Selling your business is one of the most significant decisions you’ll ever make. It’s not just about finding a buyer; it’s about getting the best possible outcome—both financially and for your legacy. In the latest chapters of “Lucrative Exits,” Gregg Kunz, founder of Rocky Mountain Business Advisors, shares essential strategies for making the most of your business sale.
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CHAPTER THREE
Making the Most of Your Business Sale with the Right Team
A successful exit tends to hinge on two things: the broker’s expertise and the adeptness of the advisors supporting you, the business owner. Together, these factors ensure we extract and realize the most from your life’s work. During negotiations, the right team can concretely back up and explain every bit of value that your business offers. Often, you’ll find that you’ve been with some of these advisors for years. Others might need to be brought on board or even set aside if their expertise doesn’t align with the mission.
Key Members of Your Advisory Team
Here are the people you absolutely want on your side:
- Business Transaction Attorney: This isn’t just any attorney. It’s not the general attorney or the family lawyer you might already have on speed dial. This needs to be a person whose bread and butter is business transactions. Think of it this way: you’d want to see a specialist when facing a specific health issue. The same logic applies here. Going through business transactions without the right attorney is like having brain surgery with a proctologist! Not ideal, right? You need someone at the apex of their game in business transaction law.
- The Right Accountant or CPA: Now, let me emphasize the word “right”. Not every accountant or CPA is cut from the same cloth. Some might simply record the numbers, resembling bookkeepers more than actual business guides. You deserve more. Ideally your accountant or CPA should have accompanied you on your business journey for several years, offering insights that only they can, given their unique vantage point. Such professionals are not just number crunchers but business visionaries who see things with a broader lens.
And let’s address another misstep: many business owners only interact with their accountants during tax time. That’s a missed opportunity. Those professionals that are solely tax preparers may not have the depth of insight crucial for this important undertaking. They are wonderful at what they do, but we want more than just tax preparation when selling a business. We want insight, foresight, and expert guidance. A business-savvy accountant can be an invaluable resource.
- Wealth or Investment Advisor: If you do not already have an experienced and qualified advisor who manages your investments, or at least provides you with guidance this is the time to begin a conversation. Now that the time has come to reap the benefits of the investment in your business, you should get expert advice prior to the sale. There are a multitude of options available for deploying your proceeds and these individuals are far more proficient than your CPA, friend, neighbor, or family member. In some cases setting up the strategy before the transaction is complete is a necessity.
- Estate Planner: These individuals can assist in answering a pivotal question: Is now the right moment to sell your business? Post-sale, will the proceeds, minus all taxes, fund the life you’ve dreamt of? If you do not have an estate planner I think it’s a wise idea to meet with one so that you can develop a plan. If you do have one please bring them into the conversation about selling your business.
- An Experienced Business Broker
Remember, even among these experts, there’s room for error and misjudgment. Often, lawyers, for instance, view transactions heavily from their legal vantage point, not always blending in the business perspective. And while the law might seem rigid, there are nuances to it. We may need to push back against certain stances, ensuring they align with the business’s real-world issues. Just because something is identified as a “risk” doesn’t mean it has a high chance of occurring. It’s our job to discern between genuine concerns and present but minimal risks that shouldn’t jeopardize the sale. Lawyers outline potential risks (as is their job) but rarely tell you what you should do (not their job). It is important that you balance the risk with the potential cost or ramifications to enable you to make a decision that may derail or squash an otherwise great transaction. Just because a lawyer states that something is a risk does not mean that you should not assume the risk. Understand the odds of it occurring and balance the potential harm in your decision to accept or reject that risk.
It’s easy to elevate professionals like accountants and attorneys, placing them on a pedestal. But just as in any profession, there are variations in quality. Start thinking about your current team. Are they equipped for this journey? If not, it’s time to make some changes. And finally, it’s also important that these advisors understand their role and remain in their lane, not overstepping into the role of the broker. The broker is the maestro of the advisory team orchestra.
The Core Responsibilities of a Business Broker
Every business owner contemplating a sale wonders, “What will my broker do for me?” It goes well beyond putting a “For Sale” sign on your business.
- The Business Owner’s Guide: Your broker helps you understand the entire sales process. This isn’t just about numbers. It’s about emotions, operations, and financial intricacies. Every business sale gets emotional, and trust me, that’s normal. We’ve seen it all before and will guide you through those turbulent times.
- The Marketing Package: Expect to see a sample Marketing document, Confidential Business Review (CBR), or Confidential Information Memorandum (CIM). Great brokers make it a point to dive deeply into understanding your business and shaping a compelling value proposition for potential buyers via the Marketing document and how it is presented to the market.
- Financial Analysis: Brokers don’t take numbers at face value. They may work closely with your accountant, pinpointing obstacles and ensuring no landmine remains undetected that could hurt the sale later on.
- Marketing and Buyer Outreach: A robust marketing plan tailored to your business will target potential buyers. They then initiate conversations with buyers and conduct debriefs with the owner to address any underlying questions or concerns that are likely to arise in subsequent buyer-seller meetings.
- The Negotiator: Once an offer is on the table, an experienced broker will review the offer and highlight the most critical aspects to ensure the terms are in your best interest. They will then negotiate the elements on your behalf while also providing insight into the buyer’s interests. Negotiating is not a one-way street, and some degree of compromise should be expected.
- The Due Diligence Facilitator: This step is crucial. Almost 50% of all transactions die during due diligence. Organization of documents, establishing a clear process with deadlines, and holding each party accountable for meeting their action steps distinguishes exceptional brokers from the pack. Broker control of the due diligence process is critical to getting to the closing table.
- Getting to Closing: This journey almost ends at the closing table when the funds are wired to your bank account, and this is also when the broker is paid their success fee. However, the period from negotiating the offer through due diligence and to the closing table is really where the broker earns their fee. It is not simply working the process with the buyer and seller, but all of the other people and entities that are a part of the sale process. Attorneys, accountants, lenders, landlords, appraisers, and other advisors create not just one but multiple juggling acts to get to the finish line. It’s for this reason that we always impress upon both buyer and seller to keep focused on the goal, maintain a sense of purposeful urgency, and expect that their stress levels will rise up as they approach the closing day. Managing the emotions of each party is one of the many skills which business brokers must be adept and experienced with. During our due diligence kick-off meeting I let the parties know that emotions are likely to arise and ask them to make me, the broker, the one that they express those emotions to. It is our job to be the voice of reason – even when one party or the other is unreasonable.
- Training & Transition: Let’s be sure not to forget that after the funds are in your bank account and you’ve lifted a glass or three of celebratory libations, you’ll likely be back in the building the next day to begin the training and transition period. As a part of the transaction agreement, you, the seller, will have committed to providing the new owner with all of the tools, advice, and guidance that they need to operate the business. Depending on the complexity of the business and the competency of the buyer, the transition period may last from two weeks to many more. The industry standard is 30 days of hands-on training followed by a number of weeks of phone and email support. Most sellers are eager to agree to the training period while negotiating the transaction but quickly lose enthusiasm when the transition period begins. The good news is that in most cases, if you have followed the sale preparation guidelines in this book, the new owner will have the roadmap they need, and your on-site presence will no longer be required after week two. The new owner will have a strong desire to take charge. Be advised that even though the deal is closed, your ownership has ended, and the money is in the bank, you have a contractual legal obligation to provide the training as promised. Funny things can happen under a new owner, and when challenges arise, or worse, finger-pointing begins, you want to be sure you have done your best to train them to take over the reins. In today’s litigious society, protecting yourself is critical.
You can think of us, the brokers, as the experienced and cool-headed quarterback of the transaction. Even if you’ve been through a sale before, we’ve been through dozens and dozens. We’re the conductors overseeing that each part of the orchestra plays in harmony even though many of the musicians play to their own tune. Understanding not only the buyer and seller but all of the other advisors and participants in the transaction and how to ensure that they perform is one of the most critical skills the broker possesses. There is a very good reason that business brokerage is a rather small specialty profession. It comes without the security of a steady paycheck, and fewer than 25% of those who enter the profession last more than two years. Choose your broker wisely.
Choosing the Right Broker for You
Selecting the right broker begins with understanding that the business of selling businesses is both complex and process-driven. In addition to normal professional courtesies (punctuality, responsiveness, etc.), you must make time to understand the skill set and experience of the broker who will represent you in what may be the largest and most significant financial transaction of your life.
By nature of the number of businesses within a specific industry and geography at any one point in time, 99% of brokers are generalists rather than industry specialists. I cannot recall when I have not been asked, “Have you sold my type of business?” It’s a reasonable question, but it’s not really important to a successful outcome, and in some cases, it can hamper a successful sale. Brokers in the top tier of the profession know that making assumptions is a crutch for those who are not willing to dig into every aspect of the business they are representing. You do not want a broker representing you who believes they know everything about your business or industry. You want a broker who is hungry for knowledge about your business and your market. I mention ‘process’ frequently, including the process the broker goes through in learning about your business. At the end of the day, your business is unique – even if the broker has sold ones in the same industry. Helpful, yes. Important, no. The overall preparation and sale processes are what count above all else.
The best brokers exhaustively make it their business to know your business, but they will never be an expert on your business, nor should they. Their role is to bring the buyer and seller together by creating and articulating the Value Proposition that makes your business the most attractive on the market. You are the expert, and the questions that really matter to a buyer should be answered by you and only you. It is the broker’s responsibility to manage all aspects of the sale process effectively, not to speak for you about the intricacies of your business and industry.
Generally speaking, all businesses are fundamentally the same. They all have sales, revenues, expenses, customers, employees, vendors, suppliers, and a host of other attributes. A broker with a depth of real-world business experience combined with a solid understanding of the interplay and impact of each attribute, as well as one who is serious about their craft are the minimum qualifications you should be looking for. Credentials matter because they demonstrate that the broker embraces the ongoing mastery of their craft. Organization, follow-up, and attention to detail matter not only because the stakes are so high but because without these skills, it will be almost impossible to achieve a successful outcome. Engaging a broker who has been a (successful) business owner is even better as they understand what it is like to stand in your shoes.
Beyond these, the little things are often early indicators of their dedication to their work, professionalism, and how they will orchestrate the sale process to a successful conclusion. Punctuality, how they dress, respect for your staff, manners, listening skills, eye contact, and mastery of the language also count. This is the person who will be representing you and your business in the market. If they do not have pride in themselves and their appearance to others, it will likely be very telling about how you will be represented.
Experience is a significant factor; it’s generally a good idea to opt for a broker who has been actively involved in the industry for more than a couple of years. Being part of a reputable association and holding noteworthy credentials are tell-tale signs of their dedication and professionalism.
Honesty and objectivity are invaluable traits in a broker. As a client, you should seek unbiased advice rather than hear your opinions echoed back to you. The ideal dynamic is when the broker provides direction rather than merely following the client’s lead. It’s natural as an experienced business owner to want to be in charge of the process but this is the time to put yourself in the arms of the broker. Finding a broker who can relate to your journey, especially one who has previously owned a business, can offer a unique perspective. Building a professional relationship is key, especially considering that you will be collaborating with your broker for an extended period, quite likely for over a year. This relationship doesn’t necessitate the bond of friendship, but mutual trust and respect are of the utmost importance.
A broker’s moral compass should always point in the right direction. Being fiduciaries, brokers have an ethical commitment to prioritize their client’s interests above their own personal interests. Because brokers are only paid when a business is sold, and therefore securing a listing is first and foremost for their success, too many brokers push a prospective client to engage when they are not ready, the business is not ready, or make a promise to sell at an unrealistic price. If a broker is pushing you to sign a listing agreement before you are ready, that is a broker you should part ways with. The sale of your business should be on your timeline, never the broker’s.
You must seek objectivity, honesty, and integrity. A great broker will respect and embrace your timeframe rather than their own. They will also detail how they arrived at the most probable selling price range so that you understand it. If the gap between what you need the business to sell for does not match what the business is likely to sell for, then you need clarity of thought to make an informed decision to determine if this is the right time to sell. Businesses very, very rarely sell for more than the most probable selling price range.
As a matter of practice, when we meet with a prospective client, we never ask what they think their business is worth or what they need the business to sell for. We do not want anything to cloud our complete objectivity. Does this mean that we may have fewer engagements than our industry peers? Absolutely. But it also means that we sell over 90% of the businesses we bring to market at a price agreeable to our clients. We tell business owners what they need to hear, which is often different from what they want to hear. It’s honesty and integrity and the only way we know how to do business.
The process of choosing your broker shouldn’t be rushed. Given that this relationship is pivotal to the successful sale of your business, you must find someone with a robust and effective process who comprehends the significance and nuance of the deal and cherishes the trust you place in them.
Local Market Knowledge
A broker with local market knowledge is important, but more than facts and figures, they must possess a feet-on-the-ground understanding of the local geography and the interplay of the business environment in that market. A case in point: A business producing $300,000 in SDE in the greater Denver area would be considered an attractive business, but just 90 miles away in the mountain resort towns, that same business is likely to be a tough sale because a new owner may not be able to afford the cost of housing. In addition, the skilled labor needed to perform the business’s services is likely to command a higher wage which will figure into a buyer’s future growth plans. As the business owner, you will be a wealth of information for your broker, but you may also be so close to your business that your objectivity may be compromised. Remember, your broker will speak with savvy buyers who will look at all aspects of your business, and merely touting how great your business is will diminish their credibility with a buyer. This is why the most successful brokers, those who attain the highest sales price consistently, tend to be seasoned business people first and foremost.
The Power of a Strong Network
A business broker’s network should consist of connections with industry professionals who can bring to bear their expertise to address and correct issues in your business as well as to provide specific knowledge to your personal situation. An effective broker should have a deep enough network to connect you with the right experts to provide clarity and resolution to the issues which may hinder a successful outcome. Exceptional brokers are creative problem solvers who make it their business to bring solutions to the table.
This network should stretch from SBA and commercial lenders to accountants, bookkeepers, tax, marketing, finance, sales, training, and real estate professionals. I always seek to surround myself with professionals at the top of their respective fields to draw on their expertise to address issues that a client’s business may have. No one can master everything, but tapping into a knowledgeable network gives you access to the best advice possible, ensuring the most successful outcome.
Team Collaboration
How about the dynamics between a business broker and other team members? First and foremost, you, the business owner, should introduce your advisor team to the broker you’re working with. Encouraging each to work with your broker cannot be over emphasized. Make it clear that they should be responsive to the broker’s requests, whether face-to-face meetings, phone calls, or email exchanges. Once the sale process is underway, delays can cause a deal to be derailed and a fatigued buyer to lose interest and exit the process. You must impress upon your advisors the importance and magnitude of the outcome to you and to your family. It’s also advisable to tell them specifically that you will compensate them for their time and for making you a priority.
Every professional has their timelines and way of doing things, and while the broker needs to be sensitive to this, you must remember that time kills all deals. As the advisor’s client, you have every right to diplomatically insist upon them having a sense of urgency. Don’t shy away from the costs you will incur from your advisors. This is when trying to save a few bucks may cost you thousands. That $400 an-hour bill from your CPA? It’s an investment. Every dollar you spend in this process has the potential to multiply and return to you at the closing table.
Understanding Business Brokerage Fees
The fees associated with the sale of your business by business brokers are fairly simple and consistent. Most brokers will charge an engagement fee ranging from a couple of thousand dollars to as much as $25,000. In our practice, this fee is returned to the client at closing as a credit to the final success fee. Success fees range from 8% to 12%. If the business does not sell during the engagement period, the engagement fee is retained by the broker to offset their expenses. Remember that selling a business is not like selling a home or a commercial property, and it is neither quick nor easy – if it were, there would be tens of thousands of business brokers as there are in real estate. Unlike residential real estate there is not a buyer for every business.
Our engagement fee is on the lower end of the spectrum and varies based on how long we expect the process to take and the likely complexity of the overall transaction. This is not solely based on the condition of the business and the market but also on our sense of how reasonable we expect the client to be. Those prospective clients who appear to be reasonable, realistic and enjoyable to work with will incur a lower fee than those who seem likely to thwart a sale at every opportunity. How do we ascertain the likelihood of a difficult seller? Owners who draw lines in the sand about unrealistic prices or terms are a tip off. Remember that at the end of the day the market is going to determine the value of the business as expressed in the sale price. If your plan is to give the broker ‘a shot’ at selling you business for an unrealistic price I can tell you from experience that it is unlikely to result in a successful conclusion. A broker who concedes to your unrealistic prices or terms expectations is likely focused on securing your listing and should be avoided. How to know if your price is unrealistic? The broker should take you through how they determined the value so that you understand it. You may not agree with the price range but you will understand how it was arrived at.
While interviewing brokers to represent you, if their engagement fee is above $10,000, you should seek an explanation. If it is to defray their marketing costs, please show them the door. Successful brokers are capitalized well enough to invest in the sale process. If not, this is not the broker for you.
You should also be wary of those who charge less than a 10% success fee. Why? Successful brokers only have so much time and can only handle so many clients at one time. Trust me, if they do take on an engagement at a reduced rate, they are likely to work just a little less hard because the lure of the client who is willing to pay them what they are worth is likely to receive the most attention. It’s simply human nature. If the broker is willing to readily concede their rate, in essence, how they feed their family, then this is likely how they will negotiate on your behalf. As stated above, the purpose of the engagement fee isn’t simply a way to compensate the broker if a sale doesn’t materialize. The more significant purpose of an engagement fee is to act as a testament to the seller’s genuine commitment to selling the business.
In the premier Main Street Market, which is usually defined by businesses with revenues ranging from one to thirty million, it’s advised to avoid brokers who ask for monthly retainers except in very unique circumstances. Such a system can suggest that a broker is more incentivized by these regular payments rather than the actual sale of the business, which is never in the seller’s best interest.
In terms of the final payment calculation, the success fee percentage will decrease as the final sale price increases into the million of dollars. In some practices, like ours, we are fond of the Double Lehman method. This approach calculates the commission with a base percentage rate for the first million in sale value and applies a decreasing percentage rate for each million in sale price. There are also variations of the scaled fee structure, the key being to align the interests of both sellers and brokers to secure the absolute highest sale price.
A few more thoughts on broker compensation. While 10% of the sale price sounds like and can be a significant amount, one needs to remember that:
- Less than 20% of all businesses listed for sale actually sell. The broker who touts how many listings they have as a measure of their ‘success’ may only sell only a few in the span of a year. The absolute gauge of a broker should be how many of their listings sell at or close to the listing price – not how many listings they have. If you want to judge the quality of their engagements for yourself, ask to see the full marketing package of a few listings that you choose from their inventory.
- Your broker will be working for many months, and even over a year, on your business sale. Depending on the business and the local market, prospective buyers may appear soon after the business is brought to market, or after many months for reasons well beyond the control of the broker. Sometimes we have to wait until the buyer finds us.
- Take into consideration what you pay your salespeople. Salespeople choose the profession because they are money-motivated, and brokers are the same. This is likely the most significant sale of your life, and now is not the time to try to save on a commission.
The Pros and Cons of Going Solo in the Sale of Your Business
In my time, I’ve not come across too many business owners who ventured into selling on their own. This is consistent with our ideal client target: they understand that the best outcome is achieved by experts in their chosen field, for the same reason their customers or clients trust them. One way or another, they come to understand the unique skill set and experience that makes us successful, and they also understand that during the sale process, they must maintain 100% focus on the performance of their business. This is not the time for anything less than a total focus on your business, as any deterioration in performance can be the death knell of a great outcome. Using a broker will ensure that your time is spent on the business and not on the many aspects of the sale process which will be disruptive at best.
Here’s the raw truth: Selling a business isn’t easy. If you’re new to this, you’ll soon discover it requires balancing and managing a multitude of day-to-day activities that are dependent upon others and where follow-up and communication cannot be slowed. This is far more than soliciting an offer and negotiating a deal to make it to the closing table. During such a pivotal time, your business needs you to be fully engaged to maintain consistent performance. Remember also that the time between an executed offer and the closing date can span many months. Both the buyer and their lender will be eyeing your financial performance every month or week up until closing and any deterioration in performance can change the dynamics of the sale, or worse.
So, what happens when a business owner decides to go it alone? Frankly, the outcomes aren’t pretty. Most deals fall through. Owners spend significant time, energy, and emotional capital only to come up short. Worse yet, they might undervalue their business or expose themselves to a multitude of unforeseen risks. It’s like leaving money on the table and only realizing it when the transaction has been completed. The few who manage to seal a deal often look back regretfully, wondering if they might have struck a better bargain with expert guidance.
On the flip side, those who’ve unsuccessfully attempted a solo sale quickly appreciate the intricacies involved. This realization often drives them towards seeking a broker’s expertise. Even with a broker, a successful sale isn’t guaranteed. Business owners are surprised to learn that fewer than 20% of businesses brought to market result in a sale. Why? Because mediocre businesses that lack documentation and preparedness for sale do not attract serious buyers, and if they do, a lender will not participate in the transaction. However, those who engage an experienced broker and enter the process with the required seriousness stand a much higher chance of a successful and lucrative exit.
I outlined the cons so it’s only fair that I mention the pros. Going it alone may allow you to avoid paying the broker’s fee. However, it is not likely to provide you with the best price and the best terms, and the distraction of the sale process may very well negatively impact the business’s operational and financial performance at the worst possible time. There are very few pros when it comes to trying to sell your business yourself.
KEY TAKEAWAYS
- Specialized expertise in your advisory team, whether a business transaction attorney, a CPA, or a business broker, directly influences the success of your business sale.
- Choosing the right broker goes beyond just credentials; strive for mutual trust, respect, and alignment of interests.
- Transparency in fee structures ensures that you and the broker are incentivized toward securing the best possible sale price. Understand the broker’s perspective that the engagement fee reflects your commitment to selling and being fully engaged in the process. Unless there is very sound reasoning, avoid monthly retainers which may better suit the broker’s financial interests rather than yours.
- Effective collaboration between your broker and other advisory team members is necessary so that each professional plays an invaluable role in achieving the best sale outcome.
- Selling a business on your own poses significant risks. Owners might undervalue (or more often overvalue) their business, face unanticipated complications, disrupt the performance of the business, expose you to post-sale risks, or simply end up without a sale. Leveraging a broker’s expertise increases the likelihood of a successful sale.
CHAPTER FOUR
Accurately Pricing Your Business
Let’s face it: in 98% of all cases, business owners are most interested in the most likely selling price of their business. After all, they have spent years, decades, and, for some families, multiple generations building a business that has allowed them to realize the American Dream. Their hard work, time spent away from family and friends, and significant ongoing investment (rather than material rewards for themselves) should be unlocked when it is time to sell.
When I decided to sell the first business I built, I was taken aback, or more specifically, shocked, when the broker told me the value I should expect to receive at closing as it was far less than I believed. I objected and said that he did not understand the hours that I had put in and how much money it would take someone to build the business to this level of quality and sustainability. I expected that he would agree, but he pointed out as emphatically as his nature allowed, “The value of the business to a buyer is in no way based on the time, effort, and money you have invested: the value is based almost solely on the financial benefit (cash flow, income) that buyer will receive.”
I was dismayed but quickly understood why this made sense. The price a buyer will pay is a function of the financial benefit to the buyer. It’s relatively straightforward with a basis in simple math: Will the business produce enough earnings to provide the buyer with an income, a return on their investment (down payment), and enough to service the debt load required to finance the acquisition? If it does not, the business is priced too high. If it produces significant excess cash after the new owner pays themselves and services the debt, the business will support a higher sale price. As I said, simple. This is why I implore business owners and those reading this book to understand this early and often by engaging with a business broker to secure a baseline valuation in the years preceding their exit.
Without a doubt, all business owners will benefit from their first valuation. It allows them to place a stake in the ground from which to increase the value of their business not only via financial performance but also by identifying and focusing on the other value drivers that positively impact the final exit price.
You may be wondering about the 2% of business owners who are not concerned about the sale price, and there are likely more than 2%. These are the owners of failing businesses who want to leave the business and their financial obligations behind. They often find that they do not have the energy, savvy, or desire to operate the business, or they may be tied to a personally guaranteed long-term lease where simply assigning the lease obligation to someone else will allow them to exit without losing their shirt. In today’s commercial real estate market especially, you will find that landlords rarely will let you out of a lease. Several years ago one of my broker colleagues had a call from a prospective seller who 9 months prior had invested over $600,000 in establishing a retail store selling Virgin Olive Oil products. The business was located in a high-end shopping mall with a 10-year lease with monthly lease payments of $12,000. After only 6 months of operations the couple realized that business ownership, particularly in the retail marketplace, was not for them. Without question they were in a predicament – and one with no good options. The business, like many start-ups, was not yet profitable and the SDE was in negative territory. As you now understand, SDE is the foundation of value determination and negative numbers cannot support a sale price which would make much of a dent in their $600,000 investment. To compound their pain they were also on the hook for the remainder of the lease period guaranteed by them personally: in effect $12,000 per month for the next 9 years – well over $1,000,000. If they were intent on a near-term exit and were not willing to build the business to profitability it was highly likely their investment would be lost. To rub additional salt in the wound they also understood they were responsible for the lease. In this case they were willing to let the business go for any price that could get themselves out of the lease obligation.
Fundamental Concepts in Business Valuation
Main Street business businesses typically sell at a price based on a multiple of Seller Discretionary Earnings (SDE). These are businesses with a selling price of up to $2,000,000. Businesses selling upwards of $3,000,000 typically are valued based on a multiple of Adjusted EBITDA or EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). Multiples tend to be specific to those realized by like-sized businesses sold within the same industry category (as evidenced by the sale prices reported by SBA lenders over the past 20 years).
Generally speaking, businesses with SDE of less than $200,000 are sold at multiples of 1.5 to 2.00 times (also expressed as ‘x’) SDE. Once a business consistently produces more than $300,000 in SDE, it begins to sell in the 2.0 to 2.5 multiple range, and once SDE consistently exceeds $500,000, a seller may obtain a multiple of 2.5 to 3.5, or even higher depending on the industry and other qualitative attributes of the business. One should understand that multiple values do not simply move from 2.0x to 3.0x but instead, based on several qualitative factors, move from 2.0x to 2.1x to 2.2x and so on. It is not only the SDE size but the overall quality of the business that will determine (and support) the final multiple.
The vast majority of businesses, if not all, with sale prices under $500,000 are sold to third-party financial buyers (those who will be the owner-operator), as well as many up to a sale price of $3,000,000. Once a business has a sale price above $3,000,000, it may attract attention from both strategic and synergistic buyers. The primary driver of value (price) in the Main Street Business Brokerage segment is SDE, which is sometimes also referred to, but sometimes incorrectly, as Adjusted Cash Flow. EBITDA (Earnings Before Interest Taxes Depreciation and Amortization) is a term that is also used to measure the financial performance of a business. EBITDA tends to be used instead of SDE once SDE approaches $1,000,000 and is the norm in both the Mergers & Acquisition (M&A) and Investment Banking markets. At the highest end of the Main Street business sale marketplace we also use the term Adjusted EBITDA defined previously. Moving forward we will use SDE.
We do not determine the listing price range as a function of the value of the assets unless the fair market value of the assets exceeds the value of SDE times the multiple, in which case the liquidation sale value of the assets will be the larger of the two. It is critical for the business owner contemplating a sale to understand that all of the equipment assets that are required to produce both the revenue and resulting income will be included in the sale price rather than in addition to the sale price. Without these equipment assets, the business cannot produce income. For example, the owner of a pizza parlor who recently invested in a $200,000 imported pizza oven will be in for a surprise when he is told that his business, which produces $125,000 in SDE, is worth $250,000. “How can this possibly be? The oven alone is worth $200,000!” Simply because businesses sell for a multiple of SDE, not the value of the assets. When the value of the assets exceeds the SDE times the multiple range you are most likely looking at a liquidation sale.
Approaches to Assessing Business Value
When discussing business value we are specifically speaking about the most likely selling price range of the business to a third-party owner acquiring 100% ownership (equity) of the business. There are three primary methods business brokers will use to determine the value of your business:
- The Asset Method: The Asset method, also called the Net Asset Value (NAV) method, reviews the assets and liabilities as reported on the company’s balance sheet and adjusts each item to its current estimated fair market value. This approach is used primarily for businesses that do not possess intangible value above their adjusted book value.
- Market-Based Approach: The Market-Based approach tends to be the dominant valuation method for the business brokerage industry. It uses SDE or EBITDA as the baseline figure to which a multiple is applied. These multiples are based on historical sale transactions within the same industry for firms of similar SDE or EBITDA performance. To determine the most probable selling price range of your business, a broker will usually use this valuation methodology.
- Income-Based Method: The Income-Based valuation method determines a business’s value by turning the anticipated (future) earnings or economic benefits into a present-day dollar figure. At and below the Premier Main Street (selling prices below $5,000,000), this is a very seldom used approach.
Identifying Value Drivers
The most significant value driver for a Main Street business is SDE performance over the last three years, with greater weight placed on the most recent 12 month period. Scale does matter, which is why a business producing $600,000 in SDE will have a higher multiple (and listing price) than a business within the same industry producing $200,000 in SDE. As mentioned previously, multiples generally do not move in an entirely linear fashion from a 2x multiple to a 3x multiple (for example). They tend to increase (or decrease) in the multiple range based on qualitative factors such as:
- Consistency of SDE (and overall financial) performance.
- Cleanliness and consistency of financial data.
- Presence of documented processes & procedures.
- Organizational structure and hierarchy which reduces owner dependency, a General Manager for example.
- Market position, branding, and reputation.
- Barriers to entry.
- The overall appearance of the business and its publicly visible assets – including its public-facing staff.
- Regulatory and/or licensing requirements of the business, owner, or key employee.
As stated previously, a common misconception is that revenue is a significant value driver. Revenue has little to no impact on the sale price of a business. Remember, profits are the main driver of the selling price. If the value of a business’s assets exceeds the profit (SDE) times the industry multiple (equalling the selling price range), you are probably looking at a liquidation sale of the assets of the business.
The Importance of Regular Business Value Reviews
Business owners will be well-served by inviting a broker to provide an Opinion of Value at their earliest opportunity, even if their timeline for an exit is ten years from now, and then have that document updated every two years, a year prior to selling, and finally a month prior to going to market. It’s folly not to know the value of your business should circumstances dictate having to sell when you least expect it—more than that, it is an excellent strategic planning tool.
Interestingly, most business owners and anyone with an investment, especially investments for their retirement, check the value of their investments every year, month, or week, and yet they have no concrete understanding of the value of their business. Why would you not want to know the value of what may be your single largest asset – especially when you are in the position to increase that value? You cannot personally increase the value of your stock portfolio but you can increase the value of your business.
Knowing where you are today will enable you to chart your path and progress towards your destination so that when you arrive, the numbers will allow you to realize the exit you have been working towards for so long. When starting to speak with brokers, tell them upfront that your exit horizon is 2 to 3 years out. The one that suggests that you call them when you are a year out should be removed from any further conversation. The ensuing year(s) will allow you and the other brokers time to build a relationship. This will also enable you to determine which broker demonstrates the competence, guidance, moral compass, and fiduciary responsibility to put your timeline at the forefront, ahead of theirs.
A great example of obtaining an accurate business valuation well in advance of an exit is my former client, Richard. For over 30 years, Richard and his wife built a strong ski rental business in one of Colorado’s most well-known ski resorts. This was a seasonal business in which 100% of revenues came in from November 15th to April 30th. The business was a model of efficiency and consistent profits, which enabled Richard to build the American Dream. It provided for their financial well-being as well as an envious lifestyle.
Richard contacted me in 2020, wondering what the value of his business was so that he could plan an exit on his terms. In essence, a financial planning equation. When would the after-tax sale proceeds combined with their savings and social security income enable them to retire without compromising their lifestyle? The business was valued between $550,000 and $700,000 at that time. Richard understood that the numbers would take another five years to add up to the reality of an exit and we agreed to remain in touch to chart his progress.
During our subsequent ‘check-ins’ we took a deep dive into the business from an operational standpoint to ensure that when the time came to sell, the business would command a sale price at the top end of the value range. This included organizational hierarchy, brand, financial and process documentation, and developing a right-hand person who might remain with the business post-sale.
We communicated quarterly over the next two years to ensure he met the “qualitative” aspects that would set his business apart. Not surprisingly, because he initiated many of the value-driving actions we suggested, the business operated more efficiently. Revenues increased as a result, but more importantly, profits increased at a higher rate. When we met for our quarterly check-in and valuation update in late 2022, we determined that the business would now command a sale price between $1,050,000 and $1,200,000. Richard realized that the numbers would now add up, and the exit he had dreamed of may be at hand.
We had a compelling story and brought the business to market in early 2023. Within three weeks, because of the attractiveness of the business, we were fortunate to create a structured auction process and chose the buyer who, in our estimation, was the best to take over the reins and continue on the legacy Richard had built. The business sold for $1,175,000. Was this luck or simply inevitable? Truth be told, it was like many successes, where planning, preparation, and action moved the exit date forward significantly. Be assured that while we suggested what actions he should take, he is the one that delivered. We were only the guide.
KEY TAKEAWAYS
- Main Street business sale value is primarily determined by SDE, times the multiple range and adjusted upwards or downwards, based on a number of qualitative factors. Adjusted EBITDA and EBITDA are used for Premier Main Street and larger businesses.
- Revenue is less significant than profit in determining a business’s value with assets playing a lesser role.
- The market-based approach, using historical business sale data within the same industry, is the most common valuation method for businesses with selling prices under $5 million.
- Consistent SDE, clean financials, established procedures, organizational structure, and a strong market position are key value drivers influencing higher valuation multiples.
- Regular valuation updates are important strategically, enabling business owners to plan and potentially increase their business’s value in the years before the sale process begins.
- Understanding and implementing value drivers helps ensure a business will realize a sale price at the upper end of the value range.
- Building relationships with trustworthy brokers well ahead of the intended exit will make it easy to identify who has your best interests in mind, understand your business, the market, and is ultimately the best fit for you.