Business Brokers

[simple1]

I have recently talked with and met with a number of falang owned business brokers in Thailand. All of whom advised me that the buyers costing model is based upon annual net profit x 2.5. Note, this calculation does not take into account the owners salary. In other words it takes a minimum of 2.4 years to regain the capital cost of the purchase & zero owners salary. It's a model that just did not make any business sense to me. I was advised this is a globally accepted pricing model. I am now in Australia, again looking at business opportunities where the pricing model is one year of net gross profit. Anyone care to comment on the Thai based business purchase model?

[Sunbelt Asia]

Thank you for the question. Simply not a simple answer, I will need to go in some detail on why this multiple is a good reference point.

There are numerous methods of determining a value for your business, over 100 valuation models in fact. Some of the common methods of valuation are:

• Balance Sheet Methods:

o Book Value

o Adjusted Book Value

o Liquidation or Bankruptcy Value

• Income Statement Method:

o Discounted Future Cash Flow

Determining the value of a business is the most difficult part of the buy-sell transaction process. It is fraught with differences in opinion as to the worth of the business. Rarely do buyers and sellers share the same perspective. Each party has their own rationale, which may be based on logic and or emotions. For the transaction to come to fruition, both parties need to come to agreement and understand how this agreement was derived.

Factors that determine value

While there are many factors that impact the value of a business, six of the key factors are:

1. Recent profit history

2. General condition of the company

3. Market demand for that type of business

4. Economic conditions

5. Ability to transfer goodwill or other intangibles to the new owner

6. Future profit potential

These key factors are impacted by other issues that help determine a fair market price:

• Special circumstances of the buyer or seller

• Trade off between cash and terms

• Tax consequences for the buyer and seller, which determines how the offer is structured

In valuing the assets of a small business (revenues of 80 million Baht or less), the Owner's Discretionary Cash method is the one I would recommend because it eliminates arguments over what amount represents reasonable compensation for the owner and what amount represents true income. No method is the Holy Grail but one that consistently over the years that seems to work year after year is the method of a simple multiplication of Owner's Discretionary Cash.

Sunbelt just open an office in London so it will be interesting on what most businesses will be acquired at there, but the rule of thumb, a number of clients have told me is 4-5 times discretionary cash flow in Europe. The definition of Owner's Discretionary Cash is an amount equal to the sum of pretax net income, owner's compensation, interest expense, depreciation, owner's perks, extraordinary losses and discretionary expenses less extraordinary gains and income Using this approach gives a value that reflects the business' ability to generating cash-flow and profits In the USA it is around 2.5 times discretionary cash. In Thailand in the past 2+ years Sunbelt has been here, this simple rule of thumb seems to hold up as well of 2.5 times. In fact last year it was 2.44 times Owner’s Discretionary Cash. We have of course had business transfers done much less than 2.5 times (<1 times and on the other hand much higher (the highest was >7 times) The overwhelming majority of small-business sales are asset sales using earnings-based valuation methods, and we ordinarily assume an earnings-based valuation when quoting a selling price. That's because for most profitable businesses, the value is in the earnings, not the individual assets (e.g., inventory, equipment). Most businesses are acquired with the equipment, fixtures, leasehold improvements, rent and electricity deposits, inventory, etc in the selling price. Another reason that 2.5 times is a good number that works. Very few start ups would ever have a 100% pay back in one year let alone 2 years. You of course are looking to acquire a proven business and feel the cuurent business model works.

A company's individual assets though sometimes can be worth more than the company's annual earnings, in which case the price determinant would quite simply be the value of the individual assets. But think long and hard before purchasing a business based strictly on the individual asset value because the goal should be to buy an established business with proven cash flow. Note: Real estate or buildings will always be a separate valuation and added to the Owner’s Discretionary Cash model.

The reason I feel that most businesses change hands around this 2.5 times Discretionary Cash model, is it favors the buyer. In 2.5 years the business has repaid the capital investment.

The seller however has maintained his same lifestyle. If that money was put in the bank, he has spent it on personal needs; versus he was using the same funds he would have gotten just by keeping the business. In 2.5 years those discretionary earnings are gone, now the Seller has to start up a new business with much higher risk than his established business, acquire another business or get a job. That’s why a seller really has to have a human reason to be motivated to sell. Less than 2.5 times earnings and he must really be motivated to sell. If he is going thru a divorce, partnership dispute, health, relocation, reduced interest in the business due to frustration or boredom, death of one of the owners or even retirement. He is motivated and is willing to accept a fair price. Otherwise I can assure you he will look at the pile of the money and say no. It just does not make good business sense to sell if you have a good business at 2.5 times unless you have a motivating factor. It’s like chasing a carrot, its one of hardest business transfers when a seller is simply selling for “Everything is for sale at a price”. Look for 5 to 7 times Owner's Discretionary Cash then!

Most buyers on the other hand, are looking at the bare minimum, acquire a business now making around 40% return on their investment. Most businesses have a 20% increase growth with a new owner giving it a spark similar to a relay race with one runner passing the baton to the next.

Among the other types of earnings bases are net income, gross cash flow, net cash flow and earnings before interest, taxes, depreciation and amortization (EBITDA). Both the Owner's Discretionary Cash method and the EBITDA method indicate values for the "operating" assets (all assets less cash, accounts receivable and nonoperating assets).

The appropriate market multiple for the EBITDA method is currently 5 times in the USA and Thailand. (A common mistake is to misunderstand that an earnings model such as EBITDA with the average 2.5- 3 times market multiple for the Owner's Discretionary Cash method.)

Before blindly applying a multiple to the earnings base, however, consider other factors that justify a higher or lower multiple. Remember: The danger with rules of thumb is that people forget they're merely guidelines. The rule of thumb may not be appropriate if there is more than one owner; the business owns real estate or has erratic earnings, how long established, is it a cash cow? Still it’s a very good starting place. It has worked for me year after year as a quick reference point to see if the valuation is in the "ballpark". Like magic though, it seems most businesses acquired, transfer around this number on average.

Remember though.... If you find a business you like, then put the offer to purchase in with conditions. It’s your price YOU are comfortable with. If the seller is motivated, even if it’s a low ball number, he may just accept it. I've seen some cases I never thought, the seller would accept, but they did. If they are very much motivated to sell, the money or cash flow model is not important at that point. Never be afraid to negotiate. I talk average of 2.5 times but still no two businesses are the same! When the seller has a human reason for selling the business, the multiple is a guide but not set in concrete.

www.sunbeltasia.com