Part of the process on the seller side of a transaction is deciding to sell and getting a valuation.
As buyers scrutinize the businesses they examine, there are three questions we encourage them to consider. All of them are centered, understandably, around profit.
Profit to Pay Salaries
Whatever goodwill you’ve generated over the years with your employees will not transfer to the new owner. You can’t sell it, not just because it’s not legally or practically possible, but because the odometer will reset with the new owner.
He/she will have to earn goodwill and trust, and if your employees (or yourself!) have been taking below-market salaries, the buyer will need to put together a financial plan that ensures that staffing issues will not be a problem.
Happy employees are one of the cornerstones of any business. While money isn’t everything to your staff, passion for the work always works best side-by-side with a feeling of being properly valued.
On the other hand, let’s say a business is valued at $500,000 and the owner has been paying himself/herself over market value to run it, let’s say $200,000.
If it could be reasonably run by a manager for half that (or if the buyer is willing to work for that amount), there’s an extra $100,000 of free cash flow which can be used for investment in the business or debt service.
Profit to Pay for Financing
Continuing on with our $500,000 example, let’s say that the bank requires the buyer to put 25% of his/her own money in the deal, which would be $125,000. Knowing that interest rates always vary, for purposes of this example, we will use a rate of 5% on the $375,000 that would need to be borrowed.
That would give us, on a ten-year term, a monthly payment of $3977.46, which we can round up to $4000 to keep the numbers simple.) In the example above, this number could be easily handled by the extra cash flow from the lower salary the owner is willing to take or delegate.
Conversely, if there’s no cash flow to support the debt service, there’s a problem – not just for the potential owner, but for the would-be financiers.
Profit to Return an Investment
Ultimately buying a business is an investment, and a reasonable rate of return should be expected above and beyond salaries and debt service. Let’s go back to the $125,000 that our potential buyer invested in the business.
He or she could have put that money into stocks, bonds, cryptocurrency, real estate, precious metals, etc. To keep our numbers simple and conservative, let’s offer the same rate of return, 5%, on that money.
That payout would be equal to what the debt service is, and in our example, that need would be met, with even a bit of a cherry on top.
Now, let’s be clear, not every buyer comes in with such an agenda. Some are happy, after years of corporate life, to just “buy a job” where they don’t have to answer to anyone anymore. And, that works for many people.
But running a business is transformational. If all you bring is a job mentality, you’ll never be successful. If you scrutinize the numbers and stay grounded first and dream later, you’re on the right road to business ownership: calculated risk, colored with a bit of hope, and powered by a lot of elbow grease.
When you meet our sellers, they might tell you that at the beginning of their journey they would’ve been happy for a 5% return on their years of hard work. But they often smile when they realize it’s many times more, and it’s because they brought the right attitude and they knew their numbers.
Regardless of your vision for business ownership, you should know yours too.