LeMans, Inc.

 

Let’s take the topic of EBITDA Earnings Before Interest Depreciation and Amortization and contrast it with Cash Flow.  EBITDA is objective financial data that is more frequently utilized in large transaction where the financial data of the business reflects an EBITDA number of $500k or more.  This is the domain of private equity investors seeking transactions in what we call “Mergers & Acquisitions”, these are privately held businesses that are financially solid and growing where the seller is seeking an exit strategy or private equity funds to grow the business.  Typically, gross revenues exceed $5 million to $10 million dollars.  This is a robust market that has numerous private equity funds seeking out businesses in specific industries that they focus on or require financial strength as described above in order for them to investigate the transaction.  They will consider “add-on” businesses which are smaller companies not necessarily meeting their financial criteria but in a similar industry that they are invested in which would compliment or “add” additional value to their existing portfolio. Cash Flow becomes a little more subjective.  Cash Flow is EBITDA plus things like owner’s compensation adjusted to reflect the cost of hiring someone to replace the existing owner’s function in a business.  In a smaller business, not meeting the criteria for an M&A transaction, Owner’s salary is 100% added back as it is the position of Business Brokers involved in these transaction that they are selling an “owner operated” business.  Therefore, EBITDA plus adding back owner’s salary reflects potential Cash Flow a prospective buyer can expect coming out of the business to them as long as they “operate” the business themselves and take out some level of compensation.  [cincopa AsMA5cqVtBGg]More later - Dan

There are two major components of value in a business. 1.      Tangible Assets – This includes all the furniture, fixtures and equipment used in the day to day operations of the business. a.       Inventory can be a component added to the tangible assets if the business has a substantial amount of inventory. 2.      Intangible Assets – two assets make up this value. a.       Goodwill – This includes but is not limited to Business Name, Registered Trademarks, Customers, Vendors, Employees and any value established due to the reputation of the business, brands, products, services and historical accomplishments. b.      Non-Compete  - This requires a seller to assure a buyer that they will do neither direct nor indirect competition to harm the business as it relates to the day to day operation and future growth of the business.  This includes but is not limited to acknowledgement for a period of time that they will not attempt to duplicate a similar business offering same types of products or services within a radius of miles and or geographical proximity of the business for a period of years. The Internal Revenue Service requires assigning a value for each of the components of tangible and intangible assets of a business.  These values are important as they have tax consequences for both the seller and the buyer of a business.   –Dan-

Recently, I have reviewed financial data from other Brokers which included the EBITDA for the business.  Unfortunately, the data disconnects with the true definition of this acronym.  So let’s begin with the basics.  EBITDA is Earnings, Before Interest, Taxes, Depreciation and Amortization, again EBITDA.  That does not include owner’s salary, rent or any other expense of the business.  EBITDA is a very objective number that can indicate the strengths or weaknesses of a business.  It is true that Owner’s Salary of a privately held business could be excessive in relation to the prevailing compensation required for the Owner’s role in the business, but please don’t spoil the integrity of what EBITDA means in the financial data from a business.  An opinion of value can be derived from the EBITDA data, along with the value of a business arrived at from a more subjective number like “Cash Flow” or “Discretionary Cash Flow”.  So if you are presented with financial information from a business and someone is representing EBITDA as something other than Earnings, Before Interest, Taxes, Depreciation and Amortization do your own calculations.  The information can be easily picked up from a P&L or Tax Return and can be readily identified.  EBITDA is objective, Cash Flow is subjective.  Both are used in valuing a business but it is important to clearly understand the difference.  More on Cash Flow later.  - Dan

It is important for small business owners and prospective buyers of a small business to understand the financing options for selling or buying a business.  The Small Business Administration (www.sba.gov/) offers financing through preferred lenders for small businesses that qualify and prospective buyers that meet the criteria.  A small business for sale can qualify if the selling price and loan exceed $250k by an appraisal process required by the SBA.  A prospective buyer of a small business can qualify by submitting a detailed application for the loan (along with the detailed financial data of the business they want to buy).  While this is not an easy process, many people have successfully acquired SBA financing to purchase a business and commercial real estate. The predominant method for financing the sale or purchase of a small business is seller (owner) financing.  This is a situation whereby the buyer agrees to buy a business with a certain amount of money down (a minimum of 30% of selling price down) and the business seller willingly holding a private note with terms and conditions satisfactorily negotiated between seller and buyer for the balance.  The note is recorded and collateral along with personal guarantees are pledged by the buyer to the seller.