by Dave Driscoll
Each new year, small business owners turn their focus to strategy, process, marketing improvements, and planning for the future —for both the business and the owner(s). Decisions about each of these elements should be based on a solid, objective assessment of the company.
The Most Probable Selling Price (MPSP) is a key metric for business owners. Essentially, MPSP is what a reasonable buyer would willingly pay to acquire the business in the current market. A comprehensive market valuation is the best way to determine the MPSP of a business.
Knowing your business’s market value, or MPSP, provides important guidance as you consider investment strategies as well as management and operational needs. Sustaining and growing your business doesn’t happen by chance, and your efforts will be most productive when based on facts rather than emotional perspectives.
Let’s say you are considering buying a piece of equipment for $1 million and you find out your business has an MPSP of $3 million. Will the return on investment justify investing one-third of the market value of your company in this equipment? The MPSP should direct your actions by highlighting risks and rewards as well as pointing out areas that most need your attention.
How is MPSP calculated?
The first step to determine the MPSP is normalizing historical financial data to reveal true earnings from operations on a sustainable basis. This includes “adding back” the seller’s discretionary spending that is not necessary for the operation of the business. Once earnings are normalized, there are three primary approaches to establish the market value of your business: market, asset, and income. Each approach involves several unique considerations and calculations. An experienced business broker can help you analyze which option is most beneficial and appropriate for your business.
Next, comparative data on “like businesses” that have sold successfully is collected from industry sources to determine and apply the appropriate multiple to either the seller’s discretionary earnings (SDE) or earnings before interest, taxes, depreciation, and amortization (EBITDA). This is the same concept as considering “comps” when pricing a house or other real estate for sale. There is a range for the multiple in each industry; whether the low or high end of the range should be applied to your company is impacted by several factors: owner-dependence, customer concentration, leadership team, proprietary information/systems, diversity of product streams, competitive advantages, documented processes and policies, and more.
This multi-step MPSP methodology takes into consideration various factors important to buyers, while removing seller emotion and owner perks from the equation. And the factors that are important to buyers are the same factors that strengthen your company’s profitability and sustainability, regardless of when you intend to sell your business.
Using MPSP as a planning tool
A realistic estimate of the selling price for your business can also help identify the best time to sell to support your retirement. If you are unsatisfied with the MPSP calculated for your business, you can devote your energy and other resources to the most significant value drivers.
When you eventually are ready to sell your business, knowing that your listing price is on target and will support your Life Beyond Business™ increases your chance of a successful sale. Determining your listing price scientifically ensures that your price and expectations are realistic. Overpricing your business when it’s initially launched to the market is a mistake that is difficult to overcome. An appropriately priced business will draw buyer interest and establish the tone for negotiating the sale. Additionally, lenders will insist that the valuation and the price align to help a buyer finance the acquisition.
The market value of your business is arguably the single most important factor that you should know about your business. Spending the time, energy, and money necessary to have a professional calculate your MPSP will highlight the benchmarks you need to make informed decisions about managing your business, while ensuring that you have a realistic concept of the business value before going on the market.
Dave Driscoll is president of Metro Business Advisors, a business brokerage, valuation and exit planning firm helping owners of companies with revenue up to $20 million sell their most valuable asset. Reach Dave at DDriscoll@MetroBusinessAdvisors.com or 314-303-5600. For more information, visit: www.MetroBusinessAdvisors.com.