2004 Fall/Winter Volume No. 4
Tips & Insights from the Trenches
Mike Adams, Managing Director
PolyJohn Enterprises Corporation
I have been thinking about selling my business.
How do I determine what it’s worth?
The first thing to understand is that every business is different. Factors that can affect valuation include:
• Management style
• Inventory and its quality
• Fixed assets such as land and buildings
• Local competition
• Local economic conditions
• The selling price of similar businesses in your area
• Your business plan and marketing strategies
• Your employees’ skills and their length of service
• The quality of your equipment such as trucks and related hardware
• Your business’s past growth and future growth potential
While there are many different theories on business valuation, one of the most common is called the Multiple of EBITDA method. It starts with information about your business that is based on fact, not opinion.
Multiple of EBITDA Method
EBIDTA is an accounting term that means Earnings Before Interest, Taxes, Depreciation, and Amortization. This value is the amount of money a business is actually generating through operations. It is equal to the total revenue minus all costs that are not depreciable. Your cash flow statements should include this number, or you can work with your accountant to figure it out.
In addition to looking at earnings, the method also adds the value of assets including real estate, equipment and inventory minus the sum of all debts and liabilities. Finally, it applies a “multiplication factor”—which is where the art of business evaluation overtakes the science.
EBITDA—The value of money a
business is actually generating
The multiplication factor is used to address the business’s return on assets or future sales. It is decided based on highly technical formulas, industry standards, growth potential, and overall quality of the business. The multiplier can be as low as 1x or as high as the market will allow (essentially what people are willing to pay). On Wall Street highly desirable growth stocks can sell for as much as 100x earnings. However, on Main Street the multiplier is more likely between 1 and 7x earnings.
Because the multiplier for every business will be different, there is no way we can provide the exact number for your business. For an accurate multiplier, a valuation expert is needed. However, most valuation experts will average as many as five years EBITDA or as few as three years. For our example, we will use the number *2.5x just to show you how the effect of the multiplier works on a company’s valuation.
Let’s take a look at an example company we’ll call ABC Toilet Service. ABC’s earnings have steadily increased over the last four years. In 2000, their EBITDA was $68,000. In the following three years, it was $72,000, $76,000 $83,000 respectively. That’s an average EBITDA over four years of $74,750.
Earnings Before Interest, Taxes,
Depreciation and Amortization
4-year average EBITDA $ 74,750
TOTAL ASSETS $579,000
BASE VALUE $653,750
Multiplier 2.5* x $653,750 =
Valuation, or asking price: $1,634,375
4 • JohnTalk – Fall/Winter 2004 – www.polyjohn.com
Taking into account the fact that ABC has grown by 22% in four years, a valuation expert might use a higher multiplier. You can see that a multiplier of 3.2, 4.7, or higher, for example, would dramatically change the valuation of the business.
On the other hand an expert may look at factors such as rising fuel prices, increased competition, or a shrinking construction market and determine that chances for continued growth are not good. In which case, a smaller multiplier would be used.
The “least” ABC Toilet Services would be worth is what the total assets would sell for at auction. The auction price would probably be somewhat less than the $579,000 figure. A business could be sold at auction if the owner dies or becomes disabled without having a succession plan in place for continued management. An auction sale could also be precipitated by bankruptcy or foreclosure.
Clearly, a healthy operating business is worth much more than one that has been closed, even if only for a short period. In portable sanitation, especially, customers need continual service or they will quickly leave for a competitor.
Even a business that has had a net loss over the past few years may be worth more than a closed business. For example, using the same formula, even if ABC company had lost an average of $10,000 a year over a 4-year period it could still be worth more than the auction price: 4-year average EBITDA (-$10,000) + Total Assets ($579,000) x the multiplier (1.4*) = $796,600. In the example, a lower multiplier of “1.4” is assumed for a company that has steadily lost money.
One other issue that can add to the value of your company is if you are willing to provide financing when selling it. A financed deal may be riskier for you, than an all-cash deal, but it will help you gain a higher selling price.
Remember that valuing businesses is inexact. You should always get more than one opinion. There are several professional organizations that can recommend a qualified appraiser including:
•the National Association of Certified Valuation Analysts
•the American Institute of Certified Public Accountants
(through their Accredited in Business Valuation program)
•the American Society of Appraisers
•the Institute of Business Appraisers
You can also expect that the buyer will have his or her own valuation expert, and your experts may not agree. The true value of your business is ultimately not what someone says it is, but the price that you and a buyer agree upon. Fair market value is essentially what’s fair to you and the buyer.
*Multipliers 2.5 and 1.4 have been arbitrarily chosen to show the effect the multiplier has on the sales price. The multiplier for every business will be different and should be set by an expert business appraiser in your geographic area. In my experience, portable restroom service companies bring 3x to 5x EBITDA on average including all assets other than real estate.
Click here for a listing of companies offering Trucks & Accessories, Decals, Financing, Restroom Trailers, Trade Publications, Marketing, Restroom Manufacturing/Sales, Billing/Routing Systems and Insurance.
Click here for more information on effectively marketing your business to special event coordinators, and construction and agricultural businesses.
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