Answer: Two times cash flow plus or minus some other factors.
You can skip the rest of the blog if that’s the answer you were looking for. Or another formula is, 25% or so of the monthly cash flow multiplied by 60 months. That’s a new formula I just heard of yesterday that makes so much sense it’s crazy! I’ll give you the explanation I heard from Mark Doran ( a client and old friend) who has been a business broker in Denver since 1984
Here’s the background on why I am writing this today.
When it comes to selling a business, there are a bunch of differe
factors. I have had the pleasure (cough) of buying three businesses in my life with values under
$500,000.00 And if you speak with an experienced and honest Business Broker (not that those two attributes are easy to find together in that trade) they will tell you that is about the value of businesses they are going to sell the most.
Why? Because there are an abundant supply of buyers for your business when the price is below $450,000 or so, and they can write a check for half of it and carry the rest. But, when the price starts creeping into the $600,000 or more range, the number of buyers will decrease until you make it well into the area that a corporation may be interested in buying you.
So how do you price your business? When is it to big to sell? When is the right time to sell?
I just had a meeting with a client and another client who is a business broker in Denver, Choicebizops.com . We wanted to understand how they could continue to build their business to maximize the purchase price when it’s time to sell. This is a process I encourage all my clients to go through. The truth is, some day you won’t want to continue running your business due to boredom, retirement, other opportunities, or you’ve just had enough.
So, understanding how to maximize the value of your business is fundamental in running your business. Every decision you make will have an affect on what your business may sell for if
you’re being smart.
There are certain characteristics of a “sellable” business. First it has to be priced correctly.
Second, people don’t buy jobs. Meaning if you are trying to sell a business that the buyers can go get a job and make the same money, without putting out a high risk investment in the tune of $100,000 to $300,000 cash, why would they. Seriously, don’t flatter yourself, your business isn’t that exciting. If they are going to make $95,000 a year owning your businesses, and they currently make $100,000, or have that ability, good luck. Not going to happen often.
Now, if your business can provide the same buyer with a $225,000 a year cash flow, and it’s a better lifestyle than working for a boss, now you have something to sell.
Another principle is you, as the current owner can not be irreplaceable to the day to day function.
(This is of course is in the view of the buyer). You need to be closer to a CEO role than a mid level management role. This can be really hard. But it’s true. If you are making most of your dollars based on you selling, or you being the production person, you may have trouble. If your primary function is leadership, oversight, and senior level, you’re in much better shape. Few will pay $400,000. for a business that they have to answer the phones, and clean the toilets.
There certainly are more characteristics, but lets move on a bit.
So whats the value of your business?
Start with this. Take your cash flow (that’s basically every dollar that you get, one way or another, through owning the business. So your salary, your distributions, your profit, and other little expense items that in fact could be considered income. If that number is $150,000 to $250,000 or so, you may be in the sweet spot. If it’s above that, and lets say $400,000 or above
you may be pricing yourself out of the market. Not that you can’t sell it, there are just fewer buyers for those earning numbers.
Here’s another way to view what your business is worth. This isn’t your accountants formula, this is the best real life view of a small business’s value I have ever heard, and it came from Mark Doran owner of Choice Business Opportunities yesterday.
This is the premise. Most sales of a small business will have terms of 50% cash (ish) and 50% carry for 3 to 5 years for the seller. So the new owner will be paying the seller a monthly sum equal to the carry amount divided by the number of months.
So here’s an example. You sell for $400,000 because you have a $200,000 annual cash flow) you take $200,000 down and carry the rest for 4 years, which is 48 months. So the new owner will be paying you $4167.00 a month to pay off the note. Their monthly cash flow starts at $16667. a month. So there is a very comfortable “cushion” between those two numbers.
With this formula (which will come out to the same amount as the 2 times cash flow) your business is worth about 25% of monthly cash flow times 48 ( may be up to 60 depending on stuff) times 2.
So if your monthly cash flow is $15,000. 25% is $3750.00. Use that and multiple time 48 and you have $180,000 and multiple times 2 and you have your estimated value of $360,000 for a business that cash flows out to $180,000. a year. Hmmm looks like 2 times cash flow.
If your monthly cash flow is $6,000, 25% is $1500 multiplied times 48 is $72,000, multiplied times 2 is $144000.00 value. Two times cash flow
The reason this formula is important is, if you are going to carry 50% (or whatever amount) of the purchase price, you want the buyer to have enough monthly cash flow to be able to pay you, and get through what ever tough periods they run into. And new business owners often will see some revenue bumps as they get behind the wheel. The last thing you want is to take back a crumbling business, or have a buyer who can not pay back what you carried.
So why carry any of it? Because you almost have to. Few buyers won’t want the seller to have skin in the game, and banks rarely will loan money on a small business sale. So let this point sink in, you will in all likelihood be carrying a loan for the buyer.
And finally, why is this important in your day to day life? Some of it is simple, this is why you do all that heavy lifting building a business. This is the pay off some day. If you plan for it, and make decisions based on a certain targeted cash flow, total revenue, and business structure you are far more likely to get there, and not overshot the goal, or have a harsh reality hit when for some unknown reason you decide to sell. Another good idea is that when you are a few years out from selling, all new revenue to your bottom line is worth double when you sell! If you can add $40,000 in cash flow, you’ll see an additional $80,000. in the selling price. <<<<<<<<<<<<<<
So investments in marketing programs that work, make even more sense as you begin the thought process of selling. SEO, advertising, sales help, all can be a huge return during that period.
Although the meeting I spoke of yesterday was only an hour and some minutes, I could write a book on what we heard and learned about selling a business. Needless to say, everything in this post is my non professional opinion, and just what I thought I heard. Some is from the practical experience of buying 3 small businesses in my life as well, but if you are looking to sell, get to a well qualified experienced business broker. If you are on Denver or Colorado, I’d clearly recommend my client.
Marketing and sales is a part of every decision you make as a business owner in one way or another. That’s what makes our service unique. How many marketing, or SEO’s have asked you about your exit plan, and helped you understand what it takes to sell your business when it’s time?
By: Mike Bayes.