As a business owner, your bottom line is likely a number that you think you know inside and out. When it comes to a transaction, however, that number can look considerably different from the one you are so familiar with. Oftentimes, certain line items that may have been back-of-mind when operating your business can have a significant impact on the bottom line when an ownership transition occurs.
Here are six things to consider when thinking about your business’s profitability from a transaction perspective:
1. Consider the cash flow
While owners/operators focus on net income, operating income, and gross margin to gauge the profitability of their business, buyers focus on cash flow. For most, this is represented by EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization). Most valuations in today’s market are based on a multiple of EBITDA, so when considering what your business is worth, you must first consider your cash flow.
2. Have you incurred any one-time or non-recurring expenses?
From an owner/operator perspective, a large, unexpected cost can be painful. From a buyer's standpoint, these are costs that they will not have to incur in the future. For this reason, a seller can often add back these non-recurring expenses to increase their bottom line when considering a sale. One-time or non-recurring expenses can include a wide array of circumstances, including legal expenses for a specific dispute, moving costs when relocating facilities, consultants or other temporary services, and many more.
3. Do you run any personal expenses through the business?
Don’t be shy, most business owners do it to some extent. Whether it is payments on your personal car, health insurance for you and your family, a “client dinner” that got a little pricey, or donations to your favorite charity, these are all expenses that do not directly affect the business’s operations, and therefore can be added back to earnings when marketing a business to potential buyers.
4. Do you or any family members take a salary or are there other expenses that will not continue if you sell the business?
Maybe you are not as active in the business as you once were, but still take a full salary. Or perhaps it’s your brother-in-law that needed a little financial help while he launched his music career. Salaries, benefits, and other related expenses that will likely not continue following a sale can be added back, and can have a larger impact than you may think. A $100,000 guaranteed salary may not seem like much when operating a business, but will add $700,000 in purchase price if added back to a business that trades for 7.0x EBITDA.
5. Has the business had any unusual revenue or earnings events?
So far, we have mostly talked about factors in a transaction that can increase a business’s bottom line, but the opposite can be true as well. As a seller, it is better to recognize and understand these circumstances early on, than to be caught off-guard by a purchase price reduction when a buyer recognizes them. One-time revenues (i.e. a single large order that is unlikely to reoccur, booking revenue from the sale of assets) or earnings (i.e. abnormally-low raw material costs) can inflate the bottom line for a certain period. Recognizing these circumstances early in a sale process and correctly framing them to buyers can help mitigate their impact on purchase price later on.
6. How are you thinking about CAPEX?
As an operator, you probably do not see CAPEX as affecting earnings, and from an accounting perspective, that is correct. Buyers, however, are typically concerned with cash flow, which is directly reduced by capital spending. If a certain capital cost is recurring (i.e. a piece of equipment that needs to be replaced or refurbished annually) and required to keep the business’s performance “level”, buyers will often view it as a direct reduction to a company’s earnings. For this reason, it is important for sellers to recognize which capital expenditures are intended to grow the business, and which are required to simply maintain it.
Whether you are considering a sale today or five years down the road, knowing how your bottom line will be viewed by potential acquirers is an important part of understanding your business’s value. TKO Miller’s professionals have worked with dozens of privately-owned businesses to identify creative ways to add value in a transaction. If you are interested in learning more about how your earnings may look within the context of a potential transaction, please contact TKO Miller for a complimentary financial analysis and valuation.