How To Value a Business for Sale (Mergers and Acquisitions)

Summary

Brent Cenkus, a business attorney and M&A advisor, discusses business valuation strategies, focusing on the Main Street market segment under $2 million. He explains that while larger businesses may use methods like discounted cash flow, for smaller businesses, comparable transaction analysis is crucial. Cenkus emphasizes the importance of Seller Discretionary Earnings (SDE) as the key metric for valuation in this market, adjusting for owner-specific expenses. He also touches on the impact of growth, customer concentration, and other business factors on the final valuation.

Takeaways

• 📈 Brent Cenkus discusses business valuation, focusing on Main Street and lower middle markets, typically under $25 million.
• 💼 He differentiates his dual role as a business attorney and M&A advisor, dealing with both legal aspects and business brokerage.
• 🔍 For larger businesses, methods like discounted cash flow and comparable company analysis are used, but not applicable for the market segment discussed.
• 🏦 The primary method for valuing businesses in the $1 million to $20 million range is comparable transaction analysis, focusing on recent sales of similar companies.
• 💹 Seller Discretionary Earnings (SDE) is the key metric for valuation in this market segment, which adjusts earnings by adding back owner's salary and discretionary expenses.
• 📊 EBITDA is a common metric for larger deals but is not used for businesses under $25 million; SDE is preferred for its relevance to smaller businesses.
• 🏠 Geographic location and industry are crucial factors in finding comparable transactions for valuation purposes.
• 📊 Multiples vary by industry and company size, with larger companies typically commanding higher multiples due to less risk and more stability.
• 🏢 The business valuation process also considers intangible assets and liabilities, adjusting the valuation based on what's included in the deal.
• 💡 Valuation is as much art as science, with factors like growth potential, customer concentration, and the business's reliance on the owner affecting the final price.
• ☎️ Brent offers his expertise as a resource for those looking to buy or sell a business, emphasizing the importance of professional advice in the valuation process.

Q & A

What are the two roles that Brent Cenkus plays in the business world?

Brent Cenkus plays two roles: a business attorney and an M&A advisor or business broker.

What is the primary focus of the video in terms of business valuation?

The video primarily focuses on how to value a business, which is crucial for both sellers and buyers.

Why is the method of business valuation discussed in the video relevant to the Main Street market?

The method of business valuation discussed is relevant to the Main Street market because it caters to businesses under 2 million dollars and the lower middle market up to about 25 million dollars.

What is discounted cash flow and why is it not commonly used in the Main Street market?

Discounted cash flow is a complex mathematical method that measures the cash a business will generate, adjusted for the time value of money and risk. It is not commonly used in the Main Street market because it is more suitable for larger businesses.

What is the dominant method of valuing a company in the 1 to 20 million dollar market?

In the 1 to 20 million dollar market, the dominant method of valuing a company is comparable transaction analysis.

What is the difference between EBITDA and Seller Discretionary Earnings (SDE)?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, which is a measure of free cash flow. Seller Discretionary Earnings, on the other hand, is used for smaller businesses and includes adding back the owner's salary and other discretionary expenses.

Why is the owner's salary added back in when calculating SDE for businesses in the lower end of the market?

The owner's salary is added back in when calculating SDE for businesses in the lower end of the market because buyers in this range are often buying themselves a job and will structure the compensation differently.

How does the size of a business affect the valuation multiples?

As the size of a business increases, the valuation multiples tend to increase as well. This is because larger businesses have more capital available for purchase and are often less risky due to factors like customer concentration and operational stability.

What additional factors are considered when valuing a business beyond SDE?

Beyond SDE, intangible assets and liabilities assumed by the buyer are considered. Intangible assets like real estate or significant equipment are valued separately and added back in, while liabilities are subtracted from the total valuation.

Why are asset deals more common in the Main Street market compared to liability deals?

Asset deals are more common in the Main Street market because buyers in this range often do not want to take on the liabilities of the business. They prefer to purchase the assets and structure the business as they see fit.

How does the concept of 'what someone is willing to pay' influence the final valuation of a business?

The concept of 'what someone is willing to pay' is a critical factor in business valuation as it reflects the subjective nature of the market and the unique circumstances of each buyer, which can lead to variations in the final sale price.

Outlines

00:00

📈 Understanding Business Valuation

Brent Cenkus, a business attorney and M&A advisor, introduces the topic of business valuation, emphasizing its importance for both buyers and sellers. He explains that while there are various methods to value a business, the focus of this discussion is on Main Street businesses valued under $2 million and up to $25 million. Cenkus mentions that methods like discounted cash flow and comparable company analysis are more applicable to larger businesses. Instead, for the target market, comparable transaction analysis is the dominant method, which involves looking at recent sales of similar companies. He also explains the concept of EBITDA and why it's not used in this market segment, opting for Seller Discretionary Earnings (SDE) instead, which includes adding back owner's salary and discretionary expenses for a more accurate comparison.

05:00

💼 Seller Discretionary Earnings (SDE) and Valuation Process

The paragraph delves deeper into the concept of Seller Discretionary Earnings (SDE), explaining its significance in valuing businesses in the lower to mid-market range. Cenkus discusses why SDE is more appropriate for businesses under $2 million, as buyers in this range often intend to take over the business operations themselves. He contrasts this with larger businesses where the management structure is more likely to remain unchanged post-acquisition. The process of finding comparable transactions, ensuring they are in the same industry and revenue range, is explained. Cenkus also touches on the importance of considering geographical factors and how multiples increase with business revenue. He advises that after calculating SDE, one should look at tangible assets and liabilities separately to get a more accurate business valuation.

10:02

🔍 Finalizing Business Valuation

In this final paragraph, Cenkus summarizes the business valuation process. He reiterates the importance of calculating SDE to normalize earnings for comparison purposes. He advises finding good multiples from similar companies that have been sold and applying these to the SDE. Cenkus also mentions considering additional assets and liabilities that may not be included in the SDE. He acknowledges that while the calculated valuation provides a solid estimate, the actual selling price can vary based on market conditions and specific business factors such as growth potential and customer concentration. Cenkus concludes by offering himself as a resource for anyone with questions regarding business valuation and transactions.

Keywords

💡Business Valuation

Business Valuation is the process of determining the economic value of a business or company. In the video, it is the central theme as the speaker discusses various methods to value a business, which is crucial for both buyers and sellers to determine a fair price. The speaker emphasizes that valuation is particularly important in the 'Main Street' market, referring to smaller businesses under 2 million dollars.

💡M&A Advisor

M&A Advisor stands for Mergers and Acquisitions Advisor, a professional who provides guidance and support during the process of buying or selling a business. The speaker identifies as an M&A advisor, indicating their role in helping business owners navigate the complexities of business sales, which includes valuation as a key component of their service.

💡Business Broker

A Business Broker is an intermediary who helps sellers find buyers for their businesses. The speaker also identifies as a business broker, highlighting their dual role in both the legal aspects and the marketing of businesses for sale, with valuation being a critical part of this process.

💡Discounted Cash Flow

Discounted Cash Flow (DCF) is a valuation method used to estimate the value of an investment based on its future cash flows. The speaker mentions DCF as a complex method typically used for larger businesses, where the time value of money and risk are factored into the valuation. It's noted as not commonly used in the market segment the speaker focuses on.

💡Comparable Company Analysis

Comparable Company Analysis involves looking at the valuation multiples of similar publicly traded companies to determine the value of a private company. The speaker points out that while this method is useful for larger companies, it's less applicable in the 'Main Street' market segment they specialize in.

💡Seller Discretionary Earnings (SDE)

Seller Discretionary Earnings is a measure of a company's earnings that includes adjustments for owner's salary and other non-essential expenses. The speaker explains that SDE is the preferred method of valuation in the 1 to 20 million dollar market segment, as it normalizes earnings for a more accurate comparison between businesses.

💡Comparable Transaction Analysis

Comparable Transaction Analysis is the method of valuing a business by looking at the sale prices of similar companies. The speaker emphasizes this as the dominant method in their market segment, focusing on recent sales of similar companies rather than how companies are currently trading.

💡EBITDA

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is a measure of a company's operating performance. The speaker mentions EBITDA as a common valuation metric for larger companies, but notes that it is not typically used in the smaller business market they serve.

💡Multiples

Multiples refer to the ratio of a company's value to its earnings or another financial metric. The speaker discusses how multiples are used in the context of Seller Discretionary Earnings to value businesses, applying a multiple to SDE to estimate the business's worth.

💡Asset Deals

An Asset Deal is a type of business transaction where the buyer purchases the assets of a business rather than the business itself. The speaker mentions that in the Main Street market, deals are typically structured as asset deals, with the buyer assuming control of the business's assets and subtracting liabilities from the purchase price.

💡Liabilities

Liabilities are the financial obligations or debts of a business. The speaker discusses how liabilities are considered in the valuation process, often being subtracted from the total value in an asset deal, as they represent financial burdens that the buyer may not wish to assume.

Highlights

Introduction to Brent Cenkus, a business attorney and M&A advisor

Discussion on the importance of business valuation for sellers and buyers

Overview of different methods to value businesses, including those not commonly used in the Main Street market

Explanation of discounted cash flow and its complexity for larger businesses

Introduction to comparable company analysis and its relevance to public markets

Emphasis on comparable transaction analysis as the primary valuation method for businesses under 25 million

Importance of using seller discretionary earnings (SDE) for valuation in the 1 to 20 million market

Explanation of EBITDA and its use in larger deals

Reasoning behind adding back owner's salary in SDE calculations for smaller businesses

Differentiation between valuation methods for businesses under 1 million and those above

Use of bizbuysell.com as a resource for finding industry multiples

Importance of geographic area and revenue range in comparable transaction analysis

Discussion on how multiples increase with business revenue within the same industry

Risk assessment in valuation due to business dependency on the owner

Process of applying a multiple to SDE to estimate business value

Consideration of intangible assets and liabilities in the final valuation

Differentiation between asset deals and liability assumption in business transactions

Final thoughts on the variability of business valuation and the influence of market conditions

Offer for further assistance and consultation on business valuation

Transcripts

Hi there this is Brent Cenkus I'm a business attorney and I'm an M&A advisor

or business broker so I have two different roles to the world one I do

the legal work the other I help sellers of businesses find buyers and actually

market businesses for sale so today we're going to talk about how to value a

business which is a question I get all the time and is very very important to

sellers and also to buyers right like how much should I pay for this business

so there's a number of different ways to value businesses if you read online you

may stumble across a couple ways that I'm going to tell you about and we're

gonna move beyond because this video is aimed for buyers and sellers at the Main

Street part of the market which is under 2 million bucks and the lower middle

market which people define differently but I define up to about 25 million so

when we do M&A advisory and Business Brokerage we do it from 1 million to 20

million that's kind of our sweet spot so this information is really well suited

for someone buying or selling in that part of the market so the other ways

you'll read about online are discounted cash flow which is a very sort of

complex mathematical I mean it's it's basically a measurement of the cash this

business is gonna throw off discounted back buy kind of for time value of money

the fact that a dollar today is worth much more than a dollar tomorrow and for

the risk that the business represents it or the cash the stability of the cash

flows that we don't use at this part of the market at all but you may stumble

across it so you should know about it that's for much larger businesses

investment bankers will crunch those kind of numbers another is called

comparable company analysis and essentially that's finding similar

companies and looking at how what their what their multiples are

usually in public markets so this is something works much better for much

larger companies that are peers of publicly traded companies now down in

this part of the market where we operate 1 million 20 million the overwhelming

most important reigned supreme method of valuing a company is comparable

transaction analysis so not where our company's trading relative to this

company all right it's where have companies sold

relative to this company it might not sound very different but it is and

there's a lot more data even though it's hard to find out if sometimes in private

markets and we're talking about but there's a lot more data about what those

companies are selling for I mean again trading data of public companies isn't really

relevant because they're totally totally different companies so previous

transactions is what we're looking for we're looking for recent sales of

similar companies and that's called comparable company analysis so the first

thing we need to do before we even get to finding the comparables is we need to

figure out the measurement that's going to equalize our company that we're

selling or buying and and others and so what I mean by that is we need to take a

measure of the earnings of the business now when on bigger deals you may have

heard the term EBITDA which stands for earnings before interest taxes

depreciation and amortization that's meant to be a measurement of free cash

flow so what you do is you say okay this business earned a million bucks but it

had this much interest that this much depreciation this much amortization they

paid this much in taxes you put all those items back in to get your

measurement your EBITDA your apples to apples comparison of one company to the

other because how you choose to capitalize your company whether you've

got a lot of debt on it or you have it debt free is your choice I may do

something different with it but if you've got a million dollars of interest

and I come in and I pay cash for the business and have no debt then you know

I should consider that million dollars a fair add back you know in other words

these are personal decisions how you choose to capitalize the company the

depreciation that's coming through depends on you know the assets in your

hands versus mine and taxes depends on different things so so this idea is a

way of getting apples and apples comparison so that's EBITDA and if you

read about things online you'll you'll come across that a lot now I'm telling

you a lot about what you know what we're not using and EBITDAs another example

of one although that's very common you'll see it that tends to be the measurement

for larger companies with companies in that 1 to 20 million sweet spot where we

operate we use something called seller discretionary earnings and it's

fundamentally pretty similar but we add back in the salary of the owner we add

back in discretionary expenses like the car that the owners running through the

company you know things that a new buyer doesn't necessarily need to do may pay

themselves more or less or nothing they may not have any salary coming out as w2

income at all might just be the the distributions at the end of the year so

we're trying to again equalize one company to the other by taking away the

things that are very personal to how the current owners operate the business and

the reason we add back in seller salaries in it at the lower end of the

market actually we really do this down around $1,000,000 to $2,000,000 as you

go up you do that less and less the reason is because buyers in the million

dollar range are often buying themselves a job and they're just gonna step into

the owners shoes and run things to take out whatever they can so it's like does

it really matter how you structured the money you took out of your company I'll

do what I want to do whereas if you're buying a 20 million dollar company

usually you're keeping the management in place or you're putting another manager

in place so in other words it doesn't make sense to take to add back in the

owner salary because we're gonna need someone playing the job of the owner and

that person's probably gonna be paid what the current owner is so I know

that's a little bit too complex but the point being there's a different

measurement at this end of the market it's called seller discretionary

earnings and you add back in the owner salary you add back in things that are

running through the company are being deducted from the earnings but are

really not necessary to run the business and then once you have that measurement

we take a look at comparable transactions other companies in the same

industry hopefully the same geographic area and the same general revenue range

and what those sold for you could go to bizbuysell.com and they'll have

multiples by industry geography can be important not always important but it's

it's if you can if you can get good comps locally you should the revenue

range is really important because probably constant for everything else

multiples will increase in the same exact industry as revenue of a business

goes up there's more capital available to buy five and ten and twenty million

dollar companies those are your even public companies might buy a company

down there whereas that you know at $250,000 like that's that there aren't

there's not a lot of sophisticated institutional investment capital

competing for those kind of businesses plus those businesses almost always tend

to have a huge risk which is their run by the owner I mean the business operates

around the owner there's fear that replacing the owner right when I buy the

business and take over the owners so integral to how it runs that it might

not transition well where's larger companies that tends to be much easier

they tend to have less customer concentration issues they're over the

initial like viability hump there's just a lot of reasons that multiples will

just kind of go up so we've got our seller discretionary earnings we figure

out what that is we find comprable companies sales to look at we make sure

that they're similar revenue type companies or earnings types of companies

and then we just applied the multiple so it would be really common for a business

a service business that's doing five hundred thousand dollars sometimes those

are valued off revenue by the way but like might be a couple times earnings

you know two times that the seller discretionary earnings not a big

multiple you just take the multiple that you find for the right industry and the

right similarly situated companies and you just apply it to your seller

discretionary earnings so if it's two times it's two times five hundred

thousand dollars in selling description earnings the company's worth a million

bucks right one other step you then take some look at and this is definitely in

the more art than science category but some look at assets that are being

purchased that aren't part of the discretionary earnings so things like

real estate for sure would be valued separately and added back in some fixed

assets I mean if it's a relatively de minimus

computers and things necessary to run the company it probably doesn't get

value separately but if it's really significant equipment or something

sometimes those are given separate credit and then you would subtract out

the liabilities that are being assumed by the buyer so this part of the market

certainly down in that Main Street one or two million dollar range deals almost

always get done as asset deals I think you've heard me talk about that before

those deals it would be rare for a buyer to take on liabilities but if a buyer

did assume some liabilities did say I'll take over that note you know if they

could there's sometimes issues about assigning that stuff but or I'll take on

your liability for that or I'll pick up your you know all your paid time off to

your employees I'll go ahead and pick that all up and there's a lot of it you

know something like that you would subtract that off the price because

generally liabilities aren't included in an asset deal so again we figure out so

discretionary earnings what we're trying to do is normalize one company versus

another and try and get some measurement of kind of free cash flow we do that by

looking at earnings and adding back in salary and discretion expenses we find

good multiples of companies that are similar situated same industry that sold

apply that add intangible assets that would have already be kind of

captured take out liabilities and that's what you got now that doesn't mean that

that's exactly what the business is gonna sell for right there's the saying that

businesses I mean they they are worth what someone's willing to pay right and

in hot markets and there will be some differences if a company is growing

quickly that will generally be easier to sell a bigger multiple on it to a buyer

if the business has a lot of customer concentration I talked about that

earlier like they've got two customers or something it might not even be sellable

or there'll be a lot of risk to it so a buyer's gonna want to apply a discount

so there's a lot of other nuances but fundamentally find SDE seller

discretionary earnings find a good multiple add it and then figure are

there any other assets we should account for and any liabilities and you have a

pretty tight measure of where that company's gonna be selling so if you have

questions about that reach out again I'm a business lawyer and a business broker

I have a lot of looks at this these transactions and would love to be a good

resource for you if you have questions Thanks