Businesses listed on business brokerage sites often follow a specific format. It can be great to have this consistency—and benefit from the apples-to-apples comparisons brokers try to set up. But when you aren't familiar with the terms, the listings can be overwhelming. In this article, you’ll learn how to evaluate a business for sale by deciphering the terms they use, the figures they report, and the meanings of some commonly used phrases.
Let's start with an example of a common business listing:
Electrical contractor business for sale in Central Michigan
- Asking price: $320,000
- Gross revenue: $554,000
- Cash flow: $130,000
- EBITDA: $100,000
- Down payment: $256,000
- FF&E included: $30,000
- Inventory: $40,000
- Real estate: $300,000 (optional additional cost)
- Financing: Yes
- Distressed: No
- Location: Confidential; Central Michigan
- Primary business category: Electrical Contractor
- Franchise: No
- Established date: 2010
- Real estate: Owned
- Building square footage: 2,000
- Lease expense: N/A
- Home-based: No
- Relocatable: Yes
- Employees: 6
- Is management staying on: No
- Required license(s): Electrical
For the last ten years, this single-owner electrical contractor has provided quality services to home and business clients in the Central Michigan area. The owner has built a solid, loyal customer base, resulting in a high percentage of repeat customers. The firm has an A+ rating with the BBB.
There is competition in the area. However, this company has a reputation for providing exceptional service.
There is potential for growth for a buyer who is interested in expanding service to other target markets. The company employs a part-time salesperson and sets a minimal budget for advertising. Additional sales and marketing spend would likely increase the business’s total sales.
Support and Training
The owner is willing to offer up to six months of training and transition support.
Reason for Selling
How do we evaluate a business for sale? Starting with the listing, let's take it on one piece at a time.
The parts of the listing
The listing title gives a brief, general description of the business that’s for sale. Sometimes, it also provides the location of the business. In the example, Electrical Contractor Business For Sale in Central Michigan, the title does both.
This section will provide you with some high-level information about the price and cash flows of the business. Listings will always include the price, but many sellers withhold some of the other high-level financials until interested buyers specifically request this information.
The terms in this section are important.
The asking price is the amount of money you’ll need to come up with to purchase the business.
In this example, the asking price is $320,000. A buyer would need to provide this total in cash or through a financing arrangement to purchase the business.
Gross revenue is the total amount of money the business received in the most recent year or reporting period before expenses.
In our example, the business made $554,000 before paying wages, salaries, interest obligations, rent, and other costs of running the business.
Cash flow refers to the amount of cash and cash equivalents that enter and exit the business. It explains whether the business generates enough cash to pay its debt obligations and taxes.
Our sample business reports a positive cash flow of $130,000. Relative to the revenue of $554,000, there is a healthy profit margin (23%).
A quick note here: “Good” profit margins vary by industry. You'll need to research your industry’s net profit margins to determine whether a business you’re considering performs well or is struggling. But in many industries, a 10% net profit margin is fair; 20% is good.
You should also know that there are a few ways brokers and sellers calculate cash flow, so rather than taking their stated cash flow at face value, you should request their financials and make your own estimates. An accountant can help you with this task.
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EBITDA is earnings before interest, taxes, depreciation, and amortization. It’s similar to cash flow, but it treats the owner’s salary as an expense.
In our sample business, the EBITDA was $100,000. The difference between the EBITDA and the cash flow is the current owner’s salary.
Down payment refers to money the buyer will pay the seller upon the sale of the business. In many cases, buyers are asked to pay the full purchase price upfront. However, a smaller upfront amount may be possible if the seller is willing to provide seller financing.
In our sample business, the down payment required is $256,000. This signals that the seller is willing to provide up to $64,000 in seller financing.
FF&E explains the dollar value of the movable furniture, fixtures, and equipment offered in the sale of the business.
In our example, the seller is offering $30,000 of FFE. Here, FFE may include desks, chairs, computers, machinery, or other office items. Buyers should verify this value in the due diligence process by getting a third-party appraisal.
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Inventory explains the number of sellable goods the business currently has on hand and will include in the sale of the business.
Our sample business states that its inventory is worth $40,000. This value should be verified in the due diligence process by a third-party appraisal.
Real estate refers to the physical buildings and land that’s owned and available for sale. Many businesses, including those that rent office space, won’t include real estate in their sale.
This sample business includes mentions $300,000 of real estate. However, the listing states that this is an optional additional cost. When the real estate is listed as “optional,” it usually means that the seller is open to retaining ownership of the building and letting buyers lease the space from them for an additional fee.
|Terms tend to be more favorable for real estate loans than loans for an operating business. For instance, SBA loans, which are often used to purchase operational businesses, usually require repayment over a 10-year period. Real estate loans can often be attained for 25 years or more. Because of this, many buyers choose to finance their new business and its real estate separately.|
Financing is a term many brokers use to designate whether the seller is open to providing what’s known as “seller financing,” or a loan for the purchase of the business. Often, seller financing is offered to buyers who have good credit and can meet the seller's stipulations.
The owner of the business in our example is open to providing seller financing. Lots of buyers may be drawn to this listing because seller financing would reduce the amount of cash and financing they’d have to attain from other sources.
Distressed is a term that describes businesses that are struggling to cover their liabilities, in default, or working through restructuring or bankruptcy proceedings. Some distressed businesses can be good investments. Still, many buyers prefer to focus on businesses that aren't in distress.
Our sample business claims that it's not distressed, which means it isn’t struggling or at risk of default.
This section gives some basic details of the business. Most listings will include the business’s location, its employee count, and the year it was established. Some listings, like our example, will provide more information. You might learn whether the business is a franchise or home-based, whether it can (or must) be relocated, whether the management team will continue on after the transfer, and whether any licenses will be required of the owner to operate the business.
Details of the business
The final section of the listing usually includes the “pitch” the seller or broker would like to make about the business. Here, the listing might highlight the benefits of the business and provide an optimistic summary of its competition and growth opportunities. You’ll need to read the summary with a discerning eye. Then, commit to making your own judgments about the state of the business, its positioning in the market, and its potential for growth through the due diligence process.
This section often includes two other key elements that you should pay close attention to: the support and training that’s offered after the sale of the business and the reason for its sale.
Support and training are valued by many business buyers because they grant access to the seller for questions, advice, and support after the sale. It’s often a good sign when support and training are offered. Here's why. First, they indicate that the seller cares about the business's long-term. Second, they show that the seller isn’t trying to run away from a problem he or she knows is about to emerge.
Reason for selling is also important. Reasons like health concerns or retirement indicate that the seller needs or chooses to exit the business for personal reasons, not reasons pertaining to the health of the business. Another reason, like “pursuing other interests,” can be a red flag that indicates the business isn’t performing as well as the seller would like or that the seller would like to exit the business before a known problem or event occurs.
This guide should help you evaluate a business you see for sale on business marketplace sites. But how can you find the hidden gems—the businesses that may be up for sale that no one knows about yet? Read this article to learn how to find under-the-radar business opportunities that could suit your goals and interests:
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