Sell My Business

July 17, 2019

My interview is with two experts on Business Valuation: Peter Gruits is a Volunteer SCORE Mentor and Eric Robinson, is a Partner with Robinson & Gruters, a Venice, Florida, CPA firm. 

Peter when someone Sells a Business, what is the buyer buying?

Every business is different. They can be buying the assets, they could be buying the customers, they could be buying the business process, they could be buying intellectual property. Typically, they’re looking to buy an ongoing business that they can do something with in the future. 

Why should a business owner establish the value of their business?

Value means different things to different people. The SCORE Exit Strategy Team focuses on trying to figure out how to fix the value leaks that occur in the business. Some areas where the value will leak is possibly in having too much of your business concentration with a few customers, having customers that are not profitable and spending time with them. Another area where there could be a leak, perhaps the business has some bad employees. Employees you should get rid of, that impact your good employees. Maybe you have too much dead inventory, inventory that’s obsolete and you’re paying for space to store it, that’s a leak. You could have spare parts inventory for equipment that you don’t have anymore. That’s a leak. You could be doing too many of the things yourself, as the owner, and you’re not really holding yourself to the performance standards of the business, that’s a leak.  SCORE Mentors help you identify and fix those leaks.

Peter, what methods are used to value a business?

One of the standards is to look at the North American Industry Classification System codes (NAICS North American Industrial Classification System). Every business has a code that matches their type of business. There are tools that help you understand what the ratios are in your industry and how your business stacks up. These ratios are based on size of the business, the location of the business, etc.

Eric, are businesses in different industries valued differently?

Yes, if you have a manufacturing company, it would be more of a derivation of book value, so the return on assets is going to be very important. For a lot of service-based organizations, or business in general, it’s going to be discounted cash flow. What do I mean by that? If someone’s going to pay you $50,000 a year over the course of 10 years, it’s not really $500,000 because the 10th payment of $50,000, because of inflation, because of the uncertainty of receiving that $50,000 10 years down the road, it’s worth less than it is now. So 10 payments of $50,000 may only be worth $375,000. If someone’s offering you 10 payments of $50,000, or $450,000 now, you’d want to compare those two offers, using the discounted cash flow method to see which one is a bigger bang for the buck.

Eric, can you explain the concept of goodwill and how that factors into purchase?

Goodwill is the difference between the price of the hard assets that you’re selling and the actual purchase price of the business. Some people commonly call it blue sky, and they’ll be able to put that on their books, and depreciate it, amortize it actually, just like any other asset. But it would be straight line over a 15-year period.

How about companies in the same industry, why would one be worth more than another? 

For example, going back to Peter’s analogy about leakage, you could have two companies with the same revenue, but one has more leakage than the other, and so that will affect the profitability. It could affect the return on assets. It could affect the discount rate. All those things could affect the eventual sale or purchase price of the business.

Peter, how can the SCORE Exit Strategy program increase the value of a business? 

I don’t think the Exit Strategy Team increases the value, but what we do, is we bring reality to the transaction. Our mentors are experienced and free, it’s a great way for you to test the waters, in reference to the selling your business.

Now I’d normally agree Peter, but I’m going to have to disagree. I think that SCORE can increase the value of a business by requiring you to plan: By making sure that you do your homework and by making sure that you look at, “What is driving the value of my firm?” You can gear your actions towards that valuation and that metric to increase the overall value of the company. I think SCORE allows you the ability to focus in, because sometimes as an entrepreneur you’re disorganized. You want to focus and hone-in on what is really important and what the seller going to be looking at. You’re looking at it as the entrepreneur, and you need to look at it as the seller, and often they’re not looking at it the same way.

How does owner benefits add to the value of the business? 

I’ve heard a rumor that some people have quasi-business expenses on their balance sheets, in order to lower their tax burden. It could be Tampa Bay Bucks tickets, or they want to drive a nicer car, and you run the expenses through the business. Anything that’s not ordinary or necessary in running the company, those kind of things, you probably with good planning, would probably want to take those out, and not have those show up on your income statement because it’s going to increase the value of the firm. If that person wants to get an SBA loan, or get a loan from the bank, it’s going to increase the chance that they’re going to be able to get a loan because the bottom line’s going to be higher. Let’s face it, if the bottom line’s higher, you’ll probably get a better price for the business. 

So just because you’re not expensing $20,000 for the car, because of the multiple factor, you may end up getting $60,000 more in your pocket, so you got to look at it. $20,000 for the car, it may create an $8,000 savings in taxes. Would you rather have $8,000 or $60,000? It doesn’t take a CPA to figure that out, “I’d rather have the 60,000.”

Eric, can you explain the concept of what EBITDA is? 

It’s Earnings Before Interest, Tax, Depreciation and Amortization, which is basically you’re free cash flow for the business. That helps people determine what they’re going to use as a multiple to pay for the business because they’re going to look at, “Okay, if I want to borrow money from the bank, how much money am I going to have to spend for that? How much money am I going to have to spend to buy equipment, to amortize goodwill?  How much money am I going to have left to as my owner benefit? What’s going to be the value to me? At the end of the day, the bottom line’s the bottom line.

Can you explain what multiples are? 

Multiples are derived from multiple factors. It’s the stability of the cash flow. If a business only has one or a few clients, you’re not going to give it as much of a multiple, because if that one client leaves, what do you really have? If it’s a high-growth company, then you’re going to give it a larger multiple because the income’s going to increase over time. If it’s a more stable company or a declining industry, you’re probably going to give it a lower multiple. If you’ve determined that EBITDA is $50,000, and it’s a high-growth business, you may give it a 30-times multiple, but if it’s a declining or stable industry, you may give it a two to three times multiple. So it’s the difference between getting $50k times three ($150,000), or $50k times 30 ($1,500,000). 

Eric, a seller may say that the buyer doesn’t need to buy NBA or NFL season tickets, so I’m going to add it back, so now those tickets cost me $20,000, and if I’m going to get a multiple of four, then that’s worth $80,000 to me when I sell. However, a bank may not look at it like that. A bank may say, “This was on your tax return, this is your net income on tax returns, and that’s what we’re going to use to determine the multiple, and that’s going to determine how much we loan you. That $20,000 may make it so that someone may not be able to put the finances together to buy your business because of that.

The Seller has to put on glasses that are reflective of what they would do if they were going to buy the business. That means you have to put so much money down, that means you have to get a loan through some kind of lending institution, that means you may have to take back paper. It means you may have to enter into an employment agreement. This comes down to the terms and conditions of your sale. The terms and conditions of your sale have as big an impact on what you’re trying to do as the price does. As you’re setting the price, and you’re looking at terms and conditions, you’re going to open yourself up to many more potential buyers if you can be flexible. 

SCORE is a Resource Partner of the SBA, and the SBA guarantees bank loans.  Banks make loans to help people finance the purchase of a business, please explain how that works? 

The SBA doesn’t loan money. The SBA guarantees a loan through a financial institution that’s qualified to be an SBA lender. You need to get a competent commercial lending officer to work with you in this regard. And sometimes they’ll decide that they can handle the transaction on a commercial loan basis. Other times they’ll advise that this really needs some help. They’re not going to put that much money down, and the SBA will guarantee a much larger portion of the deal. But SBA has credit criteria that you have to meet.

Peter, please explain the different loan programs such as 504 and 7A.

Some loans such as a 504 are related to real estate. A 7A is for an operating business. There are a number of different loan choices. The key to recognize is that your tax return has to reflect what you’re business can do. And if your performance is not reflected adequately in your tax returns, you have an uphill struggle, you’ve got to fix those leaks. You’ve got to improve that performance. There’s a lot of businesses out there that are for sale and you have got to make yourself aware of that. Similarly, if you’re going to sell a house, you got to clean the house before you put it up for sale, and you got to make sure that the value of that house is commensurate with the comparative market analysis of the neighborhood. It doesn’t matter how much money you have in the house, if it doesn’t meet that assessment, the appraisal, it’s not going to get that kind of money. Our team members from SCORE have experience and we’re going to ask you those kind of questions. If you don’t know the answer to those questions, it’s time to roll up your sleeves and get to work. You’ve got to have a good plan going forward.

Eric, how much negotiating room is there in a typical deal?

I wouldn’t put it in terms like that. I would go back to what Peter was talking about, flexibility. So if you’re more flexible, if you’re willing to stay on as a consultant, be an employee, all those things play into a mindset in flexibility. Planning and homework goes a long way in creating the right paradigm of what range that you’re willing to take, or the markets are willing to bear for the sale of your business. Selling your business is a very emotional experience. People who have spent their life trying to be independent, trying to be on top of everything, and many of the entrepreneurs are not employable. In that particular case, they have to get past the emotion. The have to determine why they are selling this business and realize there’s a lot of compromises they have to make to succeed.

You have mentioned a seller staying on for a period of time. How typical is that and what kind of earn outs might they negotiate? 

It is all over the map, but it depends on the entity. If the person owns the relationship, if all the clients think that they’re doing business with the owner, and not with the company, then you’re going to want to make sure that you have an earn out, so that there can be a transition time, to where people either know that they’re doing business with the company, or they know that they’re doing business with the new owner. You’re going to want to make sure that you get a non-compete, so that someone doesn’t sell, and they don’t start a business across the street. You want to make sure you get non-competes from some of the key employees. 

Is it difficult to obtain the non-compete after the fact? They’re already working for you and if they haven’t signed one and now you’re asking them to? 

The key employees it can be somewhat difficult to tie them up. What you can do because it’s such a chaotic time period, is you’re going to have to offer them some sort of stability. They’re worried, “Am I going to lose my job?” There are ways to finesse it, you’re probably going to have to pay to get the non-compete, but the non-compete has value. 

Peter, what should an owner not do, when selling his business? 

An owner should learn to keep their mouth shut. They should get good advice from our SCORE Mentors. But they also have to be careful that they don’t spill the beans on the fact that they’re looking to sell their business. Loose lips sink ships. It’s a very sensitive time. Employees could hear that you’re trying to sell the business, and everybody leaves and the value of your business can be terrifically impacted.

It’s important to also realize that many owners have friends who work for them. They treat those employees like their family. Under those circumstances, you have to negotiate in good faith to be representing them, as well, both for continued employment, but also maybe you need to give them a piece of the pie, as you go to sell. So you’re negotiating for the people within the firm, as well as yourself.

I wanted to add some things that the seller should do. They should make sure that they plan, something we talked about earlier, make sure you understand what it is that’s driving the sale price, and you maximize that. Give in to some of the quasi business, do your homework. But also, rely on some experts. That includes legal, good CPA, and SCORE mentors.  This is probably going to be one of the largest financial transactions you ever do in your life, and you must realize, “I don’t know everything, and I want to make sure I get this done right, because I’m only going to get one chance at it.” Using people at SCORE, that have knowledge and expertise, will in essence, increase the amount of money that you walk away with. People need to be cognizant of what’s driving the situation, do your homework, plan, and don’t be afraid to reach out, and definitely call SCORE. 

I think it’s important to not go through this alone. It’s very important for you to recognize that there are all kinds of pitfalls to this, and it’s going to impact how much money you get. You need to talk to people who know what they’re doing.  The great advantage of dealing with SCORE and the Exit Strategy Team is that we’re free, we’re experienced, and we’re confidential.