In my discussions with hundreds of small business owners, the conversation inevitably turns to the value of their small business. Unfortunately, and far too often, the business owner has no idea why the business has little or no value.
Here’s an example (names and details changed to protect the guilty).
Small business owners, Mark and Sue (husband and wife team) call me because they are considering the possible sale of their business.
After much discussion we get around to how the business is doing financially. They have revenues of $550,000 and say they are “taking about $100,000 per year out of their business”. Sounds o.k. I ask them if I can have their financial statements and do some analysis to determine what a likely selling price for the business might be. They give me their financials and I head back to the office.
After some analysis and a few calls to Mark and Sue for clarification I determine the following:
The good news……Yes, they are “taking out about $100,000 per year”
The bad news……. The way they are taking out the $100,000.
The business is earning a profit, before Mark and Sue take out anything, of $85,000 per year. But, Mark and Sue take out that $85,000 profit plus $15,000 more! Where does the $15,000 come from? They owe $15,000 more to their suppliers this year than they did last year! Mark and Sue paid themselves $15,000 of their suppliers money. So how much did Mark and Sue really make? $85,000 not $100,000 because they now owe their supplier the $15,000 as a debt.
So is $85,000 a good profit? Is this case no. Why?
During our interview Mark and Sue said they are working 60 ours a week each and hardly ever get any time off. Let’s do the easy math:
60 hrs per week x 50 weeks = 3,000 worked each per year
2 people x 3,000 hours worked each per year = 6,000 hours worked
Their $85,000 income divided by the 6,000 hours worked = $14.17 per hour worked
Does it make sense for Mark and Sue to take the investment risk of owning their small business to make $14.17 per hour? Can’t they make more than that working for someone else without the risks?
What would a buyer pay to buy a business where they would make $14.17 per hour? Not much!!!!
Small business owners need to take an honest look at what their business economics really are. Although owning your own small business holds the allure of hitting it big one day, you shouldn’t let the dream overwhelm the reality.
The analysis I did above is not rocket science and is very easy for a small business owner to do but I almost never talk to a business owner who’s actually done it. Why? Maybe they are afraid of the answer.