FOR IMMEDIATE RELEASE

FROM:  WAYNE UNZE (797-1100)  

VAUGHAN COMPANY BUSINESS OPPORTUNITIES

                           PRICING A BUSINESS

            Pricing a small business is different from pricing a multi-million dollar enterprise.

 Large businesses are generally priced at a multiple of EBITDA (Earnings Before Interest,

 Taxes, Depreciation and Amortization) with multiples typically ranging from 3.0 to 8.0

 times EBIDTA.  EBIDTA is also often referred to as cash flow.  To arrive at a realistic

 cash flow multiple, you must take into account the type of industry, financial history,

 depth of management, leasehold or real estate interest, customer base demographics, asset

 base, and of course, the cash flow being generated.

            Small businesses, on the other hand, often find that the bulk of their cash flow is

 in the form of the owner’s compensation (salary and benefits).  Therefore, to accurately

 determine a small business’s true cash flow, the seller’s total compensation package must

 be added to the EBITDA.  The corresponding multiple normally ranges between 2.0 and

 3.0.  In the event this multiple of cash flow produces a value that is less than the current

 value of the business’s assets, the asset value then becomes the true value.

                                                 EXAMPLE

ABC, Inc. has a net profit of $30,000 on sales of $600,000.  Included in the

 operating expenses are the owner’s salary of $50,000, along with his health insurance

 premium of $5,000 per year, profit sharing of $20,000 and leased company car worth

 $7,000 per year.  Other cash flow components in the operating expenses include Interest

 ($10,000), Depreciation ($25,000) and Amortization ($3,000).  When added together, the

 cash flow of this business is a respectable $150,000…a far more accurate depiction of its

 financial performance than just the $30,000 net profit (“earnings”) figure. 

Based on the above data, this business would be worth between $300,000 (2.0

 multiple) and $450,000 (3.0 multiple).  In order to more closely define the value, the

 following factors must be addressed:

            1.  Business Age and History [new or established; reputation; litigation];

            2.  Revenues [fast growing or shrinking; keeping pace with inflation];

            3.  Employees [self-directed; long-time; key management; skilled workers];

            4.  Equipment [age; condition; obsolescence; adequate for growth];

            5.  Real Estate [long-term, assignable lease at fair market rent or real estate    

    at fair market value];

            6.  Complexity [easy-to-learn or requiring special training; will seller train];

            7.  Customer Base [growing or declining; other demographics];

            8.  Size of cash flow [cash flows under $50,000 can’t provide a living wage and

     service much debt; a cash flow of $100,000+ is the most desirable].

            It is important to note that the cash flow multiple can be increased somewhat if

 the cash flow exceeds $300,000, and even more when it passes $500,000.  This is due to

 the fact that those cash flows can service a great deal more debt and still provide the

 buyer with an attractive compensation package. 

The key to any business evaluation is being able to decipher the true cash flow.  A

 seller must be able to prove all the cash flow components, i.e., any expense that the seller

 maintains is not business-related or is personal compensation must have a receipt or other

 validating document supporting the claim.  Tax returns are always considered an essential

 part of this documentation process because they are signed under penalty of perjury.

            There is a sanity test to employ when trying to decide if a business is fairly priced. 

 After a typical down payment (30% to 35%), the business’s cash flow should be able to 

 retire the balance of the debt while providing the buyer an adequate living wage.  In the

 above example, if the buyer put down $150,000 (one-third) on an offer of $450,000, the

 debt service would be about $4,700 per month, on a seven year payout, at 8% annual

 interest (standard terms).  After servicing the $56,000 annual debt, the buyer would still

 have about $94,000 remaining as his compensation package and return on his investment

 (the $150,000 down payment). 

            This cash flow evaluation model assumes a “turnkey” sale, which includes all of

 the hard assets of the business:  inventory, furniture, fixtures and equipment.  In retail

 businesses with large inventories, a carrying cost for the inventory (expressed as annual

 interest) is deducted from the cash flow, and the value of the inventory (at cost) can then

 be added to the downwardly adjusted value of the business to arrive at a reasonable price.

            If this just sounds like mumbo-jumbo, consider the lyrics of an ancient Harry

 Belafonte song, “It was clear as mud but it covered the ground and the confusion made

 the world go ‘round.”  It’s this confusion that keeps business brokers and CPAs busy.