This is the most often asked question by business owners when a business intermediary asks them if they are interested in selling their business. Often times, it is also a no-win question. If the suggested price is too high, the seller may be satisfied for the moment, but that satisfaction will end when the business fails to sell for the inflated price. On the other hand, if the suggested price is too low, the intermediary may be promptly escorted to the door.
So, how does the business intermediary come up with a price? The business intermediary will generally review the financials and add back certain items. This is often referred to as “normalizing” the financial statements. This is done by pulling out the proverbial non-cash deductions such as depreciation, interest, amortization and taxes (if shown on the statement) and either adding these amounts to profit or subtracting them from a loss.
The resulting figures are commonly referred to as Earnings before Interest and Taxes (EBIT) and Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA).
For smaller businesses (for example, under $3 million in sales), the figure most often used to determine the sale price for a business is Seller’s Discretionary Earnings (SDE). This is essentially EBITDA plus the seller/owner’s benefits and salary/earnings.
Once the SDE, EBIT, or EBITDA figure has been established, it is usually multiplied by a multiplier. This multiplication then creates a suggested or recommended asking price.
The numeric values used as a multiple of SDE can range from 0 to 4 or even 5 in some cases. Typically, a small business will sell for between 1.8 and 2.5 times SDE although many businesses can fall under or over. Larger businesses can range from 3 to 8 times EBIT or EBITDA, but again can fall much lower or higher depending on the business.
While the process above creates a good starting point, it is important to remember that, ultimately, the price of a business is determined by what someone is willing to pay for it. In other words, price is determined by the marketplace.
Every seller should consider the answer to one question: “What would you pay for your business if you were going to buy it?”