Maybe a business recently caught your eye and you’ve already done your due diligence and made first contact with the seller.
The next step is making sure the financials check-out and figure out a price.
To do that you need to understand what kinds of things use up money in the business and where money can be added back. Here are a few terms that help you cost through valuation.
Essentials for Small Business Owners!
Don’t we all just love long, confusing acronyms? EBITDA is really just a fancy word for net income.
EBITDA = net income + interest + taxes + depreciation + amortization
It’s a simple and universally recognized way to calculate the value of a business and move one step closer to finalizing that deal.
Now that we have our EBITDA, the next thing to take a look at are add-backs, which are an adjustment to this value.
Add-back’s are calculated by fast-forwarding to a beautiful future where you are now the owner of the business (and where profit statements have been adjusted to reflect that).
Let’s say the current owner takes a $200,000 annual salary. When the owner leaves after you buy out the business, you automatically get an add-back of $200,000 to the business’s net income.
Now you’re probably going to want to replace the owner with someone. Whether that someone is you or you hire a manager whose salary is more in line with the market rate for that position, let’s say $90,000, the net add-back is $110,000, which can legitimately be added to the EBITDA.
If the current owner doesn’t take a salary then you’ll have a negative add-back because hiring that manager will now take away from net-profits.
The Enterprise Multiple (EM) is a ratio that uses EBITDA, as well as the Enterprise Value (EV) to calculate the total value of the business. It has its flaws just like all the other multiples out there, but generally, it’s considered the most comprehensive way to evaluate a business’s worth.
EM = EV / EBITDA
The EV is the business’s market capitalization (its worth in the eyes of the stock market gods) AND any debt, cash and cash equivalents.
If you’re stuck between a few different buying choices, the EM is great for comparing their relative values. It can also come in handy when you’re negotiating your price as it can indicate whether the business is under- or over-valued.
No MBA? No Problem
Just knowing a few of these terms is more than half the battle. At Unconventional Acquisitions we’re here to tell you that you don’t need an expensive MBA, a Wall Street career, or any intense financial acumen to acquire valuable, wealth-creating assets like small businesses. You just need the drive to learn what you don’t know and we’re here to help you along the way.
Check out our Buying a Small Business course if you want the step by step guide, complete with the templates, terminology, and breakdown of the process that will help you successfully value and close your deal. If you know what you want and are ready to go all in, our Mastermind Group is also there to help and take your hustle to the next level.
Codie & Ryan
Co-founder- Unconventional Acquisitions