Understand the Variables in Business Value
The Value of a business is ultimately the price at which willing buyers and sellers consummate a transaction. For a successful transaction to occur, the following needs to take place:
• The seller needs to achieve their price
• The business is able to service the acquisition debt
• The transaction is financed with debt and equity
• The buyer's return exceeds their cost of capital
Depending on the buyer's objectives and the way a business is valued, privately held businesses can have multiple values. Expectations of growth, cost effectiveness, and other variables will differ from buyer to buyer; which explains in part why multiples for similar businesses of similar size in the same industry show such a varied range on closed transactions.
There are other factors that impact valuation other than the calculation of Seller's Discretionary Earnings (SDE) for small business or Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) for larger business. These variables can include:
• Capital expenditure required
• Amount of working capital required to grow the company
• Risk associated specifically to the company
These factors arise out of the fact that most business buyers obtain financing for a business acquisition and most often through the Small Business Administration (SBA). The SBA allows for longer term debt amortizations which increases the amount a buyer can pay.
Additionally, the SBA typically requires a seller to provide some level of financing. If a seller is not willing to provide this level of financing, it negatively impacts the price a buyer is able to pay for the business.
Understanding the variables in business value while determining the best financing structure of a business transaction can be critical to achieving a favorable outcome for both buyer and seller.