Privately held businesses have a difficult time knowing what their business is worth, which can prevent them from getting the best possible selling price.
Evanston Il (Vocus/PRWEB) March 28, 2011
Finding out what your business is worth has never been more important. “There will be an explosion of family business owners who will want to sell or hand down their company over the next decade,” observes Richard A. Morris, principal of Evanston, Ill.-based ROI (Resource for Ownership Intelligence) Consulting. As many as 10 million retiring Baby Boomer business owners – nearly three-quarters of the small companies in the U.S. – can be expected to try to sell within the next decade, according to Inc. magazine. The sheer volume is likely to create an extremely competitive marketplace.
“In order to get the best selling price for your business, you have to know what it will be worth to the buyer, and privately held businesses have a difficult time knowing what their business is worth,” Morris says. Most commonly, the value of an enterprise is calculated using an accounting method called ‘EBITDA’ – earnings before interest, taxes, depreciation, and amortization.
Morris explains, “When used with privately held businesses, especially family businesses, EBITDA is unlikely to determine the true value of the business. For example, how does the owner’s salary compare to what a corporation would pay? The president may be overpaid – or underpaid. Or what about the value of benefits such as cars and retreat homes owned by the business?"
To get a more accurate financial snapshot, and potentially more money at the time of sale, Morris advocates adjusting EBITDA to reflect all expenses which are more about the owners’ lifestyle than running the business. “This means adding the letter ‘L’ to the acronym to create EBITDAL, where L represents Lifestyle-related decisions,” he says.
Morris firmly believes every business owner should compute a business value annually, whether planning to eventually sell the business or pass it on to the next generation. That way, the owner can accurately compare worth from year to year and evaluate if the business is growing in value. “Since profitability can often be manipulated by accounting methods and non-business lifestyle choices, EBITDAL is a simple metric to determine if the business is doing better or worse, allowing you to take action to grow the business if needed,” he says.
While recognizing that business owners never know how accurate their valuation is until they actually try to sell, Morris observes that growth is a major component of business worth. Buyers traditionally seek a 20% return on investment, meaning they typically will pay five times the EBITDA or EBITDAL value of a business growing 5 to 10 percent. If growth is less than 5 percent, they expect to pay less because they assume more risk. On the other hand, they will be willing to pay more for growth above 10 percent.
“The bottom line is that when owners pick an EBITDAL calculation and stick with it every year, they know how well their business is doing and will have a general idea what their business may be worth to potential buyers, if and when they choose to consider selling,” Morris says.
Richard Morris is principal of Evanston-based ROI (Resource for Ownership Intelligence) Consulting which helps family owners expand and pass down their business to subsequent generations. He also provides family business education, consulting and strategic planning for cooperatives, franchises and associations, and is an adjunct professor at the Lake Forest Graduate School of Management. Previously, he managed marketing and acquisitions for his family's 80-year-old privately held company, Fel-Pro Incorporated, and served on its Board of Directors until the sale of the business in 1998. Morris also co-authored the book “Kids, Wealth and Consequences: Ensuring a Responsible Financial Future for the Next Generation” (Bloomberg Press).
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