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Last Update: Saturday May 26, 2018

Key Idea: Create A Transferable Asset

You can only sell what others can buy and what they can take over and make their own.

Key Question:

A: 

Lorraine said she felt complimented when people told her that Cactus & Tropicals was all about her. Over the years she realized, a business can't grow when it is all about the founder.

It is clear, the founder can't sell and walk away if the business is all about the person who is leaving.

Q:
How does one arrive at the price a buyer should pay for a business?

A:
Lorraine said the value is what a seller and buyer agree upon. Peter said, pricing a business is more art than science. Jim said the price is about EBITDA-- Earnings Before Interest, Taxes, Depreciation and Amortization.

And all talked about the idea of goodwill. Goodwill is the amount of money a buyer will pay the seller that can't be accounted for in EBITDA. Lorraine even said she was able to create a large amount of goodwill because people could see themselves running her beautiful business. Peter talked about the intangibles of relationships which is why his payout was not all in cash upfront. Peter's buyer put in a large chunk of cash to get the business. Then the rest of Peter's money came because the business was able to keep relationships in place.

If you are like many of us small business owners, with every closing, you look at your Profit and Loss and Balance Statements, and wonder and think about this special thing called a business. We all can see if our net assets are growing. However, when you begin to calculate your EBITDA, Earnings Before Interest, Taxes, Depreciation, and Amortization, that actually may be a bellwether that you are getting close to being ready to sell.

If you know and use the term, "EBITDA," not only are you trendy, but you are probably ready to call a business broker! EBITDA is a good calculation to discern your profitability (cash earnings not cash flow) and it is one of the key figures a business broker would use to see how your business stacks up against another like it.

Think about it

Now, if you think you grasp your financials, what key critical ratios are you following? Why? Up or down this month? What is your EBITDA? Using the advice offered by Jim, Lorraine and Peter, what do you think a buyer would pay for your business today?

Clip from: Selling Your Business

Salt Lake City, Minneapolis, and Bend: Three people -- Lorraine Miller, Jim Schell and Peter Schenck  -- tell us why and how they sold their business.  Each wanted a change. They knew their business could live on and thrive, so they went to work to find buyers who could take the business to the next level.

Here is a rare opportunity to study those who have fully completed all eight steps within the business cycle. 

Go to all the video clips of this episode...
More video on the eight steps to exit...

Cactus and Tropicals

Lorraine Miller, founder,
Scott and Karin Pynes, owners

2735 South 2000 East
Salt Lake City, UT 84109
801 485 2542

Visit our web site: http://www.cactusandtropicals.com

Office: 801 485 2542

Business Classification:
Plants/Gardening

Year Founded: 1975

Create A Transferable Asset

LORRAINE: Well, for the first few years of business, people told me, `Oh, you've created such a great place. This is all about you.'

And, you know, I, at first, took it as a compliment, but then didn't take me very long to realize that that wasn't creating a good business if it's all about me. It has to stand on its own. And as I got more involved in the actual business world, I learned the phrase `transferrable value,' and that if you want to build a business and make it sellable, you have to build a value that you can transfer. It's very simple. And so you have to detach yourself from the viability of the business so that you can step aside.

JIM: The primary thing you've got to do is create an environment where it can exist without you. In my case, we were a light manufacturing company, the relationships were with salespeople, with the buyers, and so it wasn't an issue. It wasn't a big problem for me to exit the company.

LORRAINE: I know that there's all kinds of formulas for evaluating a business, but the way Brad put it to me is, `The value of the business is what a willing buyer and a willing seller agree on.' And we used those formulas for a basis, but the potential of the business and a lot of emotional -- a lot of other things go into it.

HATTIE: Like goodwill.

LORRAINE: Right. And, also just if it attracts your attention. If you're a buyer that goes, `Oh, this is going to be a lot of fun. I could love doing this' that adds value to it.

HATTIE: How did you value it?

JIM: We valued the assets, which is accounts receivable, inventory and a fair market value on the equipment, and then a goodwill factor, which is basically earnings--figure bottom line on your P&L and then you add back depreciation and interest, which is commonly known as EBITDA and then you recast it -- what the business brokers would call recasting, which is also adding back the money that I took out of it, my salary and benefits and what have you, and you come up with a figure that's called recasted earnings, and then you apply a multiple to it.

HATTIE: Let's explain EBITDA. It is an acronym. So let's go through that.

JIM: It is. OK, it's an acronym for Earnings Before Interest, Taxes, Depreciation and Amortization. And so when I buy a business and I'm buying a business I can say that recasted EBITDA figure is an amount of money that I can expect to generate from that business.

HATTIE: Explain goodwill, and does it have a role in every business sale?

JIM: Yes, it has a role in every business sale. Sometimes it has a negative role, but let me explain that. When you buy a business, you buy inventory -- very tangible - there it is -- you buy accounts receivable -- there they are; this is what you're owed -- you buy equipment, fair market value on equipment -- very tangible -- and then you buy the intangible called goodwill, which is, in effect, the earning power of the business, or some people would say it's the customer list. And if you're buying a business and you think you can't buy that relationship then you shouldn't pay anything for the goodwill.

HATTIE: OK.

JIM: Someone once said that selling a business is like selling a house. What do you do before you sell a house?

HATTIE: You clean it up. JIM: You clean it up. The same thing with your business. And it involves customers and employees and products and marketing and administration and software systems and accounting and everything else. You bring it all up to speed.

- PETER: In valuing service businesses, you find very quickly that it is far more art than science. It is science to a degree in that you can always look at the hard numbers, but what you don't get is a sense of the momentum and you don't know how to value those relationships. They are not hard assets; they are soft assets. And they're living, breathing assets that don't see themselves as assets.

HATTIE: And they could change their mind.

PETER: Exactly. So here's everything we put together from an accounting standpoint tells the story. `Here's our award structure, our staffing structure. You take a look at us in the context of the whole industry and tell us where we fit and give us a sense of what ranges you think would be fair ranges for valuation.'

HATTIE: And so they helped you get the price. Then when you agreed on all of that how did the person pay you? Did you get it all in one big check?

PETER: No.

HATTIE: How does that work?

PETER: Let's talk about what you sell, first of all.

HATTIE: OK.

PETER: You're going to sell hard assets, you're going to sell receivables minus payables and you're going to sell blue sky or goodwill, or whatever it is you want to say. So basically, there was a cash down payment, a fairly substantial one on the front end, and then a series of scheduled payments of receivables and then a performance-based third track that would compensate us based on the client retention and the amount of volume that the new owner would do over a period of years. So those were the three tracks.

JIM: The seller sells the future; the buyer buys the past. So you want to try and make a case for the fact that, `Oh, if we only had such and such here, the business could go up somewhere.' And so the role there was for me to try and make a case for the fact that the business had all this potential so that the buyer would say, `Oh, wow! All I have to do is throw this at the business and it's off and running.'

HATTIE: So when should someone have an exit strategy?

JIM: Everyone should have an exit strategy. After all, we're all going to exit, right?

HATTIE: Yeah.
 
 

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