2010 is almost 1/2 way completed. Where do you stand regarding reaching the goals you set for yourself in 2010? Where do you have to go to reach your goals?  The first part of trying to figure out where we are going is determining where we are. 

What is your status?  In Facebook and Twitter we want to tell others of our status in our personal life, but do we tell others or even really tell ourselves what our professional, business or financial status really is.  Are you happy with your status?  Are you better off this year than last year?  Did you start that business you wanted to start, get a new job, buy a business, sell a business, retire… ? It is said when planning  ”How do you know if you got there if you dont know where you were going.”   But preceding this above-mentioned planning tenet is the need to know where you are starting from. A person wanting to start a business or buy a business and has $1,000,000 in the bank will plan to start or buy that business different than a student that just graduated from college and owes $40,000 in college loans and $0 in the bank.  It’s always a good time to plan ahead – We’re 1/2 way thru 2010.  What is your status?

1. Working for a wonderful boss and company and love my job.
2. Own my own business and business is good and look forward to continuing my success.
3. Own a struggling business and barely hanging on.

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“Make sure you perform your due diligence.” A simple statement that can have tremendously far reaching consequences. I work with people interested in buying a business or selling a business, and this statement can almost appears like “boiler plate” language and get glossed over by the parties involved. What does due diligence have to do with running my business or starting my business? – due diligence is just for buying a business. Due Diligence is a term used for a number of concepts involving either the performance of an investigation of a business or person, or the performance of an act with a certain standard of care. It can be a legal obligation, but the term will more commonly apply to voluntary investigations. A common example of due diligence in various industries is the process through which a potential acquirer evaluates a target company or its assets for acquisition. Originally the term was limited to public offerings of equity investments, but over time it has come to be associated with investigations of private mergers and acquisitions as well. The term has slowly been adapted for use in other situations (per Wikipedia) Due diligence is essentially a way of preventing unnecessary harm to either party involved in a transaction. This is a definition when read carefully, can be seen as affecting so many aspects of a business owners life that it can almost become a mantra rather than an after thought.

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When should one begin the planning  for the sale of your business?  It has been said that that thought process should begin when you start your business.  So Entrepreneurs, while in the initial throes and excitement of the planning stages of starting a new venture, it is also appropriate to broach the subject of exit strategy.  Too often the daily process of running and growing the business disallows the consideration of an  exit strategy.  A study conducted Sept.09  (as printed below) revealed that 75% of small business owners do not have an exit plan.   

SACRAMENTO, Calif., Sept. 29 /PRNewswire/ – The California Association of Business Brokers (CABB, a non profit trade organization) says that there is one thing that most small business owners fail to do when preparing to sell their business: have an exit strategy in place. A recently reported study conducted by Harris Interactive found that among those small business owners surveyed, three out of four small business owners did not have an exit plan developed.

An Exit strategy may be transitioning your business to family members, a planned merger, a planned closure, a planned sale of your business, or other possibilities.  The below is focused on issues related to the planned sale of your business.

How NOT to Consider an Exit Strategy:

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The End Game
In the business world, your professional career, your job, what is your end game? Do you have a goal to “be done working by the time I turn___ years old”? What is your goal? Starting a business and selling it for a very comfortable profit- is that your goal? Climbing the corporate ladder to the top- is that your goal? Putting a good meal on the table for the family and retiring comfortably at the age of 65 is that your goal? Retiring by the age of 30, 40, 50 60,70? Is that your goal? Sometime we get mired in our professional/business life and are to busy solving todays problem and have no time to really plan for tomorrow or for the years of tomorrows we will have after “retiring”.

“I want to start a business – grow the business – make it profitable – and hopefully be able to sell it for enough money for me to retire on.”

I believe this to be a reasonable and fairly common goal among business owners and or entrepreneurs.

But I think, like a lot of complex situations, the devil is in the detail. Lets say you are enormously successful and able to financially to accomplish your goal and sell your business at the age of 30, 40, 50, 60 years old? Do you plan to then just relax, and play out your years playing golf, tennis, and waiting for the 5:00 Cocktail hour?

Is selling your business the end game, finishing point, or just a step or part of your business life? The demographics of where I live (Southwest Florida) is such that there are many many people retired (with average age of 50-80) who we live among and interact with on a regular basis. The need to stay active physically and mentally is a priority for most of them, and these are generally people than can be retired and “do nothing.” Exit planning from a business requires careful thought and potentially some soul searching as well.

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What is an expert? Are you an expert? Do you call yourself an expert? Do your customers/clients refer to you as an expert? Undoubtedly, it provides value to be viewed as an expert in a certain field or line of work. Is aspiring to attain such status a worthy goal, or is attaining such status really just a byproduct of ones efforts towards larger, bigger picture goals?My current business is helping people and business in the process of buying and selling businesses. My perspective or “area of difference” is from the perspective of a small business owner that has personally bought many businesses over a 20 year period to add to my existing business . The interesting component of what I do in helping people buy and sell businesses is that most people only buy or sell a business once in their life once, most never do at all. So when someone is looking to buy a business or sell a business and only do it once, it can be accurately stated that that person cannot be an expert in that process. Maybe when buying a business or selling a business one should seek advise or help from an expert- but that is not what this article is about.

My opinion is that the term expert is a widely used term and its use has only been growing as the internet is reaching further through social networks and into our daily lives. Maybe the term is getting over-used and “watered down.” We all get on Google, search, and run into experts everyday suggesting, telling, guiding so many of our everyday actions and even views, or way of thinking.

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There are 3 approaches to valuing a business – market, income and asset. A thorough business valuation requires that you consider methods from all approaches. Each valuation method looks at a company from a different perspective, and sometimes the results vary widely. How do you choose the best method?

Selecting Methods
The asset-based method described in Part 8 produces the minimum value of a company because it assigns no value to goodwill. So your first step is to ignore any method that produces a value less than the adjusted asset method. If your company has little or no earning capacity then the adjusted asset method may produce the highest result and it is the best method.

The percentage of annual sales method from Part 6 often produces the highest value of a company because it is based on top-line sales only and it ignores gross profits and operating expenses. Because it produces a high value many owners latch on to this method even though it often produces unrealistic results.

Since the primary driver of business value is earning capacity, the multiple of seller’s discretionary earnings (SDE) and capitalized cash flow methods tend to produce the most realistic values. On the flip-side, potential buyers and their lenders will also be looking at earnings to justify the selling price.

Range of Values
Typically the adjusted asset method will be the lowest, the percentage of annual sales method will be the highest, and the SDE and cash flow methods will fall somewhere in-between.  This is the range of values for your company. Because valuation is based on a hypothetical sale of your company, the value of your company depends upon the most likely terms of the sale. If you had to sell fast for all cash then you would probably sell near the low end.

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There are 3 approaches to valuing a company – market, income and asset. This article covers the asset-based approach.

The asset-based approach breaks a company down in to its pieces and attempts to value each individual asset separately. For most physical and financial assets this is a fairly straight forward process. Third-party sources of market values and comparable sales data are available. A number of problems appear when dealing with intangible assets. Identifying every component of an intangible asset like goodwill is like peeling an onion. There are endless layers of factors that become increasing detached from reality.

For these reasons the asset-based approach is often applied to tangible assets only. The book values of all assets that would be included in the sale of the company are adjusted to their respective market values.

First, list the value of each asset as it is shown in your accounting records. The book value of inventory should come from a tax return, balance sheet, or trial balance. The book value of assets being depreciated should come from your depreciation schedule. Your CPA or tax preparer may keep this schedule for you. Only items of significant value should be listed individually. All other items should be valued as a group.

Now adjust each asset using the following methods:

Inventory – Adjust inventory to an estimate or actual physical count of what is currently on hand. Inventory should be valued at your cost. Only include inventory that is saleable.

Vehicles – Only include vehicles that are used in the business and that would be included in a sale of the company. Market values for cars and light trucks can be obtained from Kelley Blue Book at www.kbb.com. Search listings of commercial vehicles for sale on websites like TruckPaper.com.

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There are 3 approaches to valuing a business – market, income and asset. This article covers the income approach.

Types of Earnings
There are many types of earnings used in business valuation methods. Here are the most common ones with brief explanations. It is extremely important to use the correct type of earnings for the selected method.

Earnings before taxes (pre-tax earnings) – Many valuation methods use pre-tax earnings.

Earnings before interest, taxes, depreciation & amortization (EBITDA) - EBITDA is a close approximation of cash flow because it adds back the non-cash expenses of depreciation and amortization. A multiple of EBITDA is a common valuation formula.

Cash flow - There are many types of cash flow. Cash flow is considered a more pure form of earnings and is often preferred for valuations.

Seller’s discretionary earnings (SDE) – For owner-operated companies SDE is the preferred earnings for valuation because it represents the total earnings available to the owner. SDE starts with EBITDA then adds back owner compensation and benefits.

As described in Part 5 of this series, each type of earnings must be adjusted to more accurately reflect the true earning capacity of the company for things like related party transactions, and non-operating and unusual items.

For a company that has fluctuating or relatively stable earnings, a three to five year average will best reflect the earning capacity of the company. A weighted average can be used to give greater weight to specific years.  If earnings are consistently growing or falling, the results from the most recent year may be a better choice.

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There are 3 approaches to valuing a business – market, income and asset. This article covers the market approach.

Preferred Approach
A market-based valuation is preferred by most appraisers and users because it relates directly to the actual sale of a similar property. There is no better evidence of value than an actual transaction, but it must be comparable. That is a major weakness for applying the market approach to a small company. It is difficult, if not impossible, to find comparable transactions.

Public Companies
Every day millions of shares of stock in large companies are freely traded on major exchanges like the New York Stock Exchange (NYSE). It should be the ideal source of market data for the sale of a company, but is buying shares of a public company comparable to buying a small business? The answer is no for a number of reasons. For professionals that believe comparable public companies exist, there is the guideline public company method. A single company or group of companies is identified as comparable and adjusted to increase comparability. The most appropriate pricing multiples are selected and applied to the company being valued.

Private Companies
Due to the differences between public and private companies, data from the actual sales of private companies would seem like a better alternative. The primary problem is that these sales are private transactions that are not reported publicly. There are several commercial databases that collect this information from various sources. The available data is from a small portion of the total transactions and a limited amount of information for each transaction is available. Under these conditions finding one reasonably comparable transaction is virtually impossible.

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Both selling and purchasing a business can be a very rewarding decision, when done properly. There are many different approaches to such tasks – however, their common issue is the difficulty with determining the right business selling price. Pricing a business is both a science and an art – and it takes skill and experience to do it correctly.

Pricing a Business
Whether you are a buyer or a seller of a business establishment, pricing a business is one of the initial tasks that await you after you make a decision to buy or sell a business. It is also one of the most difficult tasks. There is not a single best method to price a business – in any case, the final selling price still depends on how badly the seller wants to sell and how anxiously the buyer wants to buy the business. However, there are commonly used methods to estimate the value of a business.

The first method is called market-based valuation. It is probably the simplest, in comparison to other approaches. Essentially, the business selling price should be similar to the price of similar businesses that have previously sold in the area and industry. While this approach clearly does not take into account unique characteristics of a particular company, it offers a “quick and dirty” method of pricing a business for sale.

Another method is asset-based valuation. This one bases its calculations on the book and liquidation values of a particular company. When determining a business for sale price, such values are usually considered to be the bare minimum, as other important features, for instance, brand name and customer base, are ignored.

The third and probably the most comprehensive business pricing method is earnings-based valuation.

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The earning capacity of a company is the primary driver of its value. Cash flow is the preferred measure of earning capacity for valuation purposes because it represents a purer form of earnings. Calculating cash flow begins with the net income or loss of a company then adjusting it for a number of items to achieve a figure that accurately portrays the true earning capacity of the company.

Depreciation & Amortization
Depreciation involves writing off or expensing the cost of tangible assets like buildings and equipment over their useful lives. Amortization involves the same process for intangible assets like franchise fees and liquor licenses. Depreciation and amortization expenses are the result of accounting entries where no cash was actually spent, so they must be added back to net income to determine cash flow.

Non-recurring Items
Income or expenses that are unusual or not likely to recur, distort the cash flow for that year. These items should be added back to (expense) or deducted from (income) net income.  Some examples of non-recurring items are: the gain or loss on the sale of equipment, fines or penalties, writing off a large bad debt, or a major theft or casualty loss. Some unusual events may be due the cumulative effects of an ongoing situation. In these cases the income or expense should be allocated over the affected period.

Transactions with Yourself
The true earning capacity of a company needs to reflect adequate compensation to the owner for the services rendered to the company. The compensation of the owner should be based on the job market in its market area for similar positions.

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As many businesses change their owners at some point, the services of business brokers can be necessary and highly valuable both from the business buyer’s and seller’s perspective. A person who is aiming to buy a business will need to evaluate the particular establishment and an experienced business broker can offer priceless assistance in this area; conversely, a seller may find it rewarding to hire a business for sale broker to help advertise the offer and facilitate the negotiations with potential buyers.

Business For Sale Brokers
Selling a business is an extensive, tiresome and demanding process, which can consume precious time and ultimately even damage the value of your business, as you are focusing a great deal of your energy on the sale process rather than on daily business operations. This is why services of business brokers can be invaluable.

To begin with, an experienced business broker can offer you confidentiality, ensuring that only the buyers you approve will be contacted. The broker will save you valuable time, by screening potential buyers in advance and checking whether they have enough financial resources to purchase your business, and will ensure confidentiality, by asking buyers to sign confidentiality and non-disclosure agreements.

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Usually, at some point there comes a time to sell your business. If it is an independent establishment, you are left completely on your own – and while this degree of freedom can be daunting at first, it also provides you with an unlimited array of possibilities. But what if you want to undertake a franchise resale? Franchises have one significant difference from independent businesses – franchisees are bound by franchise agreements, which in some cases can limit their freedom of action quite notably. Usually, a franchise resale is not an exception to this rule. Yet, virtually every franchisee can resell their business – but it is essential to know several important tenets.

Is a Franchisee Allowed To Resell Their Franchise?
A short answer is yes – if such a procedure is in compliance with the franchise agreement, a franchisee has a right to a franchise resale. However, “compliance” is the key word here. Naturally, the sale of an independent business involves far fewer concerns in comparison to what is common among franchise resales.

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Success is a Journey – Not a destination.
A well repeated phrase that ones reads, nods in approval and then moves on to other matters. But what does it really mean?  Taking a moment to interpret the meaning can provide a strong foundation for business and personal planning of a small business owner or entrepreneur.

Consider these 3 Scenarios of “Success”:

1. Just consider all the investors in the late 1990′s that made millions in the stock market Dot-Com boom.
Buy low, sell high, make millions- you are a success.  Three months later the Dow loses 600 points in one day, the market continues to fall,  those millions are lost and investors are left with no gains or worse – are you still a success?

2. Fast forward to the Real Estate Collapse that we are now experiencing.
Buy an entry level house, “flip it” make some good money- Are you a success?  Now take those gains, leverage those monies, buy a bigger house, “flip it” make a lot more money. -Are you a success?  Things are good, this real estate thing seems almost automatic, so you take all those monies, buy a $1,000,000 property with plans to fix and flip it for $1.5M, but the market turns south and all the real estate gains have gone away and you cant find a buyer for your house at $740,000- are you a success?

3. Now Consider the Entrepreneur / Small Business Owner.
You successfully start your own business. You reach break-even.  Are you a success?  You reach $1,000,0000 in annual sales, then $2M, then $3M – Are you a success? You sell your business for several million dollars – Are you a success?  I say you have reached certain successes, but the journey continues.

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The basic concept of business value is that the future benefits (returns) of owning a company must be adjusted (discounted) for the risks associated with owning the company. The sales or earnings of a company are typically used to represent the benefits (returns). Multiples and rates are used to represent the risks. The basic formula of business value is – Value = Returns/Risks. This article will address how to quantify the returns of a business.

Earning Capacity
There are many benefits to owning a business (financial and non-financial). Non-financial benefits like: being your own boss, controlling your own destiny, prestige, etc. are impossible to quantify, so valuation focuses on the financial rewards. The returns from a company are generally measured by its ability to generate earnings (earning capacity). The value of a company that does not have earning capacity comes primarily from its tangible assets.

Earning capacity is not just the net profits from financial statements and tax returns. Net profits must be adjusted to compensate for accounting principles, tax regulations, and related party dealings that do not accurately portray what really happened. Cash flow is considered a purer form of earnings because it is not affected by accounting principles and tax regulations. For these reasons cash flow is the preferred measure of earning capacity for valuation purposes.

The earnings of a small, owner-operated company must do two things. First it must provide adequate compensation to the owner for the services he or she renders to the company. Any remaining cash flow or earnings represent the earning capacity of the company.

Many small businesses don’t earn enough to provide the owner with adequate compensation. Some of these companies have existed for decades, have established customer bases, and have excellent reputations.

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A valuation is based on a hypothetical sale of the company, so two critical issues need to be well defined from the beginning – 1) exactly what is being sold (valued), and 2) who is the most likely buyer.

What is Being Valued?
Businesses are generally sold in two types of transactions – asset or stock sales. A stock sale involves selling the shares of the stock of a company that operates as a corporation. Most buyers are not interested in a stock sale because it involves acquiring liabilities – existing, contingent and potential. An asset sale gives the buyer a clean start. Therefore, stock sales of small businesses are not common. Many valuation methods produce results based on stock sales, so the results must be adjusted accordingly.

Asset sales involve selling the main operating assets of the company. That typically includes inventory; furniture, fixture and equipment (FF&E); leasehold improvements: and all intangible assets, commonly referred to as goodwill. The intangible assets include items like: customer list, trade name, telephone numbers, assembled workforce, etc. These assets are typically sold free and clear of all liabilities. Cash, trade receivables and payables, and miscellaneous assets or liabilities are commonly excluded from the sale. If the owner also owns the company real estate, it may or may not be included in the sale. The sale will also include the assignment of existing leases or contracts, or will be contingent on the buyer obtaining new ones. If the company operates under a franchise agreement or needs a specific type of permit or license like a liquor license, the sale will include the transfer of these items.

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As a business owner, you know more about your business than any one, but there is one thing you are not too sure about – how much it is worth. This is the first in a series of articles designed to help you learn about business valuation and, if you choose, do your own business valuation.

Defining Value
Before we begin discussing business valuation it is important to define what value is. When asked, most people will struggle to define it then end up using an example like a one dollar bill is worth more than a quarter. Value is difficult to define without comparing at least two items. The comparisons must be well defined to have any meaning. For example a rare quarter may be worth more than a common dollar bill. The first step in any valuation is to accurately and completely define the property that is being valued.

Value is also subjective.  Someone who needs a quarter to plug a parking meter in order to avoid a parking ticket would gladly pay a dollar or more for a quarter. Similarly, one business may have a number of values. A strategic buyer that can plug the customers of the business into its existing system may perceive more value than a person who is going to run the business day-to-day. The second step in valuation is defining for whom the property is being valued.

What is a Business Valuation?
A business valuation is simply an estimate of what a business is worth based its hypothetical sale. It may also be called a business appraisal and has some similarities with real estate appraisals.  A big difference is that much of business value is in the form of intangible assets, or goodwill. Valuing intangible assets involves a process of using various accepted valuation approaches and methods. The goal is to determine a value that can be explained and justified to others.

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Let the Buyer (ALWAYS) Beware
As a proper thinking entrepreneur, you have decided that the pizza place that’s been on the corner of your street for 15 years – and is now for sale by its original owner – would be the perfect business to buy.  You have some cash on hand, you know that the owner is willing to provide a loan for the balance (at a below market rate), and you have worked your way up through the fast food jungle from counterperson to assistant manager. All the stars appear to be properly aligned, so what could possibly go wrong?  Well, let’s think about the asking price for a minute.  Pay too much and you may find that it will take a lot longer to reach profitability.  Pay too little and…well, that almost never happens, does it?  How do you value an existing business for sale?

How to Value a Business For Sale
Any existing business has some intrinsic value, even if it’s on its last legs.  Maybe the equipment can be pawned or resold, or perhaps the brand name still pulls in a few customers.  There are many ways to calculate the fair value of an existing business – successful or otherwise – but it rarely makes sense to take the owner’s word for it.  At the very least you will want to apply your own metrics to the process.  It usually makes good fiscal sense to get a business valuation done by a professional or, at the very least, by a trusted yet disinterested third party.  Sad to say, there are literally dozens of methods that people use to determine the value of existing businesses for sale.  Not all of them will apply to the company your eye is on, but there are some basic rules worth following.

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When the full content of the deal in its entirety is fully explored and strongly considered … price, financing terms and conditions, taxes, debts, real estate, sellers goals, and the qualifications / resumes of all parties involved are all factors that should be fully considered in a well thought out deal.

“If I could get $X for my business I would sell it today.”
“I need to get $X to sell my business.”
“I know my business is worth $X.”

The above are comment statements and feelings business owners share in the consideration of the sale of their business.  But no business operates within a vacuum and many factors affect the business outside of the business including the rest of the industry, and local, regional and worldwide business climates.   What sort of a return should one get on a business purchase is somewhat relative to what one can achieve in other investments.  If one can expect a double digit return on a conservative investment, this may drive up what one may expect from a riskier investment in a business.  But as investment returns on fairly conservative investments go down, interest in business acquisition may go up, and expected / projected returns reduced.  The price of your business is not determined in a vacuum as well.  The terms of the sale, the other party or parties involved with the sale, financing and terms, and the timing of the sale are a few of the important factors (outside of price) that can greatly affect the success of a sale.

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Start a Franchise Business
Many small-business owners reach a point where their company’s success makes them think of expansion.  One possible way to enjoy additional income involves opening a second location, and then adding more as time and cash allows.  But an increasingly popular method involves franchising your business.  The franchising process will allow you to earn significantly more in both fees and royalties than you could ever hope to make by running multiple locations on your own.

The Process of Franchising
Franchising opportunities are available no matter what kind of business you run – whether it involves retail or wholesale locations, a mobile operation, or even a work from home situation.  The question of how to start a franchise rests upon several basic elements, all of which must be present in order to be successful.

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