Jeff Jones has said, in the 2nd Edition of the Handbook of Business Valuation, edited by Tom West and Jeff Jones, (John Wiley & Sons, 1999), “Perhaps better than any other appraisal method, the Multiple of Discretionary Earnings Method strives to measure the economic and lifestyle characteristics perceived by those who buy and serve as owner/operators of small to midsize businesses.” Jeff goes on to say, “The Multiple of Discretionary Earnings Method overcomes the shortcomings of the old ‘rule of thumb.’ This method has practicality that buyers and sellers of small to midsize businesses can understand. The vast majority of those who acquire small to midsize businesses are corporate executives, engineers, skilled blue-collar workers and immigrants. These people often think in terms of lifestyle and income to support their families. They look at the total discretionary earnings to see if it is sufficient to pay all the operating expenses of the business, carry debt structure necessary to buy and/or operate the business, and provide a livable wage. This is a different thought process from professional investors who buy ownership interests in large publicly traded businesses motivated more by return on investment than by lifestyle considerations.”
Discretionary Cash (Method Two)
This is a more formal alternative than the others. It is one used by Jeff Jones of Certified Business Appraisers of Houston, TX. He is a well-known business appraiser and, in addition to being the co-editor of the Handbook of Business Valuation, both the 1st and 2nd Editions, published by John Wiley & Sons, contributed the article on the Discretionary Earnings method. Jeff uses an analysis table where ten factors are weighted and a multiplier is then calculated. Each factor is rated on a scale of 0 to 3. Jeff’s method is based on the premise that a business will not sell for more than three times earnings.
Be sensitive to these considerations when you are disclosing to a competitor, by signing the
confidentiality agreement you present, a competitor is risking a law suit from you even if it
already knows, or has in development, what you are about to tell them.
Disclosing Information
For the disclosing party, the risks can also be great.
The disclosing party risks (a) disclosure of such information to its competitors; (b) disclosure
of the information to the public; and/or (c) use of such information to compete or gain market
advantage against the disclosing party.
Generational Equity
Multiple of Earnings
One of the most common methods used for valuing a business. In this methods a multiple of the cash flow of the business is used to calculate its value.
Multiplier or Market Valuation
Uses an industry average sales figure from recent business sales in comparable businesses as a multiplier. For instance, the industry multiplier for an ad agency might be .75 which is multiplied by annual gross sales to arrive at the value of the business.
Owner Benefit Valuation
Computed by multiplying 2.2727 times the owner benefit.
Sell at the right time for the right reasons.
The most common reason for selling a business is that a business owner falls ill or gets too old to continue to run it – the worst time to be selling a business. For one thing, it’s going to be extremely difficult for you to deal with the additional stress of selling a business in those circumstances; for another, the buyer will use your circumstances as leverage against you.
So don’t wait until then. The right time is when you’re still hale and hearty and have a successful business to sell.
And what are the right reasons? Selling a business is very like selling a house in some respects. When you’re selling a house, you don’t say that you want to sell because the house is too small. You say that you want to move to be closer to work, for instance. When selling a business, you want to sell because you want to pursue a different opportunity or because you’re seeking a different lifestyle (such as retirement).
Generational Equity Co Confidentiality is Key
Employees, suppliers, customers, and bankers are key factors to a company’s business. News of a possible business sale can often disrupt these relationships and effect a company’s ongoing business. Confidentiality is critical at all stages of the sale.
With Davidson Ashe, the CONFIDENTIALITY of the business owner and the prospective buyer is strictly maintained. To obtain a detailed business profile of a listing for review, the prospective buyer must submit a buyer profile form. Business profiles do not provide the name or location of the business. In order to obtain this information, a personal or corporate financial statement must be presented. When proof of financial competence to meet the down-payment requirement is provided and a Confidentiality Agreement is signed, all relevant information concerning the business is then placed at the disposal of the buyer. This typically includes financial statements, tax returns, equipment lists, discretionary cash flow statements, and other documents which may be applicable.
INCOME CAPITALIZATION VALUATION METHODS: First you must determine the capitalization rate – a rate of return required to take on the risk of operating the business (the riskier the business, the higher the required return). Earnings are then divided by that capitalization rate. The earnings figure to be capitalized should be one that reflects the true nature of the business, such as the last three years average, current year or projected year. When determining a capitalization rate you should compare with rates available to similarly risky investments.
DISCOUNTED EARNINGS: This determines the value of a small business based upon the present value of projected future earnings, discounted by the required rate of return (capitalization rate). Usually, the question is how well earnings are projected.
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