Brokers/Sellers Will Overvalue/Inflate SMB Prices

18 Ways Business Brokers Will Overvalue/Inflate SMB Price Listings/Asking Price For Sale

 

1) Weighting.

Probably the most common and most deceptive is weighting the valuation entirely on the most recent, best-year-ever. This can be appropriate if it’s still growing the next year and sustainable, but often it’s an outlier. More thoughts HERE.

 

2) Inappropriate SDE Addbacks.

The most well-known and most complained about. Addbacks aren’t a dirty word- they’re fine. But they must be provable/documented, legal, on the tax returns, and an owner-benefit that won’t be necessary for you, the Buyer going forward.

2B) The problem is when sellers and brokers get all loosy-goosy on them. For instance, if you see an add-back for “Fuel Expense”, and it’s just an owner ballparking how much of the $15K of fuel was for their personal vehicles, and it’s not something they tell the IRS… no.

 

3) Inappropriate Normalization Adjustments.

Another add-back variation is adding significant expenses that were “one time”, which can be fine if done correctly. But the $20K of new paint or fixtures still have to be re-done periodically by the Buyer, and Buyers have stuff like that too.

3B) I recommend you look hard at these and ask if that indeed won’t apply to you, and was that add-back truly discretionary or one-time in nature? If it’s a periodic thing, say $30K but happens every ten years, take the $3K/year budget into your projections. (because the broker didn’t)

3C) “Bad Debt” is a common one. If it’s one crazy story, one time, maybe… but if it’s a cumulative amount that gets periodically written off, it’s not an add-back. It’s a cost of doing business in that company. You are buying that problem and shouldn’t have to pay extra.

 

4) Lack of Rent Adjustment.

Huge landmines here are often overlooked. Rents are going up everywhere. If you have to pay higher rent at purchase, the broker should show that and negatively adjust the recast to reflect current earnings power. But they usually don’t account for this.

4B) Especially important on owner-occupied to make sure the broker is not “double counting” to ⬆️ value that includes RE. Sometimes Seller has a sweetheart deal with themselves on biz rent which inflates SDE. Then they value the RE at Market Rent, overinflating that side. Must match!

 

5) Too high of a multiple.

Pretty straightforward. Many brokers choose the 75th percentile or a way-above median multiple to hit the asking price # the Seller wants. Every Seller thinks their biz is “special”. If above average on multiple, it should be justifiable as to why.

5B) A higher multiple can be justified if, compared to its industry peers, it’s got more recurring revenue, higher margins, higher growth rate, or some special advantage that conveys to you… but if none of those is present, a premium multiple is likely inappropriate.

 

6) Applying EBITDA multiples to what’s SDE.

OMG, where to begin on this one… must thoroughly understand the difference between these. But a common trick is brokers calling SDE EBITDA and using a higher EBITDA multiple.

“I low-key hate “Adjusted EBITDA”.

Here’s why it seems shady AF every time I see it. If you have a bunch of adjustments to make, go with SDE, which is standard, clearly defined and allows for all necessary adjustments for owner pay, perks, benefits, discretionary expenses…”

 

7) Not accounting for rising interest rates.

Newer one, but sometimes brokers will model out the ROI for you or Debt Coverage Ratio for you to justify their asking prices, but they need to account for debt being more expensive than it was even a few months ago. Check for this.

 

8) Valuing projections, pro forma, and DCF approaches.

This one makes me lol, but I do see it often. Going all-in on valuing what the Seller says this year or next year “should” be in earnings or a forward-looking DCF valuation. All of these don’t apply to Main Steet <5M deals

8B) Usually, business brokers value based on historical financials. So, often when I see this, the Seller’s well-meaning CPA, Investment Banker, or MBA friend values their small business for them using methodologies of large middle market or public companies.

 

9) Owner works more than full-time.

Business Brokers Will Overvalue/Inflate SMB Prices if the owner works more than 40 hours weekly, their entire pay should be something other than an add-back. SDE is one full-time working owner at 40 hours per week. If they work 70 hours, the best way is to add back their pay and then subtract someone at market pay for the 30.

 

10) Multiple working owners.

Same as point 9 above. Only the highest-paid owner should be added back to SDE. The others should be adjusted to market compensation. Buyers shouldn’t have to fill multiple spots from SDE.

 

11) Family members working free/cheap.

This can be cut both ways. Sometimes you see add-backs for $50K for the college kid that’s the “social media manager” (not working), But sometimes their teen does rock social for them and gets paid off the books. Underpaid family does not convey!

 

12) COGS Shenanigans.

The supply chain has been rekt last few years. Look hard at COGS. Make sure you can get stuff now at the same prices Sellers could historically, which the valuation is based on. Restaurants are getting margins squeezed with rising food costs, for example.

 

13) Other Seller advantages that don’t convey.

These are hard to detect from the presentation. The most common is Seller’s Personal Goodwill, which can’t convey to you. Ex: They’re presidents of an association for 30 years and get referred heavily because of that position. You won’t have

 

14) Exclusions from Asset List.

Most deals go down as asset sales. Look at what’s excluded and make sure there’s nothing on there that might directly or indirectly help the biz make money. Is the racecar the owner’s toy, or does it get them much attention and business at the track?

 

15) Last Year’s Victory Lap. Super important one.

When you see a hockey stick up in earnings, make sure it’s sustainable. Often it’s the owner knowing they’re about to sell and gaming their last year every which way. Pulling in future revenue, clearing out old inventory, etc.

 

16) Stimmies.

PPP, EIDL Grants, Retained Employee Tax Credits etc., can be hidden all over deals these last few years. Make sure they’re properly accounted for and adjusted. Many brokers miss these if the bookkeeper puts them in the wrong places, etc.

 

17) Cherry Picking Comps.

Especially in smaller niche industries without many comps, if brokers used comps for their multiple ranges, removing some of the lower ones or leaving in a crazy high one can skew the range. Run your comps or ignore and focus on ROI.

 

18) Not accounting for CAPEX.

Sellers always add back Depreciation but then rarely budget for equipment replacement. A huge one, especially in deals that have trucks and heavy equipment. Also, watch for deferred maintenance, especially in the last year before the sale.

Business Brokers Will Overvalue/Inflate SMB

 

Business shaking as the sign of a good deal

Related Articles:

Why the Required SBA Personal Guarantee is an Asymmetric Bet

Here's why - with relatively small risk and huge reward! &nbsp;   1) Most borrower...

Read More
Why The “Silver Tsunami” Hasn’t Happened In SMB?!

I came into business brokerage 10 years ago with a promise of a "Silver Tsunami", a demogr...

Read More
HOW TO FIND A BUSINESS TO BUY

No idea why I haven't written this yet, but here's how to find a small business to buy: ...

Read More