Resource Center

By:  Rick Padrnos

The current recession is arguably the worst financial calamity since the Great Depression in the 1930’s.  It has had a negative impact on the cash flow and profitability of many a mainstreet business.  This in turn has reduced the valuation of those same businesses.  In addition, for awhile the credit markets had frozen making it difficult for small businesses to obtain financing.  The good news is that the credit markets are slowly thawing out making it easier for buyers of businesses to obtain financing.

Larger companies typically sell for a higher multiple of earnings than do smaller businesses.  Publicly traded companies usually carry the highest multiples due to their liquidity and access to many buyers.  However, the recent sell off in the stock market has created single digit multiples for many blue chip companies; just a year ago or so, the average price/earnings ratio for a Dow Jones 30 company was approximately 16.  Middle market businesses have also seen their multiples reduced.  The exciting news for mainstreet business owners (defined by author as those with valuations up to $5 million) is that multiples of earnings have remained fairly constant during the economic downturn. Every business has unique characteristics and there are a multitude of methods to value a business, including a percentage of sales; a multiple of Earnings Before Interest and Taxes (EBIT); a multiple of Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA); and perhaps most commonly used, a multiple of Seller Discretionary Earnings (SDE).  SDE is similar to EBITDA, but it includes owner’s salary and benefits, and any perks that have been expensed through the business.  A knowledgeable business broker can assist the owner in determining a fair market value for the business.

Business owners considering selling their companies in any economic environment should consider the following:

1)      Continue to operate the business as if it is not for sale.  Too many business owners “throw in the towel” once they have made the decision to sell their business.  Stay focused and committed.  This will result in a more attractive business opportunity for a buyer prospect. I have advised the owner of a wholesale operation that is considering selling their business to continue to generate as many Purchase Order’s (PO’s) as possible.  Like many businesses, the cash flow of the business was down especially beginning in the fourth quarter of 2008 and the first quarter of 2009 was even worse.  Continuing to generate PO’s and ultimately sales revenue are positive signs to a buyer, and just as importantly, to the buyer’s bank.

2)      Do not deduct personal expenses through the business.  Report all revenues and business expenses properly.  This may result in the business showing higher taxable income, however, the higher tax consequence will be more than offset by the increase in the selling price of the business.  Honesty is the best policy.  Most buyers expect there to be a minimal amount of personal expenses taken by the seller of the business. If there are too many personal expenses being taken the buyer becomes scared and they wonder what else the seller of the business may not be sharing.  The bottom line is that it raises a level of suspicion with the potential buyer and this is one of the quickest ways to kill a deal.  I’ve seen potential buyer’s lose interest in a business if there is any kind of drop off in sales for even one month, so a seller needs to do everything possible to properly position the company to look as strong as possible, especially in these tough economic times.  Mainstreet businesses historically have sold for 2-3x Seller Discretionary Earnings.  For every dollar a seller deducts for personal expenses in order to reduce their income tax liability, they are actually cheating themselves out of $2 to $3 when they sell their business.

3)      Confidentiality should be foremost in the mind of the business owner.  The fastest way to lose customers is to put a “Business for Sale” sign on your store front.  Not only do customers become nervous, but so do employees and suppliers.  Additionally, it is an open door for your competition to pursue your customers.  This is where a business broker provides value.  A reputable broker should market your business confidentially, only releasing information to potential buyers after they have completed a Confidentiality Agreement, Brokerage Disclosure Form, and a Confidential Buyer Profile.  The latter provides key financial information for qualifying the buyer prospect.

These are tough economic times.  Many businesses have seen their Seller Discretionary Earnings and valuation reduced.  There is, however, good news for mainstreet business owners.  First, the multiples of smaller businesses have not decreased nearly as much as middle market and publicly traded companies.  Second, as part of the stimulus package the Small Business Administration (SBA) recently increased the guaranty that banks receive for SBA 7a loans to 90% which has resulted in more banks utilizing the program.  The SBA also has eliminated the guaranty fee normally paid for by the buyer of a business which has improved the likelihood that a buyer prospect will qualify for bank financing.  The bottom line is that there are still many small businesses that have strong cash flow and reasonable valuations. There are always eligible buyer’s looking to buy strong businesses and a knowledgeable business broker can facilitate the process.

Rick Padrnos was a banker for 27 years prior to joining Business Acquisitions, Ltd. (www.baltd.com) as a Mergers & Acquisitions Specialist.  He may be reached at 970-987-5245 or rpadrnos@baltd.com.