Want to Know How a Business Appraiser Looks at Small Business Value?

Factors that Increase or Decrease Business Value

By: George D. Abraham

CEO & Chief Appraiser

Business Evaluation Systems

There's a range of key factors that can affect the value of a business.  While some of these factors are outside of the owner's control, steps can be taken to make the business as valuable as possible. Start planning well in advance and consider inserting an exit strategy into your original business plan. Then start implementing the factors that increase value and eliminate the factors that decrease the value.

Financial Statements

Just how good are your financials. Are they minimal or do they show an in-depth look at your business.  Can you easily track the flow of revenue and expenses flowing from the invoice to the financials to the tax returns?  Can your track the sales of your top 5 customers? Can you easily prove all of the perks you receive from the company?  Today's accounting software easily lets you do all of this and much more.  When a buyer is interested in a company, the ease at which the owner can prove the financial performance of his or her business has a direct impact on value. Incomplete or inaccurate financials tells the buyer that no one is watching and tracking the Company's performance and therefore the future performance (of real importance to the buyer) is unpredictable.  Value is created or destroyed by the ability to see the Company's future.  The longer the buyer can see that the Company will perform in the future as represented, the more secure they are and less risk is perceived.  To the contrary, when the future is a guess, risk is increased and value is decreased. 

Do you know yourself? Do you know your clients? What Kind of business owner are you?

I had a chance to meet with John Warrillow recently. He's the author of an excellent new book that talks about business owners and how they think. It's titled Built to Sell

If you have a dream of selling your business or growing your small business into a bigger business that one day can be sold, this book should help you.

If you're a business owner, or hope to one day be a business owner, this book is important for you...if you are an advisor to business owners this book is critical!

What kind of business owner are you? What kind of business owners are your clients?

• Mountain Climber
• Freedom Fighter
• Craftsperson

Take the time to figure it out, it could be worth a lot of money to you one day soon.

Give it a read, I'll bet you'll be glad you did.

Click here for the link to the book.

Thinking about buying a business? Here's a way to figure what is possible

If you want to own your own small business there are really only two ways to get into business. You can start a business from scratch, often called a start-up. Or you can buy an existing business from a business owner who is ready to sell their business.

There is much written about starting a business. The biggest problem with a start-up is in the time it takes a start-up to become cash flow positive and unfortunately many never become cash flow positive and they fold.

Buying an existing business is often a good choice. If you do it right you can be cash flow positive immediately and financing for purchasing a business is often very favorable. In a previous post I wrote about "Why would someone sell be their perfectly good business?" and it talks about why business owners choose to sell good businesses.

If you want to buy an existing, profitable, business you need to answer a couple of questions about your situation before you begin your search.

First, how much money do you have available for a down payment before borrowing any money from any banks, credit cards, etc. It will be very, very difficult to buy a good business without a down payment.

Second, what's the minimum amount of money you need to make from the business to live on once you buy the business.

If those two numbers are reasonably close to each other you have a decent shot at buying a business.

Here is a "typical" deal:

Business earnings (Seller's Discretionary Earnings)  $75,000
Selling Price of business   $200,000
Down payment    $50,000
 Earnings/Salary you need  $50,000
Get an SBA Loan for $150,000
Annual Payments for your SBA Loan $20,500 (10 years @ 6.5%)

Business earnings $75,000 - $20,500 (debt payments) = $54,500 to you the new owner.

Also, when thinking about your down payment there is a mechanism to use you 401(k) funds to buy a business without incurring early withdrawal penalties nor tax obligations.

If you want to be in business for yourself it's always a good idea to get informed and look at all your options.

Why would someone sell me their perfectly good business?

Often small business buyers wonder about this. There is an all too frequent buyer attitude that says "If it is a good business they wouldn't be willing to sell it to me!"
Here are some reasons we see business owner want to sell:

1. Divorce of husband and wife owners
2. Partnership disputes
3. Owner health issues
4. Kids don't want the business and the owner has gotten to retirement age.
5. The business has gotten bigger than the skills of the owner
6. The business needs professional management
7. The industry is changing faster than the owner wants to change (in this case the owner is always convinced the market is wrong and he is right).
8. The business is totally debt free and the owner doesn't want to take on debt to grow.

There are many other reasons that make sense to the seller, even if it doesn't always make sense to the buyer. the tricky part is, because confidentiality is so important it takes some work to locate a good business to buy. Finding a good business for sale and buying it from a seller who has a good reason to sell could be a formula for success in a business acquisition.

M&A Due Diligence from Seller Perspective

Here's an article that shows how M&A Due Diligence preparation can dramatically improve a seller's position.

Run your business like you'll own it forever..and remember it's always for sale..

Sounds like a contradiction right? Well it isn't.

You never know when the opportunity to sell will present itself. The best course of action is to run your small business like a a buyer will determine how much they are willing to pay you for your business tomorrow. Run it well, do the right things and have all your books and records in excellent condition.

But...... then why run it like you'll own it forever?

Because you can't out guess what a particular buyer will value. The best you can do is, as always, do what's best for your business.

Your decisions and actions as a business owner will determine what your business is worth, tomorrow or 5 years from now.

List of Common Problems We See in Small Businesses

Below is a list compiled from talking to and evaluating hundreds of small businesses. Small business opportunities to improve are often very easy and inexpensive, it just takes a little attention to detail and a commitment to improvement. Here is my list:

1. Detailed written procedures for critical or repetitive tasks. Most small business owners struggle with "finding good employees" the problem is usually not that the employees are not "good" it's that new employees learn differently and written instructions can get new employees productive faster and less likely to get frustrated and give up.

2. No system to follow up on sales opportunities. It's incredible how often we see this. Customer calls, asks a few questions then says "I'll call back", business doesn't even ask for a phone number much less check back with the customer.

3. Poor accounting makes the financial statements essentially useless for operating the business. The lack of accurate financials makes budgeting very difficult and consequently we often ask the question "How's the business doing?" The answer, "Seems pretty good, I guess my accountant will tell me in March." Not good.

4. The small business owner really has no idea how his pricing is compared to competitors. They don't do any "research". Their only feedback is when their customers tell them "Your price is too high!" Duh, most customers will tell them that even if it's the lowest price they received!

5. Failure to seek expert advice until they have a problem. You know the saying, an ounce of prevention....... Often small business owners do not want to pay an attorney, CPA, financial planner because they think the issue won't be a problem....but when it is a problem... it costs them 10 times as much as it would have if they had done a little up front work.

SBA Loans have new underwriting policy

A few days ago the SBA came out with a new lending policy to be used when buying a business. Business brokers are very excited about this change since it will facilitate more financing for small business purchases. About 15 months ago the SBA made a draconian change in their underwriting that eliminated business acquisition financing for goodwill in excess of $250,000. This 2008 policy change effectively dried up SBA lending for buying a business sales. Small business financing is a unique problem since the loans are usually not large enough for lenders to make much profit.

SBA loans are a very important part of the small business financing options. The newly released SBA business loan policy allows up to $500,000 in goodwill financing or if the buyer puts up at least 25% in equity the goodwill limit is uncapped.

This policy change is important because the goodwill value in the transaction is an indication of a highly profitable business.

SBA loans are back and business buyers and sellers will be more able transfer business ownership to retain jobs and help their communities grow.

Confidentiality in the Business Sales Process.. why it's important to buyers, sellers and business brokers...

One of the most misunderstood aspects of selling or buying a business is the confidentiality issue.
Why do owners who are selling a business want to maintain confidentiality? Why is everyone so paranoid?

Here's a short list:

• If employees find out the business is for sale they often assume the worst even though it's not true 99% of the time. For some reason most employees assume that if the business is being sold they will lose their jobs. That uncertainty between the time the employees hear the business might be selling and when it does sell leads employees to try to protect themselves by looking for another job. The irony is that business buyers are worried that the employees will quit, while employees worry a new owner will fire them. If the first any employee hears about the business being sold happens after the sale the new owner can say to them "I bought the business and I want you to stay with the business, you have a job ." Confidentiality helps the buyer and seller.
  
• If competitors hear about a business being sold they will talk to customers and spread rumors and try to scare customers into leaving the company. Comments to customers like "XYZ Co is for sale, they aren't able to fill your orders" can sometimes, even though not true, disrupt the business prospects. The buyer wants those customers after the business purchase so protecting confidentiality helps the buyer and seller.
• Vendors - Supplier's get antsy if one of their customers is being sold because they have a fear of not getting paid or losing the volume. So vendors sometimes will put a business on c.o.d. terms if it fears a sale will jeopardize the credit it has extended the business. Again, if buyer can tell vendor after the sale. "I've bought the business and I look forward to continuing to use you as our primary supplier" the vendor at least knows they still have a customer. Confidentiality is good for business buyer and business seller.

The above are just 3 examples of why maintaining confidentiality when buying or selling a business is important. Your business broker will have confidentiality agreements that outline in detail the specific terms that bind the parties to confidentiality. Read it, understand it and respect it because if you buy the business you'll be glad to did.

If you find this article helpful you may want to look at Part 1.

Tax Law Changes effecting Biz Sales

The new benefits offered by congress allow small businesses to reduce their tax bill which makes the business sale more appealing for the sellers.

S Corporation Built-In Gains Tax Relief. For tax years beginning in 2009 and 2010, ARRA shortens, from ten to seven years, the amount of time that an S corporation that has converted from a C corporation must hold on to its assets to avoid taxes on any built-in gains at the time of the conversion.

Is buying a business right for you?

We often get to speak to people who are undecided about looking for a new job or, usually as a plan B, buying a business to replace the income they've lost when they left their previous employer. It is rare when these people have thought through the process of buying a business with clear lens. Here are 5 Dos and 5 Don'ts when considering purchasing a business:

DOs

1. Understand your current financial situation and resources thoroughly.
2. Be prepared to move through the process at a good pace but without skipping steps. For instance, don't plan a 2 week vacation in the middle of the process.
3. Understand that being in business has risks, few of which are as risky as having a job, but risks none the less. You will not buy a quality business without some risk.
4. Be prepared to spend money for good advice from people who are experts (not your buddy at the country club who once bought a margarita machine to rent).
5. Look at businesses that need skills you have, not just businesses that "seem like they'd be fun to own". Your skills will determine the biz future, match your skills with the right business.
   

DON'Ts

1. Don't assume everyone is out to cheat you. You can find reputable people to deal with.
2. Don't let your emotions run wild. This is a arduous process that rewards discipline and a stick to it attitude.
3. Don't fail to listen, you night actually learn something.
4. Don't be afraid to admit what you don't know.
5. Don't assume the seller is your adversary. Experience has proven that the buyers who get the best price and terms on a deal are the buyers who treated sellers with respect and courtesy. You can say no in a good way or a bad way, choose the good way.
   

Why do some businesses sell and some just close?

Operating a business for the benefit of the business owner - today..... is different than operating a business that is building value and will one day be sold for a nice profit.

Do you want to be able to sell your business when you no longer want to own it?

Here's what you need to start doing NOW!!

1. Keep your books accurately. A buyer will pay you a multiple of the earnings you can PROVE. You will not be paid for earnings that you can't prove.
2. Make sure your employees are paid in accordance with all federal and local laws.
3. Get rid of any lawsuits that may be haunting you.
4. Make certain your insurance policies are up to date.
5. Make sure your business name is properly registered and protected with local agencies.
6. Pull a Security interest report and get rid of any old UCC-1 filings (remember the copier you leased, then bought, 5 years ago? The UCC-1 was probably never released by the secured party (a UCC-3 form will release the lien).
7. Limit the number of family members working in the business.
8. Fully document, in writing, all important systems and processes in the business. This is difficult and time consuming but will help you get a much higher price when you sell the business.
9. Get rid of unused assets - excess inventory, old equipment, etc.
10. Most importantly - You may not know when you'll need to sell the business so do the above NOW, so you can respond to any opportunities that might come your way.

The best advice..."Run your business like it's always for sale, because it is."

Dan

How Profitable Can a Small Business Be?

I'm often asked this question.

For some reason many people believe a business has to be really big to make a great income for the owner, it doesn't.

Here is a sample of many types of business we see everyday.

Hours - 5 days a week 8am - 5pm

Sales per day $2,000 (that's $222/hour)

Annual Sales $500,000

Income to business owner $100,000!!

That's $200/hour = $100,000 per year!

Your business doesn't need to be big to be successful, it just needs to be good.

What makes a small business VALUABLE!!!

Two things make a small business valuable:

1. The amount of sustainable and growing profit it generates
2. The ability for a potential buyer to see #1

Too many small business owners manage their business to "avoid" taxes when in fact what they are doing is avoiding "profits". If General Electric kept it's books like a many, many small businesses every manager in GE would likely be facing jail time!

Value in the eyes of the buyer?

• Can the real profit of the business be clearily and easily identified?
• Is there reason to believe the businesses profits can be repeated or improved upon in the future?

Simple questions but difficult for many business buyers to answer......because too many business owners "hide" profits in an effort to avoid taxes.

It's amazing to me, a business owner will pay his kids college out of the business and treat it as an expense (likely illegal but therefore avoid taxes on that amount) but then the biz owner doesn't fund his/her TAX DEDUCTBLE retirement plan which is totally legal!! Dumb.

Guess what, if you want to sell your business one day you will need at least 3 years of clean books to get the highest price for the business....that's three years!! And that doesn't mean go back 3 years and try to un-scramble your books, it means 3 years of clean books.

WARNING - most small business owners don't know when their business is going to NEED to be sold. Heart attacks don't give 3 year notices, in all likelihood neither do divorces, partnership break ups or all the other things that move a business owner to sell their businesses.

Want to have a better business that will pay you more now (yes, even after taxes) and get you the highest price when you sell?

Get a good accountant (no I am not an accountant), keep your books properly, take advantage of all the LEGAL tax breaks avaialble.

Make more money while you own the business, make more money when you sell the business and be a good corporate citizen along the way. What's not to like?

Start a business vs buying a business

Far more businesses are started than purchased. There are a number of reasons for this, some good and some bad. And far more start ups fail (about 15 times more) than do established businesses.

Often someone starts a business with very little capital and almost just as often the business fails due to lack of capital. The owner simply runs out of money before the start up gets to the point of positive cash flow. Starting a business with inadequate capital is often caused because virtually no lenders will lend money to a start-up. The reason? Because the start-up doesn't have a history of profits which would be available to pay back the loan. Pretty simple.

Example someone has $80,000 to start a business and they think it's enough to get the business started and operate until the business is profitable (more importantly - cash flow positive). So you sink in $80,000 and hope the customers like the product or service. WARNING..... the average time it takes a start-up to achive positive cash flow is about 3 years.

Now let's look at an existing business purchase. If a buyer has the same $80,000 they can borrow another $250,000 and purchase a business worth approximately $300,000 (Purchase biz for $300k and have additional $30k for working capital - total $330,000)! Why will a lender lend you $250,000 to buy this business? Because it has a proven history of making enough profit to pay the debt!! Not true for a start-up.

A business that sells for $300,000 will likely have a psoitive cash flow of approximately $108,000 per year ($9,000 per month). That $9,000 will need to pay for two things... debt and income for the buyer.

A Small Business Administration loan for the purchase of this business will have a monthly payment of approximately $3,235 ($250,000 loan at 9.5% for 10 years).

The positive cash flow per month that is available to the buyer, in salary, is $5,765 ($9,000 - $3,235 paid to bank to retire the debt).

So you have choices.... you can start your own business from scratch, throw in $80,000 and hope (and pray) that someday you actually have a profit or you can buy a business and have a profit from day one. Looks like an easy choice to me. But be warned - do your due diligence thoroughly before starting or buying a business!!! Where do you go to find businesses for sale? Just google buy a business in (your town here). You'll see lots of choices. Do your research carefully and thoroughly and you could turn your dream of owning your own business into a reality.

Let me know how things work out.....