Asking for Guidance (Part 3 of 3)

This posting is a continuation from Part 1 and Part 2 of Asking for Guidance.

(8) We use a different formula for commercial service businesses (like executive suites) than for retail businesses, or restaurants, or manufacturing.

You will note that the formula I’m recommending does not take into consideration the value of the FF&E. Yes, I understand how hard it is to tell a seller who has an “under performing asset’ (FF&E that’s ultra nice, but that isn’t producing enough profit; or too much slow moving inventory; or who owns a building that’s “too nice” for the profits being generated), that his business is only worth a multiple of the cash flow. I, like all brokers, have had to explain this to many, many sellers over the years. But, I’ve never been clever enough, for example, to sell a machine shop, that, say, has $1,000,000 in FF&E, but that only has an EBITDA discretionary cash flow of, say, $100,000…and then price it for the $1,000,000 the seller thinks he should recapture in a sale…unless the seller is willing to do something very, very special (which I’ll explain some other time). Similarly, when you encounter a greeting card shop that only has an EBITDA cash flow of $50,000 for an owner operator, but that has over $300,000 in inventory (at cost), you can’t sell it for $300,000 or more, and the buyer can’t finance it, unless the seller does something very, very special. The “something special” is NOT simply owner financing. The answer to selling businesses that have too much of the “wrong” asset, for a price the seller can accept, that is ok with the buyer and his banker, is more complicated than just offering seller financing. After all, loan payments that are not possible are not possible, whether it’s seller financing or bank financing. We have discovered how to get those deals done, with some unique approaches we’ve created. But, getting the seller all cash at closing for an over priced business is not the way to get those done, in my opinion. So, the formula is not “equipment/inventory/real estate” sensitive. It is, instead, cash flow oriented.

(9) Now, finally, the approach I recommend, for a commercial service business:

(a) obtain from the seller the last 3 year’s tax returns, and the current year P&L,

(b) then, identify (recast) add backs, only adding back EBITDA and owners easy-to-prove benefits,

(c) thereby creating what I call “NOB” (Net Owner Benefits)

(d) Add the 3 previous years and the current year (which you’ve annualized) together, and divide by 4, to discover the “average” cash flow benefits.

(e) Multiply the NOB by 2.5 to 3, depending on the appearance/uniqueness of the premises/equipment.

(f) So, if the exec suites business has an NOB of $100,000, it will sell for $250,000 to $300,000, with no “add-ons” to the price. This is the “turnkey” price, all inclusive of everything but real estate.

(g) If the seller also owns the building, you must deduct from the NOB any anticipated mortgage payments the buyer will pay (if the buyer buys the building), or deduct the rent the seller plans to charge to buyer, and then you have an “adjusted NOB”, and that is what you multiply by 2.5 to 3. You should not multiply the NOB times 2.5 or 3 until you’ve first deducted from the NOB the anticipated mortgage payments or rent.

(h) If you use a multiple of more than 3, you are unlikely to be able to prove to a buyer and his banker that the buyer is making a reasonable, low risk, intelligent investment. If you use these techniques, and leave none of them out of the process, you will (a) be telling the seller the truth of what his business is likely to sell for, and (b) if you list it as recommended, you will have a listing that you are likely to sell, and is one that should be possible to arrange bank financing for, if the buyer is qualified (meaning, if you match the business up with a buyer who has a 25% un-borrowed down payment, has good credit, and who has experience in his past careers with managing people and money, in some way).

(i) When you find the buyer who will buy it, you must also match the buyer up with a Preferred SBA lender, if you are to have a chance to get the “blue sky” financed. And, not all PLP’s are cash flow lenders. Some are asset based lenders, and will insist on supplementary collateral. But, there are, in every geographical area, some PLP’s who are “cash flow lenders”, who will finance these commercial service businesses for a qualified buyer, IF the buyer is buying a properly priced business. If you deviate from any of this advice, you will be closer to selling 20% of your listings, than selling 60% to 80%.

Below is an analysis we call “The Prover”. We call it that, because it proves if the deal is sell-able and finance-able. It also proves if it’s a long shot. If your listing survives The Prover, you are going to be very happy with how many of those you actually sell.

THE PROVER

So, if the business is priced at $500,000, The Prover proves that a buyer is unlikely to invest a $125,000 down payment to buy a job that pays him only $32,500, REGARDLESS OF (a) how glib the broker is, and (b) regardless of whether or not you have seller financing.

The Prover also proves that some buyers are likely to invest $75,000 to buy a job that pays $59,500. We meet buyers who will do that. And, boy, do we meet buyers who will invest $65,000 to buy a $66,700 job. That’s a “no brainer” listing.Obviously, a buyer who is used to earning $80,000 or $100,000 or more in his previous job, is unlikely to be a prospect for a business that will only pay him a salary of $59,500 to $66,700. So, it’s simultaneously vital that the broker match this opportunity up with a buyer who can get excited about these scenario’s, and not try to convince a buyer to buy it that needs more income. The “trick” is for the broker to generate enough buyer prospects, and interview them aggressively, searching for a buyer who is willing to invest $65,000 to $75,000 to earn $59,500 to $66,700.

Remember, the above pricing advice ignores the cost/value of the equipment. The price can only be justified based on The Prover, not on what the seller paid for the telephone system, for example. Yes, the more attractive the equipment, and the longer the business has survived, the closer you can price it to the upper end of the pricing formula (priced at 3 times, instead of 2.5). But, regardless of the equipment or other factors, buyers are unlikely to buy unless you can prove they are “safe”, and prove they can easily service the contemplated debt, and prove they can pay themselves a salary that makes them happy.

I agree that your being able to tell buyers that the business is 95% full, is a “good thing”. But, that won’t allow you to over price it, if you care about being highly likely to sell it. Those “good things” are terrific items for your marketing package, but, contrary to popular opinion in the business brokerage industry, those are not the critical factors in motivating buyers to buy. Those “good things” will reinforce a buyer’s willingness to buy, once the buyer’s seen The Prover, and sees that he can easily service the contemplated debt, and can pay himself an attractive salary. Those “good things” will rarely help you sell a “bad” deal.

Putting it all together, these are some of the techniques that help us price just about any business, and guarantee that we have a great chance to sell them, not just “go through the motions” of brokering. Our closing ratio’s make it easier for us to justify spending the money it takes to have nice brokerage facilities, and makes it easy to budget the money for first class advertising and marketing. And, I think this pricing strategy, which I’ve practiced successfully since 1982, is the number one reason I’ve been able to survive and thrive in this fascinating business for so long.

And, as a bonus, we find that our reputation is that we “deliver a high level of service” throughout our communities.

I hope these tips help you not only price the executive suites, but get the listing, and then sell it.

Best Personal Regards,

Bill Martin

913-553-0570