seller who finances, but national surveys consistently show that businesses with seller financing (1) sell for more money and (2) sell in a shorter time frame.

In one recent survey of 3,965 business sales as reported by Toby Tatum in Transaction Patterns, the median selling price of businesses with seller financing was 15 percent higher that those without it.  The average down payment on seller-financed businesses was 37 percent.

And of course, there is the obvious benefit to the seller of additional income from the interest charged on the note.  The going rate as this is being written is around 5 to 6 percent.  This is significantly more than you could earn if you invested the money in a Certificate of Deposit.

And keep in mind, we’re not talking about you financing just anybody.  We’re talking about a buyer whom you have approved after checking his credit report and references, and who has made a down payment of usually between 25% and 50% of the selling price of the business.  Plus, you have a mortgage on the business and all it’s assets for the term of the note and the personal guarantee of the buyer.

Most owner financing – though not all — is in the form of a balloon note.  The balloon note solves two opposing desires.  The buyer of the business wants to keep his payments low; however, the seller usually wants his money as soon as possible.  By amortizing the note – calculating the payments – on, say, a 12-year payback schedule, the payments are kept low.  But the inclusion of a 5-year balloon requires that the remaining balance be paid off at the end of five years.

After the new owner has been in business for five years and has built a track record for himself at the bank, he should have no trouble going to his bank and refinancing the balloon.  In the low interest rate environment of recent years, I’ve seen new owners refinancing the balloon even before it came due to save money.  The balloon note has been a win-win vehicle for both buyers and sellers.

To recap, if you are willing to consider financing the sale of your business to a credit worthy buyer after an appropriate down payment, the advantages you can usually expect are:

  •  A lower tax on the proceeds of the sale.
  • A higher selling price.
  • A shorter timeframe to close the transaction.
  • Additional income from the interest on the note.

In conclusion, please keep in mind that selling a business is not an overnight process.  In my experience of over two decades as a business broker, about six to eight months is average.

He’re another article that might be of interest: Top 3 Issues Involved When Buying or Selling a Business.

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William Bruce currently serves as president of the American Business Brokers Association.  He is a business broker, an Accredited Business Intermediary (ABI) and a business appraiser assisting buyers and sellers of privately held businesses in the transfer of ownership.  His practice includes consulting services nationally for business buyers and sellers.  He may be reached at (251) 990-5934 or WilliamBruceOnline@gmail.com.

Posted in Valuing, Buying or Selling a Business | Tagged , , , , | 1 Comment