- Buying and Selling a Business in a Changing Market - July 22, 2022
- How to Add Value to Your Business - January 18, 2022
- 20 Ways Business Brokers Pay For Themselves - March 25, 2021
As a business intermediary helping owners determine the “Most Probable Sales Price,” or MPSP of their businesses here in the Triangle, I hear a common question:
“That value makes sense, but what about all my stuff? Can I get paid for that too?”
The answer is rarely what the business owner wants to hear, but there’s a sound reason for it, and understanding how businesses are priced can help an owner with decisions on how to allocate resources for assets; especially if they are planning to sell in the near future.
In this article, we’ll explore the market approach for small businesses and what value the assets carry…
The Market Approach is Cash Flow Driven
The answer to the question of “what about my stuff” is, unfortunately, the following:
The buyer needs the “stuff” to make money, so the owner doesn’t get paid additional consideration for their “stuff.”
Said “stuff” could be vehicles, heavy equipment, lease up, and more, but essentially it’s the assets of the business. And it’s also important to know and disclose what is the owner’s “stuff” and what is leased/rented to the firm and quite likely someone else’s “stuff.”
There is a way to get paid for the assets of the business, but unfortunately it’s what is often called an “Assets in Place” sale. An assets in place sale essentially means that the business isn’t cash flowing, but there are worthwhile assets that a new owner could build a new business upon and hopefully make their money back.
An assets in place sale is a type of an asset sale, but should not be confused with the deal structure options of an asset or a stock sale.
It Matters Because Business Buyers Compare Multiples
A business can be outpriced if it’s not priced near its peers. There are many ways to price a business, but the “Multiple of Earnings” market approach is the most common for small businesses and it’s a natural approach for buyers because it answers their question of how quickly they can get their money back.
If an owner prices a business at a 4x multiple of EBITDA (or SDE), buyers will likely forgo it because they can buy a business priced at 2 or 3x and get their investment back in two or three years instead of four.
The multiple of earnings approach normalizes businesses because businesses with assets should have their assets depreciated and thereby accounted for in the earnings calculation.
Depreciation of assets is the “D” in EBITDA, and it’s how assets are included in the market approach.
Owners Often “Over-Assetize”
I once evaluated a business and the owner asked me about getting paid for his assets after we agreed on his cash flow and common multiples for that cash flow.
When I asked him if the next owner would need his assets to make the money he was making, he stated that they could use cheaper assets to do the same job.
More specifically, he mentioned that he’d bought an $80K forklift, when a $40K forklift would have been sufficient.
This is not uncommon with business owners; they over assetize, or they have more assets than they need. While this can be great for an owner who needs to make a purchase for tax reasons before a year ends, it doesn’t help a valuation.
In these cases it could make sense to sell off non-essential assets before taking a business to market, or right size the assets that are essential.
A business should only have the assets needed to make the money it’s being sold for, and no more.
There’s a Difference Between Inventory and Assets
The good news is that inventory is totally different than assets. And because inventory is different than assets, owners can get paid up to the wholesale value of their inventory. Nonetheless, they should have a “normal” amount of inventory. The business should be advertised, and transferred with the amount of inventory that it utilizes to make the money it’s advertised to make in normal sales cycle.
Said differently; the can of beans is different than the shelf it sits on. An owner will be paid for the beans but not the shelf.
It Works The Other Way As Well
Some businesses are sold which make a lot of money but have little or no assets. SBA loans can be funded on primarily goodwill, and this is all that’s left when there are no assets. Entertainment facilities like escape rooms or home based service businesses often fall into this category.
Some business can be highly valued even without having a lot of “stuff.”
Categorization of Assets Vs Expense Matters
Owners should work with their accountants to ensure that business expenses land in the appropriate categories. Assets and liabilities should be accounted for on the balance sheet of the business, not the Profit and Loss statement.
A payment for a service vehicle could have elements of both, with a payment reducing debt off the balance sheet, but with interest that is expensed on the Profit and Loss statement.
The details of this accounting treatment will affect the assets and earnings of the business, and it needs to be represented accurately for the next owner to have a true picture of the cash flow.
Making Purchase Decisions Before Selling a Business
Because businesses sold through an asset sale are typically sold “free and clear” of debts, it’s important to consider leasing versus purchasing decisions.
Consider this story. A pool company rents all of their equipment for jobs finally decides it is too inconvenient to do so. They take out a loan and buy some heavy machinery just before deciding to sell their business. This owner is not excited by the fact that the debt of the new equipment would be expected to be paid off at the closing of the sale; that owner has essentially purchased new equipment for the next owner… They had purchased the equipment too close to the intended sale for the value of the asset to be worthwhile to enterprise value of the business.
Much like buying new tires for a car before selling it; an owner rarely gets back the money sunk into new assets for a business too close to a sale.
Owners should pay attention to the investments they make in their assets. They should understand that buyers buy for the cash flow of the business and not the assets of the businesses.
Knowing the benchmarks for asset investments of an industry can help an owner properly allocate and not waste investment on assets. Furthermore, proper planning for the use of assets over the long term, in relation to the intended sale of a business, can help an owner get the most out of those assets. Finally, owners should make asset investments only in the amount needed for the company to efficiently make money.
Being judicious in investing in assets will enable an owner to have the most options for exit, and discussing with advisors such as accountants and intermediaries what the owner’s long term plans are, can help with decisions on depreciation and asset investment.