How much is my business worth today?

April 2017

Completing and filing your Business tax return is cause for celebration, especially for your accountant. This event is also well deserving of one of my favorite lines from Caddyshack.

 

Carl (Bill Murray) caddying for the Dalai Lama.

“So we finish the eighteenth… and he (the Dalai Lama) is gonna stiff me. And I say, “Hey, Lama, how about a little something, you know, for the effort.” The Lama responds… there won’t be any money, but when you die, on your deathbed, you will receive total consciousness.” So I got that goin’ for me, which is nice.”

 

Personally, I would prefer to be unconscious.

 

Don’t get stiffed or better yet don’t stiff yourself. Use your accountant’s annual tax preparation time to further your businesses planning goals as well.

Since you most likely meet with your accountant quarterly, now might be the time to prepare a few questions for his or her next visit.

This article will pose question number one. During the coming weeks we will add a few more that will most likely spring from question one.

How much do you think my business is worth today if I received an unsolicited offer from a willing cash buyer? 

We have simplified this question to de-clutter the playing field to determine a ballpark value today using a few years of your recent income statements.

A willing and well-educated buyer will at a minimum want to know your adjusted EBITDA prior to engaging in initial discussions. This begs the question…what is EBITDA, and furthermore how do I adjust it?

EBITDA= Earnings before interest, taxes, depreciation and amortization. It is used as a proxy for the cash flow of the business eliminating the influence of the current capital structure. Interest is added back because it is specific to financing activities. Income taxes are added back as they are specific to an owner’s particular circumstances. Depreciation and amortization are merely paper costs or non-cash deductions and are added back as EBITDA is intended to represent operating cash flow.

Sample EBITDA calculation from the income statement.

Net income              $1,000,000

Interest                     140,000

Taxes                         20,000

Depreciation            225,000

Amortization            65,000

EBITDA                  $1,450,000

 

Since this is an estimate, it may help to derive EBITDA from several years of financial statements adjusting for a variety of factors that may have affected annual performance.

It gets better. Now lets discuss those dirty financials that you love during tax season but will learn to love even more when you clean them up. Lets do some house cleaning.

ADJUSTED EBITDA

The benefits of business ownership can and should be leveraged by your savvy accountant into a lower tax obligation. When valuing your business these benefits need to be considered and either added or subtracted to arrive at adjusted EBITDA

Expenses paid by the current owner, which will not be incurred by the potential buyer must be added back to EBITDA. A thorough review of your income statement expense detail should reveal these positive add backs. These may include excessive owner compensation (current compensation minus replacement salary) including excessive family member compensation. Owner’s discretionary expenses that would not likely continue under new ownership. Examples include: Personal and family auto expenses, phone plans, travel, and entertainment expense.

Negative adjustments to EBITDA are more likely to be pointed out by the buyer and may include income from unrelated assets such as dividend income from business investment activity. In some cases the owner or related parties may be drawing below market compensation or be working in an unpaid capacity. This would require a subtraction equal to what it would require to hire suitable replacements.

Paying sub market rent to an owner controlled entity must also be subtracted to properly adjust EBITDA. Many times a retiring owner may be relying on the future income provided by this property. Therefore, an estimate of current market rent should be applied.

Here is the adjustment.

EBITDA                                     $1,450,000

Officer Wages                                 300,000

Replacement Wages                     (200,000)

Cars,Travel,Phone,Ent                  122,000

Sweep acct earned interest          (33,000)

Unpaid Bookkeeper (spouse)       (50,000) 

Sub market rent adj                     (36,000) 

Adjustments                            $199,000

Normalized EBITA                $1,553,000

 

 

By normalizing EBITDA we have built a measure to allow evaluation of the true earning ability of our company. In this case the normalized EBITDA was 55% higher than reported net income.

Normalized EBITDA when combined with an industry specific earnings multiple will provide a starting point for valuing your enterprise.

Lets assume that like many entrepreneurs you own an established business with no significant competitive advantage, stiff competition, few hard assets, and heavy dependency upon management’s skills for success. An earnings multiple of 2-4 times EBITA might apply. Whereas an extremely well-established and steady business with a rock solid market position, whose continued earnings will not be dependent on a strong management team may garner a multiple of 8-10 times EBITDA.

In other words EBITDA is not a stand-alone measure of business value but it is a good starting point.

Pull out some old financials and give this calculation a try.

We will address your businesses potential multiple next time.

Regards,

Eric Bratt

Business Legacy Strategies