Most profitable businesses sell for prices much higher than the value of their hard assets. This supplemental value is called goodwill. A company's goodwill reflects all the intangible factors that are responsible for the company's success. This goodwill could be substantially harmed if employees, customers, suppliers or other stakeholders in the company hear rumors about the company being for sale. The employees might start worrying about the security of their jobs and might leave the company. Customers might question the new owners' ability to deliver the same quality and standard of services/products and might look for new suppliers. Even suppliers might reduce their payment terms as a result of uncertainty about the new ownership capabilities and intentions. For all these reasons, confidentiality is a must in selling a business. Only at the right time, should the owner inform different stakeholders about the sale of the company. The seller/broker should make sure not to to advertise any information about the business that could make it identifiable. Potential buyers should be screened and should sign a confidentiality agreement before receiving any information about the business. This is generally very difficult to do by the business owner him/herself. The business broker is experienced in this selection and should make sure no confidential information is given to any wrong hands.
2. Selling Business Shares or Assets
The first decision to make is whether to sell assets or shares. Consulting with an accountant will help you make an adequate decision.
3. Determination of an asking price
For large transactions, we advise business owners to contact professional business appraisers to come up with an appraised value for the business before starting the process of selling a business. However, for the majority of small business transactions an experienced business broker can determine within a reasonable range an asking price for the sale of the business. What calculations does a business broker do to put an asking price on the business?
a. Normalization of your income statement
Financial statements are the primary tool used to come up with a reasonable asking price for the business. However, for a majority of small businesses, financial statements do not show the business at its best lights. Their primary purpose is to reduce tax, not to show profits. In order to get a real picture of the profits, financial statements should be corrected by adding to the profits any benefits the business owner is getting from his business indirectly but that are not necessary for running the business. Examples of those “false” costs include, auto expenses, pension funds, personal insurance, travel, donations etc.
The owner salary, depreciation, amortization and interest expenses should also be added to the profits. Thus, the total calculated is the Seller Discretionary Earning (SDE). To get a reasonable asking price, this amount should be multiplied by a multiplier.
b. Determination of a multiplier
The majority of small businesses sell for multipliers between 1 and 3. The determination of these multipliers is more an art than a science. Many factors are taken into consideration:
How many years has the business being existing?
How many years has the seller owned the business?
How much cash does the seller want for the business (vs. term payment)?
How competitive is the industry?
Is it a growing business?
What is the quality of the location and facilities?
Is this business/industry attractive to potential buyers?
Is the industry growing and by how much?
How easy is it to replicate the same business?
For each of these questions, a rate between 1 and 4 is subjectively assigned and finally a combined multiplier is calculated based on the previous rates.
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