How will Your Business be valued?

How will Your Business be valued?

Sep 19 2018

Most smaller “mainstreet” businesses typically sell based on a multiple of SDE.

Mainstreet is typically defined as businesses with revenues of $5,000,000 or less.The process of estimating the value of a business or business interest frequently requires the adjustment of certain financial statements to free them from the influence of accounting elections that were made to minimize tax liability; and to restate them in such a way as to depict the true economic performance and condition of the company. Typical adjustments for small to mid-size businesses include excess officer compensation, owner’s benefits or “perks”, one-time expenses, or other non- related businesses expenses and/or revenue. These adjustments then define the SDE (Seller's Discretionary Earnings) of the business.

An opinion of "fair market value" is based on a going concern premise with management operating in a rational manner with a goal of maximizing owner value of the underlying assets. Although there are multiple approaches to value, the most common and accepted approach is the Direct Market Data Method (Market Approach).

The Direct Market Data Method, DMDM, develops a value based on the transaction values for which similar privately held businesses have been sold. The method assumes that if you take a large group of transactions of similarly structured businesses, the central tendency of the value ratios in such groups represents the value determined in a free and open market or Fair Market Value. The size of the group has been demonstrated to require more than five transactions.

Most institutions (SBA, IRS, ERISA) consider “fair market value” as the standard.

Most middle market to larger privately held businesses typically sell based on a multiple of adjusted EBITDA (which is earnings before interest, taxes, depreciation, and amortization).

Middle market is typically defined as businesses with revenues of $5,000,000 plus. The process for this type of transaction is to first calculate the SDE and then deducting a fair market salary and benefits for an owner/operator (or manager / CEO, depending on the size of the company), to arrive at “Adjusted EBITDA”.

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