Understanding How Business Value is measured differently than Sentimental Value

Most business owners want to value their business based on years of long hours, sleepless nights, hard work and financial investment. Meanwhile, lenders and investors will tend to value one’s business much differently. They will surely want to know how much profit the business pulls in. A lender will especially focus in on whether the business can generate enough profits to cover the new loan payment of a Buyer who is considering purchasing that business.

A Seller may want a cash buyer because it seems ideal. But the likelihood of a cash buyer is based on the selling price. The lower the price, the more likelihood there is one can attract a cash buyer. The higher the selling price, the more likely it is for a Buyer to want to use financing to make the purchase. It is always good to consider leveraging.

A Buyer will most likely apply for a business loan that is backed by the Small Business Administration, a federal agency that support entrepreneurs with business acquisitions. There are many purchasers who do use SBA backed loans. Potential borrowers need to spend time learning about SBA lending guidelines and underwriting standards. It can certainly pay off in the long run.

There is one SBA financing rule of thumbs that every entrepreneur should know about. This rule is used regularly in the M&A (mergers & acquisitions) and business brokerage industry, and that is– for every $1 million purchase price financed through an SBA backed loan, a Buyer will need approximately $108,000 annually in business income to cover the annual loan cost. Therefore, if a business is priced at $3,000,000. It should typically generate at least $324,000 per year in net earnings to reasonably qualify for SBA backed financing ($108,000 x 3). This loan expense would be in addition to the business’ overhead and other business expenses such as employee wages, insurance, rents, etcetera. The business must show it can cover all of its current and anticipated expenses of a new loan for the purchase of the business itself.

Many times, Sellers will want Buyers to pay a premium for their business based on anticipated or potential future growth. Unfortunately, banks do not rely closely on potential or future growth for their lending criteria. They lend against a proven track record of cash flow, which is often at least three (3) years’ worth of tax returns and financial statements.

A business may need to consider reducing its selling price if its tax records and financial documents cannot support a certain price they are seeking. For instance, a business that is earning $100,000 per year may realistically support a valuation closer to somewhere from $700,000 to $1,000,000 and not $3,000,000. Businesses have to be realistic about the price at which they list their businesses for sale. An over-priced business doesn’t move in the market. It is a time waste, and the business can suffer. Expenses don’t stop just because you are trying to sell an over-priced business.

On the other hand, a business which is priced correctly will attract more interest, more qualified buyers, and has a much greater likelihood getting sold.
Your business’ financial picture is extremely important and will be analyzed thoroughly by lenders and investors alike when you are selling. Buyers will want to see three (3) years’ worth of tax returns and other financial statements such as profit and loss statements, a balance sheet, point of sale register tapes and anything else that can help them determine your business’ true earnings. Remember, it’s not just about the sentimental value of your business, it’s about the value you must organize and prove.