Small Business Appraisal
Small Business Appraisal is more accurately referred to as a business valuation . As a California Business Broker, one of the first things that I am asked by both buyers and sellers is what appraisal method is used to determine the asking price for a business. Sellers especially want to know about valuations for selling a business. I strive to educate my clients on the principles of business pricing or small business appraisal / business valuation. Some statistics state that sixty percent of the businesses that are listed never sell. While there are many reasons for this, one major reason is that many businesses are incorrectly priced.
One caveat: I am not a certified business appraiser. These pages are designed to give a base of knowledge to a business owner or a future business owner - not be a formal education on valuation methodology. We do offer and recommend formal business valuations in certain cases.
Click here to learn about formal valuations for selling a business.
When discussing valuations for selling a business, the first important concept to know is that cash is king. People buy businesses as investments and they want a return on their investment. There are other factors that influence price but at the end of the day the net income that a business produces will be the main component in determining the asking price.
The reason that cash flow is so important is that it is the cash flow that will service the debt on the business, provide an income for the new owner, fuel expansion plans and justify the debt in the first place. Usually, it must do most of these things at the same time! (The vast majority of business transactions involve financing of some sort.) If the net income, after servicing the debt, to the new owner is less than he or she wants or if it is a negative amount, then the deal will never happen. When it is all said and done the deal must make financial sense for the buyer to move forward.
Take a look at the following scenarios. These imaginary scenarios will illustrate why cash flow is the predominant factor used when businesses are priced.
Let's say a business has gross sales of $3,000,000 and it generates $300,000 in total benefit to the owner. Let's presume that the buyer will put fifteen percent down and will finance the deal with a combination of a seller's note and a ten year SBA loan. Combined interest is 7.5%.
Now let's look at the net result to the owner at different prices and at different cash flow multiples:
Purchase Price $1,000,000 Down $150,000 3.33 Multiple
Annual Debt Service $128,829 Net $171,170 ROI 30% ROE 114%
Purchase Price $1,500,000 Down $225,000 5.0 Multiple
Annual Debt Service $193,243 Net $106,756 ROI 20% ROE 47%
Purchase Price $2,000,000 Down $300,000 6.67 Multiple
Annual Debt Service $257,658 Net $ 42,341 ROI 15% ROE 14%
As you can see as the price increases the return to the new owner decreases dramatically. If we continued with the scenarios at the $3,000,000 price level the new owner would actually be losing money every year. At a certain point the return is not enough for the buyer to take on the risk of a business enterprise. In addition, it is highly unlikely that someone would put down $300,000 to only earn $42,341 a year. There are too many other ways for that buyer to invest their money.
In terms of valuations for selling a business: pricing your business incorrectly can be a costly mistake. Savvy business buyers and the business brokers who represent them can quickly size up new listings as they come on the market. If a business is priced way too high many buyer assume that the owner is not serious about selling and there are never any inquiries about the business.
Click on the links below and learn about small business appraisal and the steps involved when pricing a private business for sale.
Seller's Discretionary Earnings
A Small Business Appraisal is used to determine what is a business worth. The term discretionary earnings is used to describe the total financial benefit accruing to the owner. How is this calculated? Why is it important?
Risk and Business pricing
Risk equal reward, right? This is true for investors when they are buying a business. However, for a business owner, too much risk hurts the price they can get for their business.
Some businesses have attributes that are highly desirable. As you can imagine, this has a very positive impact on the price that business will fetch when it is sold.
Much of the asking or selling price of a business is goodwill. What is goodwill? How is it valued? Is the owner the source of the goodwill or is it the business?
Financial Statements - Proving SDE
In addition, a small business appraisal must be justified. A business's financial records are the proof of the discretionary earnings that will flow to the new owner. When selling a business the financial statements can make or break the deal.
Types and Sizes of Businesses
A brief description of the different types and sizes of businesses in California and the impact on pricing. When is a deal a M an A deal and when is it not?
Business Valuations / Small Business Appraisal
There are times when a formal small business appraisal or valuation is needed. We offer several types of valuations. Learn when you need a valuation and the type that is appropriate for you.
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If you are a business owner and you would like to know what your business is worth I would be happy to meet with you, do the research and give you my opinion.
Go to the California Business Broker Contact page