Frequent Q & A's

BreckenridgeBusinessConsultants

1. I have been asked......

”Why is confidentiality important?”

Confidentiality is very important during a sale or merger process to maintain current employees and customers. Trained employees and a loyal customer base are valuable assets of any business. Most people do not like change, unless they initiate the change. If an employee or customer is expecting an ownership change, then they may be the first to make a move to another company.

An “Asset Business Sale” is the sale of certain assets of a Business entity or Corporation. It is not the sale of the entire Business or the sale of Corporate Stock.

An “Asset Business Sale” will typically include Inventory and Equipment as the only tangible balance sheet items included in the sale. Intangible assets sold may include Goodwill, Non-compete agreements, and Consulting agreements.

Balance sheet asset items typically retained by the selling enterprise include cash, accounts receivable, deposits, and prepaid items. All liabilities will remain with the selling Business. Any debt related to assets sold would be paid at closing and transferred with clear title to the purchaser.

The distinction between an asset business sale and an equity business sale becomes magnified when applying a “rule of thumb” to estimate a sale price. It is important to know from which type of sale the “rule of thumb” was derived to be applied correctly.

Breckenridge Business consultants will know the difference for the sale or merger of a business. Your tax accountant and attorney will know how the difference would affect you personally.

3. I have been asked.....
“How does a Business Broker estimate the Asking Price for a small business?”

The Business Broker will estimate the “Asset Sales Price” of a business by a combination of sold price multiples that are the result of similar type and size of businesses actually sold. Business Brokers will have access to price multiple ratios from broker associations, as well as, paid subscription web sites. These files will have sold price multiples for thousands of small businesses. The multiples are usually a ratio of sold price to revenue and of sold price to owner discretionary earnings. (Not EBDIT or Net Income) Revenue is simply the annual gross sales of the business. Owner’s discretionary earnings is business net income plus the owner salary, owner perks (auto, insurance, etc.), depreciation
/ amortization and business interest paid.

Ice Cream/Yogurt store Revenue of $400K x .63 = $252,000
Disc. Earn of $100K x 2.3 = $230,000

Book store Revenue of $400K x .43 = $172,000
Disc. Earn of $100K x 1.8 = $180,000

This seems to indicate that the Ice Cream store is earning less than average and the Book store is earning more than average. The Broker would estimate an Asking Price based on judgment from the above method. There is no exact formula that will give the correct Asking Price every time. The ratio formulas are only a guide for a knowledgeable, experienced Business Broker’s judgment.

The Business Broker estimate of an “Asset Sale Price” is not an appraisal of the business. A business appraisal is generally based on market, asset, and earnings approaches to value. An appraisal will estimate value for the entire business entity or a divided interest.

4. I have been asked.....
“How is a Business Appraisal different from a Business Broker estimate of Asking Price?”

The Business Broker estimate of an “Asking Price” (previously described) will include only the value of intangible and tangible assets that would be transferred as an “Asset Sale” (previously described).

A Business Appraisal is an equity value estimate of the entire business and will include the market asset value less associated liabilities. It is an opinion of value by an appraiser based upon established methods in accordance with valuation industry standards. Business valuation estimates are generally based on market, asset, and earnings approaches to value. The market approach is a comparison with like kind and size of businesses sold in “the market”. Assets approach is based on the value of tangible & intangible assets. The earnings (or cash flow) approach to value capitalizes business earnings at a market derived rate adjusted for the individual business being appraised.

There are no mathematical formulas or computer programs to derive a business value as a substitute for the judgment of an experienced, Certified Business Appraiser.

Businesses are generally purchased for the amount of provable cash flow to the owner. A business owner should eliminate tax saving expenses and personal perks three years before selling the business. Cash income not reported and expenses overstated will reduce the business cash flow.

                     Year                1                      2                      3
Tax deduction            $1,000            $1,000            $1,000                        Net tax saving
(@ 20% rate)               $200               $200               $200

Breckenridge Business Consultants understand cash flow for the sale, merger, or valuation of a business. Your tax accountant and attorney will know how the taxation, of a business would affect you personally.

6. I have been asked....
“What is a rule of thumb price?”

A rule of thumb price is the average price paid for an average business within an industry. It is usually expressed as a percent of annual Sales or a multiple of annual Earnings. Both calculations should result in the same price for an average business.

Obtaining the Annual Sales (Gross Sales) information for a business is relatively easy.

Earnings will need more explanation and clarification. There are several types of earnings: Earnings before depreciation, interest and taxes (EBDIT); Net Income; Owner’s Discretionary Earnings; or a combination from the above. It is very important to know which Earnings a rule of thumb ratio is to be applied. To be applied properly the Earning Rule of Thumb should be derived from the same “type” of Earnings. In other words, if the Earnings Rule of Thumb was obtained from an average Owner’s Discretionary Earnings, then that ratio should only be applied to the same “type” of Earnings. It is not meaningful and is misleading to apply an Owner’s Discretionary Earnings ratio to the Net Income of a business.

Remember, a rule of thumb is for average businesses within an industry. If a business is earning above (or below) average, the percent of sales rule of thumb would not reflect a true price. Also, most rules of thumb are for “asset sales”, not corporate equity transfers.

A professional business appraiser should be consulted for an accurate price estimate of a business. Rules of Thumb are only for price generality of average businesses within an industry.

Revenue reliance over 20% from any one customer or industry is a risk. A business or private practice should have a multiple-customer revenue allocation by type of industry and amount. It does not matter how “good” the one large customer may be at this time. Large public companies merge, downsize, or sell divisions, which may eliminate the need for purchased goods or services. Even government contracts have an expiration date and are subject to political changes. New products or services may be required to attract and enlarge the customer or client base. A plan should be instituted over time to include new customers from various types of businesses. Merger or purchase of a business or practice with a dissimilar customer base is another way to spread the customer and client risk. Diversification of customer risk is one method that would add value to a business or private practice.

A professional business intermediary will be able to assist you with a merger or acquisition plan to reduce revenue reliance risk of your business or practice while protecting the value.