The following is an excerpt from Demystifying the Process of Selling Your Business by OneAccord Capital President Scott Smith. To get your free copy of the ebook, click here.
Your adjusted EBITDA is the starting point for pricing your business for sale, and other factors can and will determine what a buyer is actually willing to pay for your company. The consistency of your earnings will be a big one. If your track record is full of fluctuations up and down, your business will be valued for less than if it had a steady, stable upward trend. Other factors will include your historical growth, the quality of your management and the market.
There are two hugely significant factors that will gut the value right out of your business.
If all your work is done for one customer, you’re in trouble. Let’s say you manufacture parts exclusively for Boeing. This means the livelihood of your business is entirely dependent on one customer. If Boeing ever gets into trouble, so do you. (Fortunately, in today’s market Boeing is booming. But what goes up will come down…eventually.)
A quality management team that can keep the business going without you is valuable to a potential buyer. If you’re central to the survival of your business, your business is less attractive. Then, if you do find a buyer, he or she is going to want to lock you in to helping with the transition for a long period of time. So once you’ve sold your business, you’re not actually done with the day to day.
If you have customer concentration issues and the wrong management in place, your sales plan must address these.
I work with a lot of people who are looking to sell their business. And one thing I’ve noticed is that many of the owners I’m talking with aren’t aware of how the tax code has changed since they founded their company.
Before 1958, the United States only knew two kinds of businesses: C-Corp and sole proprietor/partnership. The latter meant total liability so many business owners filed as a corporation. Few of these owners realized they could change their designation when the S-Corp was born.
The S-Corp recognized private, domestically held business with fewer shareholders. It allowed business owners to retain some protection in terms of liability but eliminated the double taxation upon the sale of their business. From what I’ve seen, countless business owners went on unaware of the change until the time came to sell. Then they faced double taxes that they could have avoided had they only known their options.
The difference between the tax burden you will bear as a C-Corp vs. an S-Corp is significant. Consider a C-Corp sold for $2.5 million. The owner pays his 35% in corporate taxes and makes $1.6 million from the sale. This puts the owner into a new personal income tax bracket, one that pays, on average, 24.3%. By the end of tax season, this owner will have paid more than $1.2 million in taxes.
This same business designated as an S-Corp would avoid the double taxation because S-Corps are recognized as a source of income for their owner and that income is directly tied to the performance of the business.
There are limitations for S-Corps and not every business is eligible. If you’re thinking of selling, talk with your tax advisor as soon as possible to determine if changing designations is a viable option. If you determine it is, the transition will take time and you’ll want it well underway as you begin preparing to transition your business.
If you’ve calculated your adjusted EBITDA and aren’t happy with the result, change it. The average business owner needs three years to get his business ready to sell. This is a reasonable amount of time to increase the value of your business. Make a plan to bring this number up to something you can live with.
You might have built your company with your bare hands from the ground up, but trust me, this is not a plan you want to make alone. An investment banker, broker or other advisor who buys and sells businesses for a living can help you avoid wasting time and money and help you create an effective, focused plan that will deliver results.
This plan will include four specific elements:
Any potential buyer is going to want to see consistent growth. If your earnings fluctuate up and down over the years, that’s a red flag and you’ll have a hard time convincing a buyer to stick around. Buyers want to see consistency in the upward direction.
Your managers need to not only be able to run the business without you, they need to be able to do it well. This will start by having the right people on your team and having those people in the right roles. Now, I know your son is a great kid. However, if he knows nothing about sales and he’s leading your sales team, he’s going to be a liability. Potential buyers want to see a business they can ease into without worrying it’s going to collapse while they’re getting up to speed.
We discussed this issue in our last post. No one client should represent more than 20% of your business. If your company is leaning too heavily on any of your current customers, get busy bringing in new business while continuing to serve well the customers you already have.
Look at your business through the eyes of your potential buyer. If you start cutting back on your investment into your business, your growth and your people will suffer. You don’t build strong businesses by backing off and if your business isn’t strong, don’t expect to attract buyers—or a good price.
Your business may be operating smoothly now, but if you’re entertaining the thought of selling you need to see it through the eyes of a potential buyer.
Two things that trip up plenty of successful businesses include customer concentration issues and the owner’s role in the business.
This is a common problem with the potential to sink the value of your business no matter what your adjusted EBITDA is, and for good reason. Any buyer interested in your business will instantly recognize concentration issues as a great risk.
This is putting all your eggs in one basket. If the majority of your work is done for a single client, you’re gambling the future of your entire business on their performance and/or their reliance upon you. If you make widgets for Company Inc. and they go under or find a widget seller they like better, your entire operation can come crashing down.
Bringing in more business with more diverse customers relieves your dependence on any single client. So if Company Inc. goes away but only represents 20% of your business, your company survives.
The second issue that commonly deflects potential buyers is you. Consider your role in your company carefully. If you leave, does your management team have the knowledge and experience to keep things running smoothly, or will operations grind to a halt? If your role is central to the success of your business, a potential buyer is going to have to bring in and train an entire management team. They’re going to need you to stick around during a very long, slow transition just to keep things going.
Make sure you have a good team in place, one made up of the right people in the right roles, who can run the business on their own.
More business owners than ever before are preparing their companies for a good exit and one of the primary questions many are asking is how to value their business. Multiple methods exist to suit the various kinds of businesses operating today. The most common valuation calculation method is found by taking a multiple of EBITDA to Adjusted EBITDA.
EBITDA = net income +( interest + taxes + depreciation + amortization)
To Calculate Adjusted EBITDA, you take your EBITDA calculation, add back expenses that the new owner will not incur (owner’s personal expenses, owner’s salary) then deduct the amount for the new cost of running the business (new CEO salary). Then use the table below and apply a multiple to the calculated adjusted EBITDA.
You probably know your net income already. This is your company’s income minus the cost of goods sold, expenses and taxes. To get your adjusted EBITDA, start by adding your taxes, depreciation and amortization to your net income.
These are any one-time expenses or income that the new owner is not likely to incur. For example, if you built a new plant this year add what you spent on it back to your EBITDA, because the new owner is probably not going to build a new plant every year.
This accounts for the changes in cost to the new owner. For example, if your son has been helping you out at the business and isn’t on payroll, the new owner will need to hire someone to replace him. You’ll need to subtract the salary the new owner will have to pay your son’s replacement. Or if you’re taking a $1 million salary and the new owner will hire a president to do your job for $200,000, you’ll need to add the difference between these two numbers.
Once you’ve added the costs for the new owner, multiple the result by the correct multiple. This multiple is determined by the size of your business. If your EBITDA is:
The result is a reasonable estimate of the value of your business for most manufacturing, distribution and service businesses. These multiples do not apply to hi-tech or software firms.