Why should you know about “Multiples” and “Discretionary Earnings”? When you begin to investigate selling your small business, it is likely that you will hear these terms. They will be used by people who have a serious interest in understanding the value of your business. So, it will be vital to be familiar with this jargon.
A multiple is a component of the math used to establish the value of your company. Some companies are sold for a “multiple” of the total revenue.
Annual revenue = $1,000,000 x 1.5 = $1,500,000 company sale price. The multiple is 1.5.
Other small companies sell for a price which uses a more complex formula. It is based on a multiple of the owner’s discretionary earnings.
Discretionary Earnings usually include the total of:
- Net Income before Interest, Taxes and Amortization
- Interest expense
- Depreciation expense
- Amortization expense
- Owner’s compensation
- Owner perks
When I established a sale price for our last business, I relied on my accountant to figure out the Depreciation and Amortization dollars. But I could specify the rest of the discretionary earnings.
Examples of some of the items to include are: Club memberships, car expenses, some travel expenses, family members on the payroll and charitable contributions.
To get an idea of what your discretionary income is, look at your Profit and Loss Statement. Identify the appropriate items and the amounts. An example follows:
Sometimes the Owner’s Perks are combined with other employee expenses. For instance, the cell phone expense for all employees, including the owner’s could be consolidated into one figure. The cost of auto insurance for all company cars is bundled together. You may want to talk to your accountant about setting up the books to separate the owner’s expenses from all others. This could save you time and money in the future. And even better, it could increase the sale price of your company because you won’t leave out anything.
According to some experts,
most small businesses sell for 1 to 4 times
the seller’ s discretionary earnings.
The average selling price is 2 to 3 times the annual earnings. This assumes that your business has annual sales under $1 million and you have under 20 employees.
So, let’s do the math for the example above:
Total Seller’s Discretionary Income = $228,500
- 1x Seller’s Discretionary Earnings = $228,500 Sale Price
- 2x Seller’s Discretionary Earnings = $457,000 Sale Price
- 3x Seller’s Discretionary Earnings = $685,500 Sale Price
- 4x Seller’s Discretionary Earnings = $914,000 Sale Price
If the company sold within the average multiples for Discretionary Income, the Seller would reap between $457,000 and $685,500.
These figures can be exciting to many small business owners!
This article focuses on just two of many factors that could be used to set a sale price for your enterprise. There are many other items that will be considered, including inventory, real estate holdings, whether the market is in a growth cycle, is it a turnkey operation, etc. However, investigating the sale multiples in your industry and estimating your discretionary income will definitely pay off when it comes time to sell your small business!