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PASADENA, CA
600 South Lake Avenue
Suite 507
Pasadena, CA 91106
Phone: (626) 449-1500
Fax: (626) 551-2845
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VR Business Sales|Mergers and Acquisitions
PASADENA, CA
Professional Valuation Services
There is no black and white rule or formula for pricing a business. All pricing is a subjective decision, primarily made by a Buyer that is a function of risk and alternative investments. The process of Valuation is really an attempt by Sellers to guess at the market’s perception of those two factors. When it comes right down to it, a business is just a financial investment for which a Buyer expects a return for his money and effort.
The value of a business (which for this discussion we will equate to price) is a function of its cash flow. There are many formal valuation methodologies, which we can discuss with you, but the most common is the market approach. That is, a comparison to other, similar business that have been sold. The underlying rational for this approach is that the market (i.e. recent business buyers) will intuitively buy a business for an amount that incorporates all of the various factors affecting the “value” of a specific business, such as: the competitive environment, industry trends, ease of entry, expertise, risk, etc…
We generally find that we can quantify this market pricing approach by evaluating the ratio of the sales price to cash flow. The cash flow figure that we use is referred to as “seller’s discretionary cash flow.” It is the amount of cash that a new Buyer is likely to see generated from operation of the business, before any taxes or debt service. It is calculated by taking the cash flow from operations (also known as “EBITDA”), then adding back all of the owner compensation and benefits that have been run through the business.
For example:
Revenue
- Cost of sales
= Gross Profit
- Operating Expenses
= Net Income
+/- Adjustments (examples may include):
+ Personal Auto Expenses
+ Depreciation
+ Interest
+ Owner Salary
+ Owner Health Insurance
- Adjustment to Market Rent
= Sellers Discretionary Cash Flow (SDE)
To determine a market value we will then multiply the SDE of the target company times the ratio of (Sales Price/SDE) for comparable businesses.
The FFE of the business will be included in this value – since their use is required to generate the SDE. On the other hand, inventory is generally not included, and is added to the valuation determined by this methodology. Other current assets and liabilities, such as cash, A/R and A/P are also excluded and usually considered the property of the Seller.
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