How To Value a Business for Sale (Mergers and Acquisitions)
Summary
TLDRBrent 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
- π Brent Cenkus discusses business valuation, focusing on Main Street and lower middle markets, typically under $25 million.
- πΌ He differentiates his dual role as a business attorney and M&A advisor, dealing with both legal aspects and business brokerage.
- π For larger businesses, methods like discounted cash flow and comparable company analysis are used, but not applicable for the market segment discussed.
- π¦ 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.
- πΉ 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.
- π 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.
- π Geographic location and industry are crucial factors in finding comparable transactions for valuation purposes.
- π Multiples vary by industry and company size, with larger companies typically commanding higher multiples due to less risk and more stability.
- π’ The business valuation process also considers intangible assets and liabilities, adjusting the valuation based on what's included in the deal.
- π‘ 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.
- βοΈ 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
π 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.
πΌ 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.
π 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.
Mindmap
Keywords
π‘Business Valuation
π‘M&A Advisor
π‘Business Broker
π‘Discounted Cash Flow
π‘Comparable Company Analysis
π‘Seller Discretionary Earnings (SDE)
π‘Comparable Transaction Analysis
π‘EBITDA
π‘Multiples
π‘Asset Deals
π‘Liabilities
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
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