The key issues that influence a company’s value when there are two working owners:
1. What is the profit level of the business after allowing for the second partner’s salary Sellers Discretionary Earnings (SDE)?
2. Do a few customers dominate the sales? I see some great companies where one customer is over 50% of the sales volume. In this case if the biggest single customer left, the company’s value would collapse? Read more
I noticed a trend about 20 years ago. The trend went from undeclared cash payroll to employees being declared on the business books. It started with automotive businesses and then moved into restaurants. It now can be found in many industries. The construction industry still has not caught on to this interesting trick yet. They still operate on many undeclared cash wages. Read more
Is the claim that there is big profit in Day Care Centers, too good to be true?
Are Adult Day Care Centers making the big money they claim?
Last year I was asked to do a business evaluation and financial review of an Adult Day Care Center in Ventura County and render an opinion as to the profitability and viability for a client wanting to buy this business for the full asking price or for any other price. I was told before I began, that it was clearing $50,000 per month profit, and the asking price was $3 million.
Many business buyers try to use a rule of thumb to value a business. This is a valuable tool but if you actually try to purchase a business based on it, you are sure to regret it later. Last week I received a call from an experienced restaurant manager that wanted to buy his own restaurant. He wanted me to confirm that restaurants were selling at 3 to 5 times net profit. I told him that they were not selling in that range in the current market. He insisted that he had seen comparable to prove they were. I thought this would be an interesting subject for an article.
Rules of Thumb – Business Valuation Pitfall?
When valuing a restaurant or any business by using rules of thumb you need to have an accurate profit figure. This is rarely available. There are so many definitions for net profit that there is a book used in the IBBA (International Association of Business Brokers) training class to teach calculating profit that it is actually 6 inches thick. This is not a book for CPAs but just business brokers.
Lets assume we have now come up with a profit figure that works for our purposes. The rule of thumb must clearly specify what profit figure it is based on. There are “Sellers Discretionary Earnings” EBIT (Earning before interest, and taxes but after reasonable salary for the owner) and “EBITDA” (Earnings before interest, taxes, depreciation and amortization) just to name the 3 major profit figures used by business brokers. The rule of thumb, if one exists is different for each of these three methods.
Lets assume you now have a profit figure and a rule of thumb. Lets assume the rule of thumb is 3 times net profit.
The problems with rules of thumb still would have to be addressed. Rental amount, type of restaurant or business, franchise or not, all are not addressed by a rule of thumb. Would you pay the same price for a restaurant with $2,000 rent as $10,000 rent even if they both had the same bottom line? I wouldn’t. $50,000 is a salary not a business investment.
The next big issue then comes forward: Would you pay $150,000 for a business clearing $50,000 with the owner working 60 hours a week, if there were similar businesses available for $450,000 that were making $150,000 profit, with the owner working 60 hours a week?
I hope this is of some help in navigating the river of misinformation floating around regarding how to value a business.
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When I was a young entrepreneur of 25 I had three goals.
They were:
Well I made my first million long before I was 40 and proceeded to lose large hunks of it from faulty thinking. Read more
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