What Will Your Small To Mid-Sized Business Sell For?
The simple answer: A buyer will only pay what they can afford to pay. In making that determination, a buyer will look at the operational cash flow generated by the business. Once that number is confidently determined (always a challenge in loose accounting SMEs), a potential buyer first figures out what they will have to pay earn in order to maintain and/or increase the cost of their lifestyle. After that, because few buyers can write a check for the entire amount of the purchase, the debt service on the financing for the purchase must be covered. Last, a sophisticated buyer will provide for a return on the capital invested and fund a contingency.
Once this math is done, a buyer who can’t afford to pay for these items based on a certain purchase price, will either pay less or shift the risk to the seller via the terms of the deal. This is why when selling SME (small/mid-sized enterprise), you must put yourself in the other party’s shoes to think through this dynamic before setting your asking price.
This should bring home this point: Ensuring the accounting will show a strong Seller’s Discretionary Income is vital to obtaining the highest price for your SME. Taking cash out tax free hurts you in the long run as a buyer can’t confirm that income, hence a lower purchase price.
The quick answer is: Whatever the government says your business is worth. Why? Simply stated, most purchases of small/medium businesses are financed through loans guaranteed by the Small Business Administration. Generally speaking, the guidelines for banks extending SBA-guaranteed loans require the seller to pay 10% of the purchase price with the banks financing the balance of 90%. Obviously, banks don’t give away money; the financials of the business being bought must support the repayment of the loan.
Assuming the other underwriting requirements are able to be met, the math looks like this to a bank considering a loan for a business selling for $300,000. The business would need to be generating $134,570 of Seller’s Discretionary Earnings in order to qualify for the loan:
Purchase Price: $300,000
Bank Closing Costs (5% of PP): $15,000
LOC/Working Capital (5% of PP): $15,000
Gross Purchase Price: $330,000
Buyer Equity (10% of GPP): $33,000
SBA Borrowed Funds: $297,000
Debt Service (10 year amortization @ 7.25%): $39,884/year
Return on Buyer Equity (15%): $4,950
Compensation - Buyer: $60,000
Growth Investment (5% of Revenue): $22,956
Net Cash Flow: $6,780
Seller’s Discretionary Earnings: $134,570
As the SDE figures rises or falls, the amount available for financing likewise rises and falls. In this way, the SBA in large measure determines the selling price for a business.