From our newsletter archives:
What these owners don’t know is that there are very simple but detailed methods to determine the value of a company. The other fact is that the buyer will most likely be going to a bank for money and they also will be using these methods to value the business. It doesn’t matter that you clean the shop every week or that you just painted the walls. Great job but in the financial world they only look at the books for the initial value. Only after the offer is accepted and the due diligence starts will any weight be given to aesthetics and other subjective matters.
So what are buyers and banks looking for?
Cash Flow. Or as they put it, SDCF. (Seller's Discretionary Cash Flow) With the net income in hand, they’ll add back the taxes, depreciation, interest and seller specific expenses to get the SDCF number. This number is then multiplied by an appropriate “multiple” to get the “value” of the company. Where does this multiple come from? It is determined by the value that that industry is worth to a prospective buyer. Right now I’ve heard that multiples are about 1-3 for manufacturing companies.
Other investors use EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) times a higher yet reflective number that should give about the same number as just using SDCF.
If you've made the decision to sell you business, hopefully you'll get an offer at or near your estimated value. After some negotiations and a final offer is made and accepted, then the fun begins. The buyer looks at all kinds of factors like the value of the equipment, EPA issues (if any), personnel, real estate, book of business by customer, contracts and much more.
Should any of these reveal potential problems, the value of the company will be reduced, in many cases significantly. Sellers should not be surprised when these issues come to light even though you may feel that they are not material. Remember, it's personal to you, it's strictly business to them.
You Can Increase The Value Of Your Shop!
It behooves you, as a potential seller, to anticipate what a prospective buyer would be looking for and correct issues that would otherwise devalue the ultimate sales price. You might even find that the value would go up if you’ve made sure that the SDCF can be maintained and even increased!
I’ve simplified the process a bit but you can get a rough idea of what your company is worth. For a more detailed explanation or ways you can improve your company prior to offering it for sale, give me a call to discuss your situation.