Seller’s Discretionary Earnings – What Is It and How Is It Calculated?

One of the basic financial figures used in valuing businesses is this thing called EBITDA which stands for Earnings Before Interest, Taxes, Depreciation and Amortization. When it comes to valuing small businesses, however, you will often find that the value has really been based on something called SDE which is Seller’s Discretionary Earnings. So what’s the different between the two?

The International Business Brokers Association (IBBA) defines Discretionary Earnings as the earnings of a business enterprise prior to the following items:

  • Income Taxes (EBITDA item)
  • Non-operating Income and Expenses
  • Nonrecurring Income and Expenses
  • Depreciation and Amortization (EBITDA item)
  • Interest Expense or Income (EBITDA item)
  • Owner’s Total Compensation for those services that could be provided by a sole owner/manager.

As a general rule, the Non-operating and Nonrecurring Income and Expenses would be adjusted out whether the basis for the valuation is EBITDA or SDE. Based on the above, you can see that SDE can also be calculated as EBITDA+Owner’s Total Compensation.

When is SDE used instead of EBITDA? Generally when a business has a hands-on owner-operator or is the type of business which is typically owner-operated, SDE is used. When the business is typically investor owned or is management run, EBITDA is used.

Large Contracts – Friend or Foe?

There are many types of businesses in which the business owner or one of his/her employees is bidding/quoting for contracts. It’s exciting when a large contract is awarded and often times, the business revenue jumps tremendously which in turn provides a dramatic increase in net profit to the business owner. What happens when the business owner is trying to sell the business and the large contract has run its course?

It can be difficult to determine the value of a business when 60% of the revenue was derived from a single client contract and that contract is out for rebid. Perhaps the company will be lucky enough to land the contract again. Perhaps they even have priority over other bidding vendors. However, to a buyer, there is a very high probability that the business revenue will drop by 60%. Buyers are typically interested in mitigating their risk to the highest extent possible. If the total revenue drops by 60%, what does that do to the overall profitability of the company? Will the remaining revenue be sufficient to handle the fixed overhead?

There are other implications as well. What about staffing? If 60% of the revenue disintegrates, is the company now over-staffed? Are there employees that will have to be let go? What about the business premises? Does the company end up with a space and with equipment that is substantially underutilized?

As a business owner, when you land that large contract, congratulate yourself  and get to work on it. And, get to work on bringing in new clients and additional jobs to spread the revenue. When any client or any contract generates more than 5% – 10% of the gross revenue for your company, look at that client or contract as a double-edged sword and make sure you don’t end up bleeding.

Happy New Year! What 3 Things Will Help You JumpStart 2014?

Happy New Year everyone! I love the New Year because it’s brimming with excitement and possibilities. If you made a list of just three things you could do that would jumpstart 2014 for you, what would they be? Launching a new product or service? Implementing a new customer service system? A new marketing campaign?

What three things would really help you move forward in your business, or even in your personal life? Think about it and write them down. It’s much easier to focus on doing and completing three things rather than making a laundry list of To Do’s, which for most people, serves simply to overwhelm them.

Pick three things. Write them down. And then get them done. One at a time, if possible, or if not, jump back and forth as necessary moving each item further toward completion. And every morning and periodically throughout the day, look at the three things and ask yourself, “what can I do today to help me get these completed?” When you do complete one or more of them, make a new list — of just three things. Every day, focus on just three things. If you finish your three things before noon, congratulate yourself and make a new list of just three things.

Now you’ve got the hang of it. Just three things. And guess what? After a few days or maybe a few weeks, depending on the complexity of your three things, you’ve completed nearly everything that would have been on your laundry list of To Do’s, and even more. And you accomplished it all because you focused on just three things.

Have a phenomenal 2014!


Starting Fresh in 2014

It’s December 31st.. the last day of 2013. Where did the year go? So many events, conversations, lessons, new clients and new friends. I’m looking forward to 2014. We have several new projects in the works… projects that will allow us to provide better service for our clients, provide more education to small business owners, and add more value to what we put out into the world.

We’re looking forward to many more new prospects, clients and friends. This year our plans include more webinars, video presentations and various speaking engagements… more opportunities to educate and assist business owners in achieving their objectives.

We hope 2013 was a beneficial year for you and wish you much success in 2014. Have a magnificent New Year!


Three Costly Mistakes to Avoid when Buying a Business

Buying a business is a complex process. It is important to stay alert and focused throughout the transaction.  The following are three costly mistakes to avoid when buying a business:

1. Do Your Due Diligence

Take the time to review the tax returns, financials, purchase orders, invoices, vendor contracts, customer contracts, work orders, and other documents associated with the business. Include review by appropriate professionals (i.e. your attorney, CPA, etc.) Many buyers don’t want to incur any expenses until they actually purchase the business. However, the few thousand dollars paid to a CPA and attorney for reviews should be viewed as insurance. Is it better to pay $4000 or $5000 to learn the business is not going to generate the cash-flow you require without substantial additional investment, before or after you pay the $500,000 for the business? If you learn this information beforehand, you can terminate the transaction and walk away having invested only $4000 or $5000 in the process. If you don’t learn this information until afterward, you are stuck with a $500,000 investment which does not satisfy your requirements.

2. Know Your Working Capital Requirements

It is important that you have sufficient working capital to operate the business once the transaction closes. Sometimes buyers fail to consider the working capital requirements and have cash-flow problems from the day they take over. Depending on the structure of the transaction, Accounts Receivable and Inventory may or may not be transferred to the buyer as part of the deal. If not, you will need sufficient operating capital to purchase necessary inventory and you may be incurring expenses without income for 30 to 60 days while your own Accounts Receivables are building.

3. Have Critical Machinery and Equipment Inspected

The last thing you want to do is complete the transaction, take over the business and have an expensive key piece of equipment fail three or four weeks later causing disruption of the business as well as unexpected repair expenses. Any piece of equipment that is critical to the successful operation of the business should be inspected by a professional to ensure it is in good working order.

In summary, do your due diligence, know your working capital requirements, and have critical machinery and equipment inspected. When you do these three things you will minimize the risks inherent in buying a business.

How and When to Tell Your Employees about the Business Sale

Selling a business is a process, not an event. There are many moving parts to the process and it’s important to maintain confidentiality about the business sale and inform people on a need-to-know basis. Communication at the right time and in the proper manner is a critical component of a successful transaction. If the wrong people know too soon, they can intentionally or unintentionally take actions which would be detrimental to the successful completion of the transaction.

In larger business sales, the board of directors, executive team, and other key employees are all aware the company is being sold. However, when it comes to small businesses, it is not uncommon for the business owner to be the only person at the company that knows the sale is taking place.

There are some business owners that decide to tell their employees when they originally put the business on the market for sale. This can be beneficial because there are times when an employee may step-up and want to purchase the business. It can also be detrimental because the employees may get nervous and start seeking other employment opportunities. If a key employee leaves, or if too many employees leave, it can be disruptive to the business and the business value may suffer. (more…)

How to Creatively Finance Your Business Acquisition

When you are looking to acquire an established and profitable business, there are many creative ways of financing your acquisition. Cash may be king, but let’s face it — leveraging your cash gives you much more purchasing power!

Retirement/401k Financing: There are several companies that assist buyers in using funds from their IRA, 401K, etc. for business acquisitions. They have specific programs that have been designed to comply with IRS regulations and this is an area where you definitely want to use professional services. There are certain procedures that must be followed and if not done correctly, you may be subject to taxes and early withdrawal penalties. However, this is a great option for people that want to invest in their own business instead of investing in the stock of other companies.

Portfolio Financing: If you have an investment portfolio that is worth more than the business you are acquiring , you may be able to obtain a loan using your portfolio as collateral. The benefit with this type of loan is that you are not required to liquidate any of your securities.

Seller Financing: Asking the Seller to finance your purchase is always an option. Just keep in mind that many Sellers want to retire and their business is their largest asset. The sale of the company is essentially funding their retirement. This means that carrying a note for you places a high risk on their future.  Therefore, if you are going to ask the Seller to finance, understand that the Seller will generally want you to have more skin in the game than they have, so asking them to carry more than 50% is typically a losing proposition. In fact, in the past seven years, the largest seller note I’ve seen in any of our transactions has been about 30%.

Inventory Consignment: If the business you are buying has a substantial amount of inventory, it may be possible to reduce your acquisition cost by entering into a consignment agreement with the Seller for the inventory. This way, you will pay for the inventory only after it has been sold. A consignment agreement can be established for part or all of the inventory. For example, if there is $150,000 of inventory at cost, you may purchase $50,000 with the business acquisition and enter into a consignment agreement for the remaining $100,000.

These are a few of the ways you can creatively finance your business acquisition and there are many more. Depending on your assets, credit, contacts, and relationships, the possibilities are limitless.