Tuesday 30 October 2012

The Truth About EBITDA vs. Cash Flow

EBITDA and Cash Flow are essentially the same measurement, with a couple of exceptions – usually BIG ones. 

EBITDA (Earnings Before Interest Taxes Depreciation and Amortization) leaves in, or adds in if necessary, an expense for a General Manager to run the operation and does not recognize Discretionary Expenses as being discretionary.

This is why a “multiple” used in an EBITDA evaluation is usually higher than one used in a Cash Flow evaluation.  The reason being is with the EBITDA measurement, because there is “management in place”, the buyer is buying a “passive” investment.  Hence, the Buyer is generally prepared to pay a higher multiple (and earn a smaller return on their investment).

The following example of the same Business highlights the point:


EBITDA CASH FLOW
Net Profit $800,000 $800,000
Adjustment for GM at FMV (fair market value) -$150,000 not applicable
Adjustment for Discretionary Expenses not applicable $110,000
Adjusted Net Profit $650,000 $910,000
Multiple x4.14 x2.93
Value of Business $2,691,000 $2,666,300
 


Due to the reasons outlined earlier, an EBITDA Buyer may pay a higher “multiple” for the business, but the business has essentially the same value.

This subtle but significant difference between “multiple” in these two methods can mean a big difference if the wrong “multiple” is applied to the wrong measurement.  For example, an EBITDA multiple of 4.14 applied to a Cash Flow Adjusted Net Profit measurement of $910,000 will grossly overstate the value of the business.

Typically you will find the majority of businesses in “Main Street” transactions generally have an Adjusted Net Profit of $600,000 or less, and typically have the owner as the operator of the business reaping the benefits of the Discretionary Expenses.

Do you have a small business question you would like answered about this article or others?
Bill Sivell is a salesperson with VR Windsor Inc. [www.vrwindsor.com] 519-903-7807, which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. His blog appears every Tuesday.

 

Tuesday 23 October 2012

Barriers to entry help business value


As a business owner you probably are aware that there are many different factors that impact the value of your business.  A major impact to value is the amount of cash flow your business produces.  This makes sense considering buyers are buying business for the income they produce, so the more cash flow a business produces the higher value you would associate with that business.

But one company’s cash flow may be more valuable than another.

Why?  These factors are commonly referred to as value drivers. And they are elements that help make one business more attractive, less risky or more appealing than another. 

There are a number of value drives to consider.  For example, size of the business plays a heavy influence.   The perception that smaller companies are riskier than larger businesses drives prices down on small business and helps protect value on larger companies.

An interesting factor impacting value is best described as ‘Barriers to Entry’.   As a general statement, the easier it is to enter a particular industry, the less a purchaser will be willing to pay.  On the other hand, if there are substantial barriers to entry the less resistance you should get to a higher price.

How can you influence your industry’s ‘barriers’?

In many ways barriers or lack of barriers are specific to the industry you are in.  For example, the restaurant industry is widely understood as a very low barrier industry, while capital intensive industries such as manufacturing tend to have a high degree of barriers to entry. 

Regardless of your particular industry, I would suggest taking a close look at 3 factors to build a layer of protection in your market place…

Market Share:  The higher your share of the market the more likely you are able to differentiate your product or service from the competition.  Being able to stand alone protects pricing from becoming commoditized and further insulates you from new competition.

Customer Base:  Build a diverse cross-section of customers to protect business value.  If you have one customer that represents greater than 10% of your overall gross sales, you are exposing your business to risk of losing that customer and largely effecting profitability. Buyers tend to associate higher risk to businesses with one or two large customers, and pay a lower premium for those businesses.

Proprietary product: Things like patents, and licenses protect your business from competition.  They allow you to ensure profitable margins and they make your business more valuable to buyers.  In a world where buyers are using historic cash flow results to predict future profitability, proprietary products helps mitigate the risk of the competition duplicating products & services and stealing customers.

Do you have a small business question you would like answered about this article or others?
Bill Sivell is a salesperson with VR Windsor Inc. [www.vrwindsor.com] 519-903-7807, which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. His blog appears every Tuesday.

 

Tuesday 16 October 2012

Owner burnout is bad for business


Many business owners have operated their companies for too long and have lost their interest or drive.  As a result, the business can flounder and stop growing.  Not only do revenues and profits suffer, but the value of the company goes downhill. And it only gets worse in a down economy.  When a business owner hits burnout, he or she must learn how to deal with it, or take steps to sell the company

A popular story I like to share with clients and prospective clients relates to the need for business owners to plan their eventual exit from their business.  It goes like this….

Claude and Mary are a lovely local couple married for nearly 50 years, 3 grown kids, and 5 grandkids.  Claude started his small manufacturing business in 1971 in the garage of his home. By 1980, he added a couple of employees, and started to rent some industrial space in the county. He built a strong loyal customer base that carried him through 35+ of business, not-to-mention put his kids through University, and lived comfortably along the way.  By 2004, both were 65 years old, their business was rolling along just fine, sales were approaching $1.5 million and at the time their business would have a value of $750,000… a perfect nest egg for retirement.

But they never did sell and their kids had their own careers and they were not interested in taking over for Mom and Dad… just a couple of years later, following a stroke and mild heart attack, Claude and Mary are still working now into their 70’s, albeit at a slower pace.
Last year when I evaluated their business, it’s value was a mere $40K
This is the classic… Sell out before you burn out!

There are many tools available to help individuals get into business, but few that help them get out.  Exit Planning is not mysterious, time-consuming, nor just a clever way to sell you another product.

Exit Planning is ALWAYS about 3 GOALS….
  • Leaving on the date you choose.
  • Having a choice in your successor.
  • #1… Receiving the amount of MONEY you want.
Just as there is an almost infinite variety of businesses and business owners, so too are there many different Exit Strategies.   Yet all plans contain several common elements.  It usually takes 3-5 years to appropriately plan and execute an exit plan, if you haven’t started planning the exit from your business, it’s never too late to start.

Do you have small business questions you would like answered about this article or others?  Please visit www.VRWindsor.com or call 519-903-7807. 
William Sivell is a sales representative of VR Windsor Inc., Business Brokerage; his blog appears every Tuesday.

 

 

Tuesday 9 October 2012

Exit your business step-by-step


 


It is easy to understand why some business owners do not take the time to map out an exit strategy.   Time demands and pressures of most start-up and day-to-day operations makes planning your departure seem impractical. 

The rewards are high when you plan in advance.  With an effective plan business owners will likely get more for their business and they are more likely to have a successful transfer.  Planning will help with minimizing the tax consequences and will dramatically improve the likelihood of future success for the business.  Plus, planning helps protect owners from the things they don’t expect and preserves personal wealth, estate and the business before a transfer is made.

There are a variety of exit strategies as unique and personal as the assortment of different businesses and business owners.  

A good starting point is to begin with the end in mind.

Start by painting a realistic picture of your long term income needs and retirement goals.  A business owner must be able to determine how much money the sale of the business must generate in order to retire.  Similarly, a personal snap shot of the owner’s vision for future legacy and role of the business within the family will help determine how you stage things for the next owner.

Every business owner needs to know there finish-line or departure date.  Is it age 55, 60 or 65?  Conversely, is it a dollar value of your business’ sale price?  Or, most typically, is it some combination of both?  Business owners need to set their finish-line, it needs to be written down and visible. Whether it is an age limit or income needed from the sale of the business or both, business owners who set their goals are more likely to achieving them.

Finally, and perhaps most difficult, business owners need to prepare themselves for life after their business transfer.  Building a business is hard work and an emotional endeavor.  It’s common for business owners to grieve the loss of purpose and stature that running a company can bring.  For many the financial wealth and security they have created can mask what really mattered most, the fundamental desire to build, problem solve and challenge themselves.


The overall exit plan can seem like a daunting project which is why many fail to begin.  Breaking the process into smaller manageable parts establishes realistic goals and objectives.  Plus, it will keep you focused on what is really important.  

Now that you have established where you want to be, you’re ready for the next step.

Building an exit plan should begin the day you start your business, however, it’s never too late to start! 


Do you have a small business question you would like answered about this article or others?
Bill Sivell is a salesperson with VR Windsor Inc. [www.vrwindsor.com] 519-903-7807, which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. His blog appears every Tuesday.



Tuesday 2 October 2012

5 Keys to Keeping the Sale of Your Business On Track

Selling your business takes many twists and turns. Here’s how to ensure you stay the course

In every business, whether it’s manufacturing a product, providing a service or retailing to consumers, those who are successful in making sales share some fundamental characteristics.  They all have a well-planned marketing strategy featuring qualified prospects, a detailed product (or service) profile that highlights the product (or service) features, and a clear definition of the benefits of a purchase.

The same can be applied to selling a business. But when it comes to selling your company, you also have to factor in the personalities and motivations of both the buyer and seller. To ensure you sell for the best price to the right buyers in a timely fashion, employ these five additional strategies:

Ask a reasonable price. Too often, inflated prices discourage potential buyers from giving the business any serious consideration.

In my experience, sellers who inflate the asking price in an attempt to create some “wiggle” room will find that buyers don’t give these businesses a second look. If they do, they are savvy enough to tilt the discussion in their favour, and negotiate lower prices because the lack of buyer activity makes sellers more anxious to discount the price.

A good litmus test is to honestly ask yourself if you would buy your business at the price and terms you’re offering.  If the answer is no, you need to reconsider.

Focus on day-to-day operations.  Continuing to operate the business as you always have is critical throughout the selling process. 

You don’t know when a buyer will materialize, so the business’s financial performance needs to remain strong. When a buyer does come forward, it will be important to both parties that the business is moving in the right direction before and after the closing date.

Those who let their firm’s performance slide should expect buyers to view the most recent performance as the most reliable indication of present value and future success. 

Maintain confidentiality. By interviewing and requiring all prospective buyers to sign a non-disclosure agreement binding them to complete confidentiality, all parties can comfortably communicate without impacting the business.

What would happen to sales if customers feared a pending sale might result in product delays or a change to product lines or services provided? Picture the performance of staff who worry that a pending sale will result in layoffs. What if your competitors found out and leveraged that information to steal market share, staff or suppliers?

By maintaining confidentiality, sellers will protect their current operation and be better able to transition a business that can appropriately plan and communicate the transfer of leadership to customers, staff, suppliers and competitors.     

Negotiate, but don’t dominate. Business owners are used to getting their own way, but for a successful transaction all parties need to find common ground.

If you attempt to rule the negotiation, you’ll unwittingly stifle buyer motivation—a critical ingredient to overcoming the inevitable sale-process hurdles. Buyers who feel they can work with the seller are more likely to navigate the bumps in the road.

When both parties focus on the issues that are important to them rather than details that are not critical, they find themselves more satisfied with the results. They are more likely to work in concert with each other and less likely to throw in the towel at the first sign of adversity.

Keep the process moving forward. One of the easiest ways to keep the deal going is to establish timelines and meet them. 

Few things kill deals like undue delays, which frustrate the process, slow enthusiasm and allow doubt to creep into the minds of buyers. Sellers forget that buying a business is risky. When a buyer has narrowed his or her options to your business, maintaining the buyer’s interest is imperative—once it’s lost, it’s impossible to get back. This does not mean rushing through the process. What’s important is to be open about the expectations and timelines, responsive to questions and willing to make the investigation and negotiations a priority.

Selling a business is not easy. The emotional tie you have to your business can make you do irrational things. The best way to prevent that is to remain objective and avoid the potholes along the way to realize your desired result.

Do you have a small business question you would like answered about this article or others?
Bill Sivell is a salesperson with VR Windsor Inc. [www.vrwindsor.com] 519-903-7807, which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. His blog appears every Tuesday.