What Is My Business Worth?
There are a number of methodologies used by business appraisers in valuing a business. However, we believe that the ultimate value of a business is what a qualified buyer is willing to pay for it.
Aside from the many subjective factors in valuing a business, there are four key elements to determining what a qualified buyer would be willing to pay:
- The cash flow generating capacity of the business.
- The year-over-year volatility of this cash flow.
- The value and maintenance expense the assets used in the business.
- The financing options available to a qualified buyer.
Seller’s Discretionary Earnings
The cash flow generating capacity of a business is typically measured by Seller’s Discretionary Earnings (SDE). SDE represents the total cash flow available to the business owner, and is typically greater than pre-tax net income. For example, SDE includes owner’s salary, which is a form of income to the business owner and is expensed to the business. SDE also includes personal expenses that are run through the business that are a a form of in-kind income, such as automobile expenses. And SDE includes any expenses that generate cash on an after-tax basis such as depreciation, amortization and interest expense. Privately held businesses are typically valued based on a multiple of SDE.
The purchaser of a business is acquiring an income stream. In some cases, the acquirer of a business is actually buying himself (or herself) a job. In any case, the greater the SDE, the more the business is worth. Privately held businesses that change hands for $1 million or less typically trade at a multiple of SDE between 1.5 and 3.5. The multiple is determined by various factors, including the four main factors listed above. Generally speaking, turn-key, absentee-owned businesses sell for a higher multiple of SDE than businesses where the owner is essential to the day-to-day management of the business.