There is a formula to follow
Once you decide to at least explore the possibility of selling your business the first major piece of information you will need to know is how to establish your asking price.
While this can be a bit subjective there are several formulas for setting a realistic baseline number as a starting point.
One suggested formula is based on the Sellers Discretionary Earnings (SDE). SDE is equivalent to EBITA (Earnings Before Interest, Taxes, and Amortization) but is adjusted to add back to your net earnings various amounts that you deducted to reduce your net earnings number in order to pay less income taxes.
PLEASE NOTE: This is just a suggested starting point. Your broker or advisors will be able to nail this down more accurately based on YOUR individual circumstances.
Calculate Your Net Income
Your net earnings is a number that should be already on your tax returns.
It’s arrived at like this:
- Net Income = Total Gross Revenue – Cost of Goods Sold – Operating Expenses – Other Expenses
NOW, CALCULATE WHAT I CALL YOUR MAGIC NUMBER
Now using your net income number as your starting number, add back the Owner’s Salary:
- Net Income + Owner’s Salary
Then Add Back Non-Cash Expenses. Depreciation and amortization expenses are considered non-cash expenses and are added back to the net earnings:
- Net Income + Owner’s Salary + Depreciation + Amortization
Next, Add Back Interest and Taxes. Since the new owners will not be paying what you paid in interest and taxes you add that back to the net earnings as well.
- Net Income + Owner’s Salary + Depreciation + Amortization + Interest + Taxes
Lastly, Add Back Other Non-Recurring Expenses. Legal fees, real estate purchases, equipment purchases and the like are considered one-time expenses and are also added back to the net earnings:
- Net Income + Owner’s Salary + Depreciation + Amortization + Interest + Taxes + Other Non-Recurring Expenses
To sum this up by example, if your net income was $100,000, salary was $100,000, depreciation and amortization was $20,000, interest and taxes and other non-recurring expenses was $10,000, your “magic number” would be:
-
-
- $100,000
- $100,000
- $20,000
- $10,00
-
TOTAL: $232,000
Now, using that $230,000 number, you can set realistic expectations by multiplying that number by 2 to 5 times to arrive at your starting asking price.
My multiple was 3.5 so if we use that multiple, times the $230,000 in the example above, the suggested asking price would be $805,000.
THE GOLDILOCKS PRINCIPLE
To be clear: this is NOT a hard and fast rule but it’s a good starting point to at least get you in the ballpark. Your broker will know how your asking price and your business model stacks up against other similar businesses for sale and compare them to recent sales in the marketplace.
Make sense?
BOTTOM LINE: So your goal is to be like Goldilocks — don’t ask too much — don’t ask too little. Ask just the right amount. This basic formula will help get you started. A qualified broker can get you to the finish line.
ALSO – PLEASE NOTE: There are items like health insurance, 401k, auto, travel, meals, entertainment, office supplies etc., that may fall into the “discretionary/personal” category. Also, things like rent and utilities could be an addback if an office or warehouse is not needed to run the business by the next owner.
