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Certain aspects of the carpet cleaning or restoration industries are unique, especially the broad spectrum of customers and specialized equipment and tools necessary to do the work.
Yet, when it comes to placing a value on your business for sale or considering the purchase of another business, some key principles come into play just as they do for other businesses in other industries.
The standard, textbook definition of fair market value (FMV) is an estimate of a property’s value based on what a knowledgeable, willing and unpressured buyer would pay to a knowledgeable, willing and unpressured seller in the market.
As you can see, knowledge is key to determining the fair in fair market value.
Business brokers and others who work as intermediaries between buyers and sellers typically use business valuation rules of thumb to help sellers price their businesses for sale. These rules can be applied to nearly every small business, but they also represent a gross simplification and should only be used to provide a general idea of the suitable price range for that business.
When valuing the business, whether it’s your business or one you’re considering purchasing, it is important to look at the complete picture, and that means reviewing earnings, earnings before interest, taxes, depreciation and amortization (EBITDA), tangibles and intangibles, as well as owner value.
It isimportant to understand how a business is doing in terms of earnings.
Specifically, a buyer will want to isolate the average earnings per year over the last three to five years. To do this, examine the seller’s latest tax return to determine the most recent year’s earnings. Ideally, broaden that to look at the last three years, but remember, buyers are buying the future and not the past. Therefore, a buyer will also want to project future earnings and consider the risks involved in owning the business.
As mentioned previously, EBITDA stands for “earnings before interest, taxes, depreciation and amortization”. Essentially, this refers to net income with elements like interest, taxes, depreciation and amortization added back into the equation.
EBITDA is helpful for assessing the cash flow of a business, as long as you keep in mind that it doesn’t necessarily represent the business’s profitability.
Tangibles and intangibles
To value a business, you must consider the various tangible asset values like real estate, equipment, vehicles and inventory. And don’t forget to consider intangible asset values, such as franchise opportunities.
You also need to review one-time expenses that are on the books to determine how those should be handled as part of the sale.
Fair value should also take into account whether to include the owner’s salary and perks and whether the deal includes a seller’s agreement to consult with the new owner after the sale. And if a non-compete agreement figures into the sale, what value does that represent?
So now that we’ve looked at the valuation considerations, what is an appropriate valuation multiplier? For most, that number is somewhere between one-to-five-times earnings before interest and taxes (EBIT).
The multiplier should be less where there are fewer tangible assets and more if the business is uniquely attractive. As for what makes a business uniquely attractive, any of the following might apply:
- A national presence.
- A proven business model.
- Experienced management.
- Niche products or services.
- High financial prospects.
Keep in mind, though, that determining an appropriate earnings multiplier can be fairly subjective.
The reality is that it is very difficult to estimate the market value of a business because a marketplace of buyers and sellers is not easy to observe and quantify.
In fact, if a given small business doesn’t have many buyer prospects, buyers pay prices that are unique to their circumstances, which can sometimes be considerably above or below any fair market value.
James Sullivan is president of ATS Advisors, a full-service CPA firm offering individual and business tax preparation services, financial statement preparation and business consulting in Plymouth, MI. Contact him at TaxMan@875Main.com or visit www.875main.com.