Business Pricing Basics

Some Pricing Basics

Defining the Earnings

What are earnings - are they the bottom-line profits shown on the income statement? Are earnings expressed as EBIT (earnings before interest and taxes)? Are they expressed as an EBITDA (earnings before interest, taxes, depreciation and amortization) number? Or are they expressed as SDE (seller's discretionary earnings, which is EBITDA but with the seller's salary or draw included) figure? How the earnings are expressed can make a big difference in the price from both the seller's and buyer's viewpoint, since the price range is often stated as a multiple of the earnings.

What's Missing?

The common initials mentioned above seem simple enough, but there is one major ingredient missing, common to all of them. They should all have "after add backs" added to the definitions. Add backs are those expenditures considered "one-time" expenses, such as the purchase of a major piece of equipment, the cost of litigation, a move to new facilities, the cost associated with a fire or other unexpected closure, etc. The idea is that one-time expenditures should be added back to earnings since they won't be repeated annually.

Earnings and Pricing

The basic principle behind these terms is that the price of a business should be based on the cash received from the business by the owner. It is this figure against which a multiple is applied to arrive at the price, or value, of the business. For example, SDE is the figure most often used in small businesses and the multiple is generally somewhere between 1 and 4 with 1.6 to 3 being a normal range. EBIT or EBITDA is more common for larger businesses. Since EBIT or EBITDA are more restrictive (and smaller) than SDE, their multiples are higher, often in the range of 3x to 10x (or more).

Keep in mind that while the price is important, so are the terms. The lower the down payment, the higher the price, and the more cash paid up front, the lower the full price. Also, the buyer should ask to see documentation to verify the financial information. A seller telling a buyer what the business is making is not sufficient. A broker or M&A intermediary can help either party evaluate the earnings of a business and also provide information and data on pricing the business.

Buying a Business in a Recession, part 4 in a series

Adapted from an article by Matt Joyner, a partner in the law firm of Bishop, Dulaney & Joyner, P.A. in Charlotte, NC.

Buying a business is a major undertaking in the best of times. In the current weak recovery from a recession, it becomes an even more complicated proposition. There are four important considerations when buying a business in a recession or weak recovery period:

#3 - Buyer protection in seller-financed deals

- The difficulty of borrowing acquisition funds from a bank has resulted in an upswing in seller financing of business sales, i.e., instead of being paid in cash at closing, the seller agrees to be paid over time by the buyer, frequently out of the proceeds of the future operation of the business. This situation makes it easier for a buyer to withhold payment of purchase funds from the seller in the event there is a dispute after the closing regarding the business and the accuracy of the seller's representations and warranties about the business. Buyers need to protect themselves in the deal through provisions allowing them to escrow a portion of the purchase funds or to offset against the future payments owed for any claims the buyer develops against the seller after the closing. (Similarly, sellers need to protect themselves if they offer to finance the deal.)