Did you know that statistics show only 3 out of 10small businesses end up being sold on the open market. There are many reasons for this, but in my professional opinion the biggest reason is unrealistic value expectations from the business owner. This causes too big of a price gap between seller and potential buyers so a deal cannot be made.There are very few resources on determining how much a business is worth and many companies will offer business valuations for $5,000+ (USD). I think it's time small business owners learned how to determine the realistic value of their business. Here you go:Step 1: determine your SDESDE stand for Seller's Discretionary Earnings, and it's one of the most important numbers to know as a business owner. SDE is the 'true income' a business creates for its owner and is found using the following formula*:• SDE = Net Income + Primary Owner's W-2 Salary and Owner's Payroll Taxes + Depreciation + Amortization + Interest Expense + Discretionary ExpensesThe most frequent question I get 'what is discretionary expenses?' Discretionary expenses are expenses that are not required for the business to operate but are expensed by the owner because they can for tax purposes. Examples include: Owner's Retirement Plan contributions, owner's family's cell phone plan, owner's vehicle expenses, owner's personal insurance, family employees on payroll who don't actually work in the business, one-time expenses such as remodels, and overpayment to an owner's spouse (relative to market salary for their role) if they work in the business.*Key things to keep in mind here:Only use one financial statement (profit and loss or taxes) when finding your SDEYou can only add-back something that shows up on a financial statement as an expenseOwner's draws are not added back. This is accounted for in the net income.Step 2: determine your SDE multipleSmall businesses are usually given a multiple of 1-4 times their SDE. This is the biggest misconception. I've heard too many owners think the multiple is times total revenue or gross income. This is incorrect! Those formulas really only apply to VERY large, often publicly-traded companies and do not apply to small businesses. The following rules will help you determine a range of value for your business.If your SDE is:Between $0 and $100K, your multiple is 1 to 1.5xBetween $100K and $250K, your multiple is 2 to 3xBetween $250K and $750K, your multiple is 2 to 4xOver $1 million, industry dependent but is usually 3 to 5xStep 3: multiply the SDE time the multiple to determine a realistic range of valueLet's say you found your SDE to be $300,000. Your SDE multiple would be 2-4x. On the low side, your business would be worth $600,000 ($300,000 x 2) and on the high side it could be worth $1,200,000 ($300,000 x 4). The most realistic estimate would be right in the middle at $900,000 ($300,000 x 3).Step 4: add inventoryUsing the example above, let's say the business has inventory that cost $50,000. The total value for this business is around $950,000 ($900,000 + $50,000)Example: Here's real life example for a business we recently worked withStep 1: determine SDENet Income$300,000Primary Owner's W-2 and Payroll Taxes$70,000Depreciation$10,000Amortization$0Interest Expense$4,000Discretionary Expenses (car, health insurance)$16,000SDE (total of all the above)$400,000Step 2: determine the SDE multipleThis business is in an industry where the multiple is 2-3x and this business has many traits buyers find attractive (strong client base, passive ownership, strong management team in place) so the multiple we'd use is 3.Step 3: multiply the SDE times the multiple$400,000 x 3 = $1,200,000Step 4: add inventoryThis business has $75,000 worth of inventory so:Business value = $1,200,000 + $75,000 = $1,275,000TLDR: Business owners understanding of their business's value is very important but usually incorrect. In most situations, the formula for determining the value of your small business is the following: (Seller's Discretionary Earnings * SDE Multiple) + Inventory (at cost) see hubwealthy.com/wealthy
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