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Another Successful Purchase
Business Sales Group (small business division) is pleased to announce the successful completion of the acquisition of an Event and Promotional Production Company In Arizona. The Buyer was from the mid-west and hired BSG as his buy-side advisor to advise him through the whole transaction. BSG successfully completed the Business Valuation, Due Diligence, Negotiation, LOI, Accounting and Advising functions for the buyer. Lori from Midwest Bank was big help in making this transaction happen as well. Congratulations to J.H. and his family who will surely help this business excel.
Purchase of Jibij
Business Sales Group, Small Business Division, is pleased to announce the successful purchase of Jibij by James Sawyer. With the help of his father, James acquired this excellent business. Rick Krebs was the Advisor for the Buyer (Buy-side Advisory) helping him navigate all aspects of the sale from start to finish including valuation, negotiation, due diligence, licensing transfer, closing, etc.
Jibij is an online retailer of ski, outdoor, and rafting products including well-known brands such as Patagonia, Oakley, Under Armour, Scott, and Volkl. James will certainly do well with this excellent business. Christon and Liz Horstman were excellent sellers to work with and extremely helpful in making this purchase possible.
Congratulations James!
Beware: A Self-input Business Valuation is not a good idea
There is a type of business valuation software and service available that allows a business owner to input their own financial information. Although this may seem like a good idea, it is a very bad practice. Valuations, like tax returns are complicated and require a seasoned professional to analyze and input the data to get an accurate number for value. One of the main reasons that a business owner would not want to do the valuation themselves is there are key expenses that can be added back into the EBITDA and Cash Flow calculation. If these expenses are missed, the valuation number is inaccurate.
Key add backs and charges tend to be buried in the tax returns or financials and are easily missed. These include:
- Amortization Expense, which is usually shown on the Schedules and buried in the tax return.
- Section 179 Depreciation Expense, which is usually shown on Schedule K-1 of the Tax Return and erroneously added back with the rest of the depreciation.
- Partner Wages and cost to replace the owners for a situation where there is multiple partners who own a business.
- Cost of a working spouse who is not paid.
- Adjusting the lease to the market rate.
- Correct calculation of SDE, EBITDA.
- Repair and Maintenance Expenses that need to be capitalized.
- An S-corp tax return will show more Taxable Income (Net Income) than the P&L due to the expenses and pass through items on the Schedule K-1’s. If the business owner doesn’t understand income and pass-through entity taxation, he will undervalue the business.
- Schedule M-1 on the Tax Return contains important information and business owners tend to not understand how Schedule M-1 works.
Business Valuations are exponentially more accurate if a Valuations Expert or CPA gathers, assimilates, and inputs the critical information pertinent to the engagement to get an accurate value for the business.
The second consideration applies to financial advisors who refer clients to a third-party valuation service and allow their clients to input sensitive financial information themselves. One main reason for a Financial Advisor to not want to refer a client to a self-valuation service like BizEquity is the client’s data is captured by the provider and that data is sold to competitors. Financial advisors often pay for the service, send clients to the service provider, and their clients’ personal financial information is resold by the business valuation service provider to anyone who wants to purchase it. It doesn’t make sense to give competitors sensitive client information, especially when an advisor is paying for the service.
I recommend that a business owner contact a knowledgeable valuation expert who is an independent third party to get an accurate estimate of value for their business. If a client inputs the financial information themselves it is highly likely to produce an inaccurate value for the business.
Important tip for Buyers of businesses
One important thing for Buyers looking to purchase a business is for them to recalculate EBITDA and SDE if there are multiple owners of the business. It is easy for a Seller or Seller’s advisor to overlook the true SDE and EBITDA when there are multiple owners of a business.
For example, see the Line 12 number of $38,957 below for Compensation of Officers for a tax return.
It seems like SDE and EBITDA would be easy to calculate, just add back the $38,957 for SDE and EBITDA would remain unchanged. If there is only one Seller that calculation would be correct, but what if there are multiple Sellers? How does that change EBITDA and SDE? Does it changes SDE and EBITDA?
The Buyer would need to replace one of the Sellers. This cost to replace the Seller would not be added back to arrive at EBITDA, it would be subtracted. Both EBITDA and SDE would be reduced. The reason for this is the Buyer would incur the cost of replacing one of the Sellers. Here is one other thing to consider: is the current wage of the Seller who is going to be replaced more or less than the is receiving less than the cost to replace them? Whatever that cost is going to be, that is the amount of expense that would be included in the calculation of SDE and EBITDA.
For example, let’s assume the cost to replace one of the owners is $25,000. See the correct calculations below:
Erroneous Calculation Correct Calculation with Multiple Sellers
Net Income $X,XXX,XXX $X,XXX,XXX
Add:
Interest XX,XXX XX,XXX
Inc Taxes XX,XXX XX,XXX
Deprec XX,XXX XX,XXX
Amort XX,XXX XX,XXX
Cost to replace
Owner XX,XXX (25,000)
EBITDA XX,XXX XX,XXX
Plus:
Owner Wages $38,957 $38,957
Cost to Replace
Owner XX,XXX XX,XXX
SDE/Cash Flow $XXX,XXX $XXX,XXX
The result of the above is that EBITDA and Cash Flow are reduced by $25,000. We used $25,000 as a basis for the example, but the number could far greater impact on the business because, let’s assume a 3x multiple of SDE as a basis for value, then the value of the business would actually be $75,000 less due to the correct calculation.
This is a critical part of an acquisition: Buyers beware!
USING MULTIPLE ARBITRAGE TO MAXIMIZE THE VALUE OF YOUR BUSINESS
According to Rick Krebs, Principal at Business Sales Group and Business Valuations Group, here are 3 ways for you to maximize the value of your business using multiple arbitrage.
- Make an investment in your books. It is common among business owners to view the cost of financial reporting (keeping the books and accounting) as an expense. It is seen as a “necessary evil”. The cost of the accounting department is viewed as a necessary expense incurred to do business. This view is wrong. I suggest you have a paradigm shift in regards to how you view the financial reporting for your business. Make an investment to have good books and records that will pay dividends of over 875%. One word of warning about this. You may experience some growing pains here. I’ve seen many businesses that have literally outgrown their CPA. You will need to “get real” with yourself and honestly assess the advice you are getting, the timeliness of service and quality of the reporting. Do not be loyal to a fault here. If it’s time to let go, then cut the strings.
- Convert to full GAAP/Accrual accounting for internal reporting purposes. Business owners sometimes think that merely keeping the books on a cash basis forces them to not do full accrual/GAAP accounting for in-house purposes. This is simply not true. Keep the books on an accrual/GAAP basis in-house and on a cash basis for tax purposes to maximize the selling price of your business. Eventually the IRS will force you use accrual accounting for tax reporting, but your CPA will generally recommend that you stay on a cash basis as long as you can. Be prepared for some backlash here from your CPA when you tell her what you are doing. She’s going to look at you over her black-rimmed glasses like you have lost your mind, but it is an INVESTMENT that will pay off. The important thing to remember is Investors buy based on GAAP/accrual basis financials. Many small businesses do their books on tax basis or cash basis accounting. Why? Tax basis or cash basis accounting minimizes short-term Net Income. When we sell or value a business, we seek to maximize the Net Income because buyers buy and value a business based on EBITDA (Net Income plus interest, taxes, depreciation and amortization) which is a derivative of Net Income. GAAP accounting maximizes Net Income. If you look at publicly traded companies, they do their financial reporting on a GAAP basis. Why? So they look good to their investors! This is precisely what you want to do when selling your business.
- Pay more taxes. When the IRS forces you to go to accrual accounting pay your taxes and be happy to do it because the investment will pay dividends of 875%. I never thought I’d say this with all of the government waste (another topic, another time), but it is FAR BETTER for you to pay your taxes when positioning to sell a business. Here’s the math: For every $1 you increase EBITDA you get $3.5 more dollars of selling price. For every $1 you show as income on your taxes it costs you roughly 38 cents in taxes. Invest 38 cents to get $3.5. Now let’s convert that to real numbers. If you show an additional $100,000 of income, depending on the tax bracket you are in, you’d pay $40,000 of taxes. If you show an additional $100,000 of EBITDA, you would get $350,000 of income at the time of sale. The question I ask is: would you rather have $40,000 in your pocket now or $350,000 in your pocket in the future? Spending $40,000 to make $350,000 is an 875% return on your money. Where else are you going to get an 875% return?
By Rick Krebs – Mergers and Acquisitions Professional, Business Broker, CPA. Rick Krebs brings a unique blend of sales, entrepreneurial, and financial experience to Business Sales Group. He began his career as a CPA, working in Nevada and Utah where valuable financial experience was gained. He uses those skills every day. He graduated with a Master’s of Science Degree and Bachelor’s Degree from Utah State University. As a business owner he started Liberty Mortgage, a mortgage bank licensed in 23 states nationwide. Rick Krebs eventually sold the successful company to an investor from California. He has been in the M&A space helping people sell their businesses since July, 2010. During his first year as a business broker with BRC, he listed and sold more businesses than the entire office combined.
As a sale-side and buy-side advisor for Mergers and Acquisitions transactions Rick’s advisory, accounting, and management skills are invaluable when advising sellers as they maneuver the intricate details of the deal through closing. Rick is also a CNA (Certified Negotiation Expert) which helps him negotiate the most favorable terms for clients in a transaction.
Rick Krebs - Business Broker / M&A Professional 