Pricing methods such as multiples of SDE, EBIT and EBITDA all have two things in common: one must calculate SDE, EBIT, and EBITDA, and then calculate a multiple based on many factors relating to the business. Multiplying the two should then produce a price for that business. Unfortunately, these methods are based on two figures that are calculated by the person attempting to arrive at a price, opinion of value, or a value itself.
The other method used in the Guide calls for a multiple of sales. An advantage to this method is that it doesn’t call for calculating any figures. One simply takes the total annual sales (minus sales taxes) and multiplies it by a percentage that “people in the know” are comfortable with, based on their knowledge and experience. The annual sales of a business are a provable figure. An argument could be made, especially in very small businesses, that the owner could be “taking money off the top,” thus reducing sales. However, unless the owner is really stealing from the business, small amounts shouldn’t influence the price dramatically.
Although multipliers may stay about the same, the final result is based on figures that reflect the impact of the economy. Sales are down and costs go up, especially in relation to sales. Therefore, we are comfortable with the final pricing results. Keep in mind that rules of thumb are just that. Using benchmarks and other data, the user can adjust the rule of thumb up or down.
The pricing of businesses is based on the sales and earnings for the most part; however, it is important to point out that other factors may enter the process. Simply stated, the price of a business is not cut and dry. It is not based just on earnings, as a valuation may be. The price of a business is ultimately what someone will pay for that business. In short, the price of a business is market driven.
How does all of this impact the rules of thumb for pricing businesses? The information in this book presents a ballpark figure for putting a price on a business. The marketplace—supply and demand—determines the ultimate price. Over the years, our team has found that the rules of thumb come just about as close to what a business is worth as any other pricing method. If used properly, rules of thumb can provide a pretty close approximation of what a business will sell for.
Rules of thumb in the Guide usually come in two formats. The most commonly used rule of thumb is simply a percentage of the annual sales, or better yet, the last 12 months of sales/revenues. For example, if the total sales were $100,000 for last year, and the multiple for the particular business is 40 percent of annual sales, then the price based on the rule of thumb would be $40,000.
Quite a few experts have said that revenue multiples are likely to be more reliable than earnings multiples. The reason is that most multiples of earnings are based on add-backs to the earnings, which can be a judgment call, as can the multiple. Sales or revenues—they’re the same—are essentially a fixed figure. One might want to subtract sales taxes, if they have not been deducted, but the sales are the sales. The only judgment then is the percentage. When it is supplied by an expert, the percentage multiplier becomes much less of a judgment call.
Another rule of thumb used in the Guide is a multiple of earnings. In small businesses, the multiple is used against what is termed Seller’s Discretionary Earnings (SDE). It is usually based on a multiple (generally between 0 and 4), and this number is then used as a multiple against the earnings of the business. Many of the entries also contain a multiple of EBIT and/or EBITDA.
The terms used to express earnings are as follows:
EBDIT (EBITDA) Earnings before depreciation (and other non-cash charges), interest, and taxes
EBDT Earnings before depreciation (and other non-cash charges), and taxes
EBIT Earnings before interest and taxes
According to the International Business Brokers Association (IBBA), Seller’s Discretionary Earnings are “The earnings of a business enterprise prior to the following items:
The above definition of Seller’s Discretionary Earnings, although completely accurate, is a bit confusing. If you change the words “prior to the” and substitute the word “plus,” it may be easier to understand. We would also suggest that the highest salary be used in the calculation of SDE. The reason is that we must assume that the buyer will replace the highest compensated employee or owner—at least for the SDE calculation. We should also add that this is our definition.
Keep in mind that the multiples for the different earnings acronyms mentioned above will be different than the multiple of SDE, which, as mentioned above, generally is a number between 0 and 4. The rules contained in the Guide are specific about what is being used. It will say 2 times SDE or 4 times EBIT, etc.
All businesses are arranged alphabetically. If the business is known by two names, such as gas stations or service stations, we use the one that we feel is the most common, and we cross-reference them. If you are looking for a particular franchise, check the type of business for more information. For example, if the franchise is an ice cream store and it’s not listed, look up ice cream stores and other ice cream franchises.
The heading for each business tells if the business is a franchise and gives the name of the business and cross-references. Franchises also include, where available, the approximate total investment and the estimated annual sales per unit.
Below that are the Standard Industrial Classification (SIC) and the North American Industry Classification System (NAICS) numbers for the industry, plus the number of businesses or units for that business in the U.S. Where there is an IBISWorld report for the business, we use that number. IBISWorld (www.ibisworld.com) provides extensive, detailed reports on many different businesses. You must subscribe to get full access to these reports, but they are well worth the price.
The Rules of Thumb
The price, based on the rule of thumb, does not include inventory (unless it specifically states that it does), real estate, or other balance-sheet items such as cash and accounts receivable. We have noticed an increase in Industry Experts telling us that inventory is included in the multiples. The price derived from the rule of thumb is for the operating assets of the business plus goodwill. It also assumes that the business will be delivered free and clear of any short- and long-term debt. If any debt is to be assumed by a purchaser, it is subtracted from the price based on the rule of thumb method.
Work in progress, prepaid memberships, etc. also normally belong to the seller. Items such as these may be divided between buyer and seller. For example, in a dry cleaning business, the seller may have taken in a customer’s clothing for dry cleaning, but the buyer may take over the business before the work has been completed and delivered back to the customer. This is generally handled outside the transaction and does not usually figure in a pricing or valuation.
Pricing Tips provide information from Industry Experts and other sources and supplement the rules of thumb.
This section allows our Industry Experts to add their own personal comments about this type of business. These comments may amplify a particular area or provide additional pricing information. Quite often these Industry Experts provide information or data that can’t be found anywhere else. Some Industry Experts, who own or manage an office with associates, list themselves under more than one business; this may mean that one or more agents in that office are experts in that industry.
It is very important, in analyzing and pricing a business, to compare that business to similar businesses. We have included as many benchmarks as we could find. Most of them have come from IBISWorld, while many have been contributed by Industry Experts.
One common benchmark is the expenses, and in many industries we have included Expenses as a Percentage of Annual Sales. Since we often meld the figures from several different sources, these may not always add up to 100 percent, and in some cases they exceed 100 percent. We provide only the major categories, and there may be other expense items not included which would make up any difference.
Buyers and sellers could use this information to raise or lower the selling price. For example, if the business under review has an occupancy percentage of twelve percent against an average eight percent benchmark, then perhaps the price should be reduced to compensate for the higher rent. Certainly a new owner could lower some of the expenses, but a trained labor force, for example, is hard to replace. Reducing the percentage multiple is a judgment call; but let’s face it, even business valuation is not a science, but an art—and judgment plays a large part in it.
Our researchers are constantly checking industry websites, associations, and publications—as well as news agencies and other Internet sites—to find the latest information about the ever-changing business scene and how it affects each industry.
Our Industry Experts provide this critical information to help buyers decide where to get financial backing for their purchase and what terms are currently being used.
What questions should you ask the owner (the seller) about the business? Many of these questions are the ones that Industry Experts feel are the most important for that business. Answers to these questions by the seller or his or her representative could dramatically impact the price.
We provide resources that we have used, including publications, books, trade associations, etc. For most of the associations, we have included their website. Some are very informative; others are really only for members or consumers. Many of them offer books, pamphlets, or studies that can be informative. Every year we find that more and more associations are offering research materials to members only, and they charge non-members a high price. Don’t forget that IBISWorld has great reports.
We also suggest that if you need additional information you email or call an Industry Expert. A list may be found on www.industryexpert.net.
Note: Our Industry Experts and researchers provide a wealth of information for the Business Reference Guide. Because of space limitations, however, we cannot include all the information in the printed book. A subscription to the Online BRG will provide you with all the latest information.
This edition of the BRG contains more franchise data than any previous one. Our Franchises entry contains a quick rule of thumb for almost 200 franchises. Additional information can be found under the individual entries.
If you can’t find the specific franchise you are looking for, go to the particular type of business that the franchise represents. You may add to or subtract from that rule of thumb based on your assessment of the value of the franchise. Even if there is a rule of thumb, it is always wise to refer to the type of business for more information.
Some associations conduct their studies and surveys only every other year or even less often. In some cases, we have done a particular section prior to the new data becoming available; however, we attempt to keep the BRG as current as possible.
We know that some of the information may be contradictory, but since we get it from those whom we believe to be experts, we still include it. The more information you have to sort through, the better your final conclusion.
We want to thank all of those who contributed rules of thumb, industry data, and other information to the Business Reference Guide. It is a tribute to them that they are willing to contribute so much of their knowledge. In gratitude for their contribution, we list our Industry Experts on our website and give them a copy of the current edition of the BRG. If you are interested in applying to become an Industry Expert, go to www.industryexpert.net .