THE BUSINESS VALUATION PROCESS

Having an accurate and realistic understanding of the true market value of your business and the various factors that positively and negatively impact that value can be one of the most important tools in completing a successful business transaction.  We have over fifteen years of formal education in business valuations, and a finger on the pulse of the business valuation market as a result of constantly negotiating business transactions.

Sierra Company, LLC offers two types of valuation services.  The first is a no cost Valuation Summary which generates a valuation range to help prepare a Business Owner for the business sale process.  The second service is a comprehensive Business Valuation Report which includes a detailed Valuation Document for Owners seeking a professional third party valuation report.   This service varies in price based on the size and complexity of the business.

To begin either process we need some basic information about your Company including complete year end financial statements for the past three years and some general information about the business.  A Valuation Questionnaire that guides you through all the information needed for a valuation can be found in the FORMS AND RESOURCES section of this website.  If you are interested in a Business Valuation, please call us at 303 903-2100 for a no-cost initial meeting. 

Below is a summary of the general valuation process.

The first step In the Business valuation process is to identify the Company’s true business earnings through an in-depth study of the income statements, balance sheets, and tax returns, as well as a basic review of the overall business and industry.  The term, “Seller’s Discretionary Earnings” (SDE) or Cash Flow is commonly used to refer to a Company’s overall earnings.  In larger Company EBITDA or Earnings Before Interest, Taxes, Depreciation and Amortization is commonly used as the measure of Company earnings.  SDE is calculated by starting with the Company’s net pre tax income from the Income Statement and adding non cash expenses including depreciation, net interest expense and amortization.  The Owners compensation and benefits are then added back as well as contributions, donations, one time non-recurring expenses, and other personal or non business related expenses. 

The key is to identify the true cash flow that would have accrued to a “normal” independent Owner over the past three to four years.  For example, if the Seller takes $5,000 per month in rent on the facility he owned, but would charge a new Buyer $6,000 per month in rent, the Seller would need to deduct $1,000 from the SDE to “Normalize” earnings.  Alternatively, if the Seller’s uncle is paid $100,000 per year as the Service Manager, and a new Owner would replace the uncle for $60,000 per year, $40,000 should be added to the SDE.

The process of identifying SDE is often referred to as “recasting” the financials statements.  A Financial Recast Worksheet is included in the FORMS AND RESOURCES section of this website to help you with the process.  Be aware that all banks and almost all buyers will compare tax returns with Income Statements (even audited statements) and will expect a clear explanation of any significant variations between returns and Income Statements.

It’s important to then identify what is including or not included on the Company’s Balance Sheet.  These are points of negotiation put to have a clear understanding of value you must have a common reference of assets included.  In a traditional assets sale, the Seller would retain cash and the company would be transferred free and clear of any long term debt.  However, Accounts Receivable, Accounts Payable, personal assets, Inventory may all be included or excluded depending upon the negotiations of the transaction.

Once the Company’s true earnings (SDE) and included assets are identified, the next step is to apply valuation formulas.  There are many complex valuation formulas including formulas specific to certain industries (rules of thumb).  Some of the more common valuation formulas include Capitalize Net Earnings, Discounted Future Cash Flow, and Capitalized Excess Earnings.  In general, the results of these valuation formulas tend to approximate a multiple of Earnings or SDE.  For example, Company value equals a multiple (2.8) times SDE (425,000) or $1,190,000.  This multiple can be considerably difference depending upon the size, location and industry of the business, but in general the multiple gets larger as the Company’s SDE get larger.  The chart below provide some common samples of SDE Multiples which could vary greatly from you company’s specific multiple.  As a Company’s earnings approach $1,000,000 Buyers tend to rely more on a multiple of EBITDA and multiples also tend to increase.

                          SDE            MULTIPLE         COMPUTED VALUE RANGE

                        250,000         2.0  to 3.0                $500,00  to     $750,000

                        500,000         2.5  to 3.5            $1,250,000  to  $1,750,000

                        750,000         3.0  to 4.0            $2,250,000  to  $3,000,000

                     1,000,000         4.0  to 5.0            $4,000,000  to  $5,000,000

After identifying earnings and applying an appropriate valuation formulas (multiple), the next step is to verify your valuation result by comparing the computed value to the sale price of other comparables Companies.  There is a significant amount of real world comparable data available through the internet for a fee at sites such as: www.bizcomps.com, www.bvmarketdata.com, www.prattsstats.com.  A review of actual sale prices for similar business will allow you to narrow in on your appropriate price to earning (SDE) multiple and determine the applicable range of value for your company. 

What will determine where your company’s market price will fall between the range of values is the Buyers perception of your businesses overall strength.  Below is a sample list of factors that can positively and negatively affect the market value of your Company.  While these factors will weigh differently for each buyer, improving as many of these factors as possible will generally tend to result in a higher overall price.

                 Business attributes that justify a HIGHER multiple:

A consistent historical record of growth and profitability

10+ years in business

Substantial hard asset value

Accurate and timely Financials, Tax Returns, and records

Easy to understand motivation for selling (e.g. retirement)

Strong stable management team, owner not critical to operations

Lack of family or partners in the operations

Few employees, low employee turnover

Clear opportunity for growth and/or improvement

A broad diverse customer base

Longevity of customers

Strong competitive advantages

Barriers to entry for competitors

Proprietary or exclusive products

Recurring revenue accounts

Current and well maintained assets and facility

Strong facility location

Favorable facilities lease

Property included in the sale

A high demand (manf, distro, service) vs. low (retail, bar, rest.)

Favorable seller financing