Exiting a small business will likely include preparing financial statements for potential buyers as well as obtaining a business or net asset valuation (ExitGuide Pro includes a valuation). If you need a refresher on some of the terminologies or you do not “speak finance” ExitGuide has summarized many key terms or definitions below in what we hope is a clear and practical explanation.
Table of Contents
Add Back describes certain expenses related to a business valuation, typically these include discretionary income such as healthcare for family, club memberships, and a car lease for the owner. When using a Seller’s Discretionary Earnings approach for valuation, Add Backs are added to the owner’s salary and the net profit.
Assessment is a term used by ExitGuide that provides a very simple estimated range for what a business could be worth by using estimated revenue, profitability, and owner salary.
Asset Purchase Agreement
Asset Purchase Agreement is a legal agreement between a seller, often a business or business owner, and a buyer of selected assets. In addition to the price, the agreement will typically cover payment terms, representations, and warranties, conditions of the items at the time of purchase and may include support after payment has been made.
Business Valuation This is the process for putting a value or range on a business using a variety of financial methodologies. A valuation is only as good as the financial data provided, a lack of details or errors in your business financials may lead to an inaccurate valuation. If you want to get an accurate valuation, start with accurate and up-to-date financial reports (profit and loss statements and balance sheets).
Business Broker is someone who will help value, market, and sell a business, often in exchange for a fee that is a percentage of the sale price. Licensing is handled on a state-by-state basis with some states requiring a real estate license while other states do not have a real estate license. When engaging a broker, it is important to understand their experience in the industry, locality, and reputation as well as financial acumen.
Comparables, often referred to as “comps” to describe similar businesses or assets in an effort to help establish a price. The number of comps, how recent the comparables are as well as reliability of the source is important factors. Getting reliable comparables for small businesses can be a challenge due to the uniqueness of businesses versus available information. For example, a local bakery versus a fine patisserie or a hair salon versus a nail salon and location/geography can vary significantly.
Continuity Plan is a plan that businesses develop to provide instructions and vital information to keep a business operating in the event the owner or key operator is unable to perform day-to-day duties. The continuity plan is for others to have access to information about accounts, business processes, and key contacts so they can perform their duties and in some cases step in and take on some of the responsibility of the owner.
Data room is a secure place to store important documents related to a transaction. Typically this includes financial statements, leases, loan agreements, and important contracts with suppliers or customers. A prospective buyer will want to review these documents during the due diligence process and having a data room helps organize everything in one place and can demonstrate a professional approach by the seller.
Diligence (Due Diligence)
Diligence (Due Diligence) is the process a prospective buyer goes through to review information related to the business such as financials, legal agreements, loan agreements as well as inspect the property, equipment, or supplies. The parties may agree as to what items are part of this process, how long the process may take, and how to resolve issues that may arise in the process in order to complete a transaction. A prospective buyer will often want to finish this process before finalizing the price or a definitive agreement to acquire a business or assets.
Discounted Cash Flow Analysis
Discounted Cash Flow Analysis is a common way to calculate the value of a business. To generate a valuation, a user must provide at least three years of profit and loss statements, a balance sheet, and projected revenues for the next three years. This information is then plugged into a formula that tries to project future cash flow from a business based on an investment made today. For example, if an investment of $100,000 were made in a business today, what impact does that have on generating cash flow in the future.
Discretionary Earnings refers to the proceeds a business owner(s) decides to take out of the business in the form of salary or other compensation once other liabilities are covered. The owner may use her/his discretion to determine the amount, provided expenses and liabilities have been paid, and in what form. For example, if the business has $10,000 at the end of the month after paying all the liabilities, the owner may decide to take a salary of $7,500, pay a car lease of $250 and leave $2,250 in the business account. This is an important term to understand as it applies to Seller’s Discretionary Earnings to calculate the value of a business.
Dissolution is the process of legally closing a business by filing required documents with state and local entities to prevent the business or its owners from incurring additional fees or liabilities. In order to complete the dissolution process, all taxes must be paid and up to date including any fees or penalties. It is highly recommended to cancel any permits or licenses associated with the business as well as any liabilities such as leases, payroll, and other obligations.
Doing Business As (DBA)
Doing Business As (DBA) is also known as a “fictitious business name” for purposes of marketing and operating a business. Often this is used as a public-facing name that is more suited to marketing to consumers or customers. When filing for dissolution, it is important to contact your local registrar or government office and inform them your business is no longer using the DBA or “fictitious” name.
EBITDA is an acronym for Earnings Before Interest, Taxes, Depreciation & Amortization. Profit does not include these items and not all businesses pay Interest on loans (or gains from money market accounts) or have assets that Depreciate or need Amortization (the I, T, D, and A in EBITDA). A service-based business may not have equipment or supplies that depreciate or need to be amortized (spread out) over a few years whereas a small manufacturing business may have equipment that does depreciate.
Exit Coach is a professional with experience in the process of exiting a small business including exploring alternatives to selling, how to prepare for an exit as well as navigating the selected exit path. An exit coach is paid to help business owners manage the process and are not financially compensated based on a particular outcome.
Exit Planning is sometimes used to describe a documented plan for a business owner to transition out of their business. A plan will often include a current valuation of the business, a net asset value of the business, a summary of potential buyers, and how to finance a transaction. Most experts recommend that business owners have some sort of plan in place before they need to exit the business.
Intangible Assets are assets owned by a business that are not physical or tangible assets. This may include software, intellectual property, brand name, trademarks, customer lists, or know-how for something like a business process or manufacturing process.
Letter Of Intent Or LOI
Letter of Intent or LOI is (mostly) a non-binding agreement between a seller and prospective buyer that outlines key terms for acquiring a business and/or the assets. An LOI will typically include price, what is included in the price, the timing for completing a transaction and how the buyer will finance the transaction,
Liquidation is the process of closing a business by selling off tangible and intangible assets, paying creditors, taxes, and other liabilities. This may be done through an asset purchase agreement or selling assets to various individuals or businesses and using the proceeds to pay down liabilities.
Main Street Business
Main Street Business is a term commonly used to describe businesses that generate less than $5M in annual revenue and have fewer than 10 full-time employees. Most reports indicate that over 90% of U.S. businesses meet this criteria. These are also referred to as micro-businesses.
M&A stands for mergers and acquisitions and is used to cover a broad range of transactions for buying and selling a business from a small “main street” business to multinational corporations.
Multiple is a term used, in most cases, to estimate or help calculate the value of a business and there are numerous multiples that are often based on historical data (previous transactions). So, what is the right multiple, and what is it applied to; revenue, profit, EBITDA? It depends, typically it starts with industry and category in that industry. For example, a printing business may have the same revenue as an e-commerce business but the e-commerce business is likely to have higher profit margins and therefore, a higher multiple. If the industry multiple is 2.5, it can be applied to the EBITDA or Seller’s Discretionary Earnings to calculate the value of the business.
Net Asset Valuation
Net Asset Valuation If a business owns assets (furniture, computers, equipment, supplies) they have a value that should be listed on the company balance sheet. In some cases, an owner (or potential buyer) may want to understand the value of these assets AFTER liabilities have been paid. So, the Net Asset Valuation (NAV) is calculated by subtracting the liabilities (what the business owes) from the assets (what the business owns). If the NAV is positive (assets are more than liabilities) – an owner may choose to exit the business by selling assets, paying down liabilities, and then filing for dissolution. Any remaining cash may be kept by the owner. This is sometimes referred to as “Book Value.”
Non-cash adjustments are an accounting term used when a business makes adjustments to business financials that do not involve a cash payment. Confused? So let’s say an owner buys equipment for $10,000 and a year later, the value of that equipment listed on the balance sheet is adjusted to $8,500 (time, wear and tear, etc.). No cash was involved but the value did decrease. These adjustments do not impact cash flow.
NWC Is Net Working Capital
NWC is Net Working Capital is the capital (cash) you have to invest in your business operations. Money into the business to make it work (and hopefully grow). It is calculated by subtracting your current liabilities from your current assets. Assuming that number is positive, that is the NWC for your business. If it is negative, that likely means an owner is investing their personal money into the business or that the business is running at a loss and could run out of money required to function.
Online Marketplace is a term used to describe websites that list businesses for sale and advertise to attract prospective buyers. Business owners pay a fee to list their business in the hopes that qualified buyers will find their listings and engage in the process to acquire the business.
Present Value is tied to Future Value (FV). Future Value is the value of current assets (real estate, equipment, etc.) at a specific point in time. The Present Value (PV) works from the other end by taking the Future Value of an asset and applying a discount. The discount rate used is based on what the money would be worth if invested. This may sound confusing because it is. Imagine a business owns the building they operate in, today it is worth $100,000 and over the next 5 years, it is expected to increase in value by 3% annually.
Revenue forecast refers to projected revenues for a business, typically based on revenue generated in previous years as well as the growth rate from one year to the next. A prospective buyer will often seek to understand the underlying assumptions used for these projections during the due diligence process.
Seller’s Discretionary Earnings
Seller’s Discretionary Earnings is a very popular approach to calculate the value of a small business because it largely relies on what a new owner could expect to “take out” of the business as income. This may be a salary but may also include other forms of income (disbursements for example) and things like a car lease paid for by the business.
Seller Financing is a common way to finance the sale of a small business to a new owner. When a seller “finances the deal” they typically agree to take a regular payment over a set period of time which comes from proceeds from the business and paid out by the new owner. Seller financing is an alternative to an asset-based loan or SBA loan from a bank or 3rd party lender.
Tangible Assets are physical assets owned by the business such as real estate, furniture, equipment as well as supplies, and inventory. These assets have a value that is recorded on the company balance sheet.