In this training, Carl Allen introduces an innovative approach to business valuation, highlighting four key angles beyond traditional financial metrics: financial valuation, seller psychology, deal structure, and transfer value. He outlines five valuation methods, beginning with the widely used profit multiple, and introduces others like the balance sheet, discounted cash flow (DCF), capitalized earnings, and liquidation values, explaining the relevance of each in specific scenarios. He then delves into the nuances of EBITDA adjustments, particularly with add backs and take backs, and emphasizes the significance of seller discretionary earnings (SDE) for accurate valuation.

Carl also compares traditional financial metrics with unique industry insights, demonstrating how the valuation multiple fluctuates based on a business’s size, sector, and profitability trends. For instance, technology companies often receive higher multiples than industries like manufacturing. Additionally, he introduces essential models, including the DCF and capitalized earnings methods, both valuable for assessing long-term growth potential or consistent earnings.

The training dives into the balance sheet method, valuable for asset-rich, cash-poor businesses, and how adjustments in assets, liabilities, and working capital affect valuation. He explains liquidation value as a key exit strategy for baby boomers and highlights the importance of offering creative financing to maintain a business’s legacy instead of it shutting down.

Finally, Carl presents an overview of real-world deal-making stats, noting that most deals occur through EBITDA multiples or liquidation, encouraging viewers to focus on acquisition opportunities in businesses otherwise headed for liquidation. He concludes with a segue into deal structuring, the next crucial step in the acquisition process.

Full Transcript:

So let me go to my slides. I got some Google models I wanna show you as well. So can somebody give me a thumbs up that you guys can see my screen? Okay.

Great. So we’re gonna be talking about valuation, but I’m gonna be attacking it from four different angles. Right? We normally only be able to look at valuation in in terms of math, in terms of numbers, But I’m gonna give you three other lenses of which to look at the evaluation, then we’re gonna bring it all together at the end in a summary.

And then uncle Carl has built you a little cool nifty model where you can implement all the stuff that that I’m gonna teach you. So nobody else in the world looks at valuation the way I do. Nobody. Right?

Nobody else in the world is doing this. So you guys are gonna be the first people in the world to kinda see this. Right? I’ve built this training over the past three or four days.

No. Not even John’s seen this. I literally finished the training twenty minutes ago. Right? I’ve been at this, like, hardcore trying to get this right for you guys.

So before we start, though, there’s gonna be a lot of numbers in here. So if you were in Tampa, you remember I said, I want you to all shout really loud, you know, I love numbers and numbers love me. Right? So remember, you might need to go through this recording a few times, and I’ll send you the slides and you can play with the model.

Right? And we’re gonna stack this from a foundation level all the way up to, like, real freaking ninja financial analysis that we’re gonna be doing on some deals. So when I look at valuation, I look at valuation as as a four legged stool, really. We we look at financial valuation.

We look at valuation that’s impacted by seller psychology. Obviously, if somebody’s really motivated to sell a business, they’ll sell for a lower amount. And for somebody that’s, you know, not really that motivated, we talk a lot on red light, green light calls about something called the MUD score. We’re gonna talk about that.

I’m gonna build on that as well. The structure of the deal can also impact valuation. If you’re paying all the money at closing, you could pay a lot less for a business than if you’re doing an annuity deal and you’re paying for that business over a ten year period. You’ve gotta offer more.

But how does that work? And then a business also has something called a transfer value. Right? So as we go through this training, I’m gonna show you what transfer value means and and effectively how to calculate it and how to adjust evaluation based on how transferable it is in terms of value to somebody else, I.

1. You as the new owner. So we’re gonna start off with the financial stuff first, and then we’ll look at all the other three elements. So what what I’m gonna show you real quick is that there are actually five ways that that you could value a a business.

The most popular method that that we teach you is we value a business based on something called a profit multiple. Right? So if you’ve never looked at any of the valuation training before, if you’re brand new into Protege, you joined through the Tampa event, a lot of this stuff’s gonna be really useful. But if you’ve looked at valuation stuff before, what I’m gonna show you in the next five minutes is gonna be a really nice kind of refresher.

So profit multiples is the most popular. There’s also a method called the balance sheet method, where we look at the net asset value of the balance sheet, and then we look at adding goodwill. We’ll get into that.

And then for the first time ever, I’m gonna show you what a discounted cash flow valuation looks like. You never ever ever need to use this in a deal, but I’m gonna show you how to do it so that you’re adding that extra little skill. If if someone ever talks to you about discounted cash flow, you’ll know exactly what it is and how to do it. There’s another method called the capitalized earnings method.

It’s kinda similar to discounted cash flow, but with a few differences. I’ll show you that. And then all businesses have something called a liquidation value. And that becomes very, very important when we look at the transfer value of a business.

So I’m gonna do that as well. So when we talk about profit multiples, oftentimes we ask ourselves, well, we’ve got this business, What’s the multiple? Right? Why is a technology business sell for a higher multiple than, say, a a commercial cleaning business or an engineering business?

And all deal multiples are tracked by the deal stats value interest, which is owned by Bureau van Dijk, one of the big data analysis firms out there. We’ve got a subscription to this. John did a deep dive training on this.

Gosh, John, was it late last year, when you went I think so. Yeah. These numbers come out, and we share them with you. We have a subscription.

We we can download them, and we can put them into, the groups for you. So the q one twenty twenty three numbers are not out yet because we’re we’re only two months the way through q one, but we do have the q four twenty twenty two multiples. And what they do is they track lots of different data points to these guys. It’s a very interesting database.

So you can see over time how these multiples kinda spike up and spike down on average.

And, you know, we kinda had a a kind of a low point at the start of twenty twenty two, and then multiples have started, to come back again. But the most important set of multiples that we look at is we we look at the price that the selling price, the asking price divided by EBITDA, which is our main profit measure, we look at these multiples by size. Because as you know, the bigger the profit, the bigger the multiple. That’s why a company like Apple is worth twenty four times its EBITDA, whereas most small businesses tend to be valued around the three x range.

So what this does for micro businesses, zero to a million dollars in revenue, multiples are lower, one to five million. We’re kind of banding in between that three to five range as an average. And then as we get to five to ten million dollar businesses, the multiples can go higher. And then, obviously, ten million dollar deals and above, probably up to twenty five million dollar businesses.

We’ve got these kinda higher multiples as well. So we’re really focusing on that kind of brown line, which tends to band in between that three and five, and it’s kind of trending back down to about three times right now. And what these guys also do, which is really cool, is using NAICS codes, which is the way America kinda classifies its types of businesses. And these are very, very similar no matter what country.

Australia’s a bit higher, UK, Canada, US, they’re all around the same. But what they do is they look at all the multiples per industry, and there’s a really wide range. So that kind of three, three and a bit kind of average right now, the lowest values are going for around one point eight. So if you were buying educational services, you’re paying on average about one point eight times.

If you’re buying kind of accommodation food services, you’re paying around two point one times.

If you’re buying businesses in transportation and warehousing, you’re paying around two point nine. Stay away from technology.

Technology businesses are are going for around nine nine point seven times EBITDA. I think factored into this, John, is is probably the larger deals.

You know, I’m buying lots of IT businesses and online businesses right now. You know, I’m not really paying more than five.

So I think that number is skewed with a lot of people. All sizes. So you already made that point, though. So it’s something So but it’s a really wide range.

But what you can do and you can look at this is, you know, say, well, hey. You know, I’m buying a manufacturing business. On average, those deals are around the three point six multiple. But what you’re gonna learn as part of this training is that the multiple and the financial valuation is only one of the four parts of the equation, that you really want to look at.

So so let’s do the math based on using EBITDA multiples. So, again, start from the very, very basics. Let’s say we’ve got a business that’s doing two million dollars in revenues. It’s got a million dollars cost of sales, so that’s the cost for the business to produce the service or the product, that it sells to customers.

So that would leave you with a million dollars of gross margin gross profit, and that would give you a fifty percent gross margin for that business. And then the business has overheads, which we sometimes refer to as s, g, and a. And when you look at most financial accounts or tax returns from a business, They’ll quote what they call EBIT, earnings before interest and tax. So to calculate EBITDA, we kinda have to add back the depreciation and the amortization of intangible assets.

Let’s say in this example, that was fifty thousand dollars. So we had a million dollars of gross profit, less than seven hundred and fifty thousand dollars of overhead, two hundred and fifty thousand dollars was the EBIT number. We’re adding back the depreciation and the amortisation. So our EBITDA is three hundred thousand dollars, and that would be a fifteen percent profit margin.

And the reason we use EBITDA is that’s the most common uniform way of measuring profit. Because when we’re looking at businesses, you might look at two completely identical businesses that have got the same EBITDA, but they might have very different capital structures. So the interest might be really high in one business, but really low in another. They might have completely different schedules for depreciation and amortization.

So we wanna net all that out and just say, well, hey. What’s the operating profit? What’s the profitable to this business before all of these things kind of get added and taken away and adjusted? So EBITDA is always the common measure that we’re looking to use. Now there’s loads of different adjustments to kind of EBITDA.

One of them is EBITDA versus something called SDE, which stands for sellers discretionary earnings. We’re gonna go into that. We’re gonna talk about something called add backs, which is a recasting of the EBITDA number to reflect the change of ownership. So whatever the owner’s doing in the business with comp expenses, families on payroll.

I once looked at a business, and, the the guy had put all of his pet dogs, the cost of the dogs and their insurance and food and all that stuff through the box. And I said, well, hey. Are you are you leaving the dog as part of the business? He’s like, no.

So, you know, you’re recasting for all that. Then we’ll look at the diff what’s the difference between enterprise value of a business and equity value of the business? We’ll look at that. And then we’ll look at whatever adjustments we need to make to the valuation in terms of the working capital.

So to go from EBITDA to SDE, all we’re doing is we’re adding back the total amount of the owner’s compensation, the salary, the benefits, and their expenses. So if you’ve got a business doing three hundred thousand dollars and the owner is earning two hundred thousand dollars from the business in all of the different ways, then the true SDE in that business will be half a million dollars. So if you go to BizBuySell and you look at a deal and the broker’s telling you, hey. This business is doing five hundred thousand dollars of SDE, You then need to do the math the other way.

You need to say, well, okay. What’s the owner taking out?

What’s the benefit? What are the expenses that the owner’s taking out of the business? And then you would work that back down to the EBITDA number. And then once you’ve got EBITDA, we then need to do the recasting exercise.

We need to look at, well, what are the add backs and what are the take backs? They’re very, very different. An add back is something that you add to the EBITDA to create that recasted profit, and a take back is where you’re taking away from that EBITDA number to calculate the recasted profit. So let’s say our EBITDA was three hundred thousand dollars.

Let’s say the total owner’s compensation plus benefits plus expenses was two hundred thousand dollars. And then let’s say we’ve got another two hundred thousand dollars of add backs. There might be lots of family members on the payroll that actually don’t do any work, and they don’t need replacing. So those would all be legitimate add backs. And then the take backs would be, well, okay. We’ve got to replace the owner with the general manager.

And let’s say that’s hundred, hundred and fifty thousand dollars. And then in some deals, you might find that you decide not to buy the real estate. So if you don’t buy the real estate and you’re then gonna be renting the real estate from the owner once you bought the business, then that cost of that rental expense needs to be a take back so you reduce the EBITDA by the same number. So in this example, we had three hundred thousand dollars of EBITDA. We added back all the total owner’s comp and benefits and expenses to give us that SDE number of five hundred thousand dollars. Then we added all the other add backs that we decided, were were in agreement, and then we took away the two hundred and fifty thousand dollars of costs that we’re gonna incur once we buy and own that business. So our adjusted EBITDA in this example would be four hundred and fifty thousand dollars.

So the next thing that you gotta do is you’ve gotta look at the averages. Right? And you’ll see this on the red light, green light. We always look at averages for numbers.

So you’d repeat that exercise for the last three years. If the profitability is going up, we take a three year average. So in this example, let’s say they adjusted EBITDA this year was four fifty, last year was three twenty five, twenty twenty was two ninety. We’re gonna take a three year average of that.

So So we’re gonna come out with three hundred and fifty five thousand dollars as that three year average. However, if the profitability is going down, we don’t take the average. We just take the lowest number. So if profit in twenty twenty was five ninety, profit in twenty twenty one was five two five, profit in twenty twenty was four fifty.

But I’ll take a three year average because, hey, the profit’s going down. So we take the four fifty number, but then that would be a red flag, wouldn’t it, in your deal analysis. You’d want to understand from the seller, is that trend likely going to continue?

If you were looking at a business in, say, September of twenty twenty three, you’d want to know what were the first eight months of profit. Is that number gonna be maintained, or is it gonna continue to go down? Because then you’ll be looking at a lower number when you come to do your valuation. K?

So we take an average when the numbers are going up. We take the lowest, the final number, when the numbers are going down. And then what we can do, once we’ve got the recasted EBITDA and we know the average, is we can calculate both the enterprise value and the equity value. So the enterprise value is whatever the average adjusted or recasted EBITDA is, and then we apply the multiple.

I’ve just used three for now because you don’t know what sector this business is in. So we’ll use, the deal stats data when we get into a worked example later. So to calculate the enterprise value, the enterprise value is the value of the business. It’s not the value of the equity.

So that’s simply your adjusted average profit multiplied by the market multiple. So in this example, we’ve used three. So the enterprise value of the business is a million and sixty five thousand dollars. Right?

So that’s the value of the business. To now calculate the value of the equity, we need to make some adjustments. And it’s like you could have two houses. They’re both worth half a million dollars in terms of value.

One’s got no mortgage, so the equity value is the same as the enterprise value. But if the other house has got a four hundred thousand dollar mortgage, the equity value is only a hundred. So we’re calculating now what the value of the equity or the stock or the shares in the business are. And for that, we’ve gotta make adjustments.

So first thing we gotta do if you’ve ever been through the simple model, you’ll know how to do this. The The first thing we need to do is we need to add any real estate. We’re not buying any real estate as part of this deal, which is why we have just did for the rent expense that we’re gonna have to pay in the future as the owner of the business. There’s some surplus cash in the deal.

How do we sell calculate surplus cash? Well, we take the last twelve months’ worth of revenue. We divide it by twelve. That’s the minimum amount of cash that we actually need.

So in our case, that’d be a hundred and sixty seven thousand dollars. There’s actually three hundred and two thousand dollars in the bank for this business. We don’t need all that. So the surplus cash is the difference, which should be a hundred and thirty five thousand dollars.

We’re gonna add that to the valuation, but then we can also use that money as part of the deal structure, as part of the financing.

And then if we’re inheriting any debt when we buy this business, typically, long term debt or noncurrent liabilities as they’re called. I’ll show you where they are in the accounts in a minute. If we’re gonna be inheriting existing debt as part of the business, we’re going to deduct for that. So we’re taking the million and sixty five, running the hundred and thirty five thousand dollars less the two hundred thousand dollars of debt to inherit.

So it’s circa a million dollars equity value just to keep the math nice and clean and nice and simple. What we can also do in this as well is we can look at what the target net working capital needs to be at closing when we inherit the business. And ordinarily, I recommend having at least two months worth of revenue as your net working capital. So in in this example, we’d need about three hundred and thirty four thousand dollars of net working capital in the business, including that lovely cash that’s being left behind.

When we look at the balance sheet, we’ll be able to see whether or not that is in the ballpark.

Then when we look at the balance sheet, balance sheet, the the classic accounting equation is that the total assets minus the total liabilities equal the owner’s equity. The UK, we call that shareholders’ funds. And it because it’s a balance sheet, we also use that as something called net asset value. And we’re gonna be getting into that in a little bit when we talk about the liquidation value of a business and how that is very important when we look at transfer value. We’re still only looking at the financial valuation of the business at the moment. Balance sheets, you have assets. These are things that you own, and you have liabilities.

These are things that you owe. So assets typically have fixed assets, like plants and equipment, like real estate.

Current assets would include cash, accounts receivables or trade debtors, as we call them in the UK, and inventory.

Liabilities, current liabilities are things like payables, tax notes, money that you owe that you have to pay within the next twelve months. And then we can have noncurrent liabilities like long term debt loans, long term leases, all those different things as well. So all assets minus liabilities equals the owner’s equity. So when we do a balance sheet method valuation, the balance sheet method valuation is designed for businesses that are asset rich, but their earnings poor.

Right? So they can have a slightly different valuation. Now ordinarily, it’s really tough to buy a business even if you value it and you buy it using the balance sheet method. Because it doesn’t really matter what the value of the balance sheet is, the value of the assets.

If you don’t have any cash flow coming out of the business, you either can’t, a, make an annuity payment, or, b, you can’t service the debt from an external financier that’s putting the money in to allow you to buy the assets. But if we look at the balance sheet method, the balance sheet, it’s all about driving down to that owner’s equity or that net asset value. So let’s say in this example, we’ve got three hundred and fifty thousand dollars of fixed assets, five hundred thousand dollars of current assets. So our total assets are eight hundred and fifty thousand dollars.

And then we’ve got a hundred and fifty thousand dollars of current liabilities, so AP, tax payments, etcetera. And then let’s say we’ve got two hundred thousand dollars of those noncurrent liabilities, which you’ll remember from the valuation, that’s the debt that we were gonna be inheriting as part of this acquisition.

So our net asset value, our owner’s equity, is the eight fifty less the three fifty is five hundred thousand dollars. And then we now because we have the current assets or current liabilities, we we can calculate what the net working capital is, and it’s one minus the other. So the net working capital in this business is three hundred and fifty thousand dollars. And you remember from the other analysis, we know we need three three four.

So we’re kind of like bang on the money when it comes to the working capital that we’re gonna inherit as part of the deal. So there wouldn’t be an adjustment to make for that. And then what we’re looking to do with the balance sheet method is say, well, okay. What’s the value of the balance sheet?

In this case, it’s half a million dollars. And then what we’re gonna do is we’re gonna calculate what the retained earnings are. So to calculate the retained earnings, we’re looking at what the adjusted EBITDA average was, which was three three five. We’re gonna net off the interest.

We’re gonna net off the depreciation in the business. We’re gonna net off the amortization of goodwill and intangibles.

We’re gonna calculate what the net operating income is to pretax profit. So that will pretty much mirror what’s going on in the tax returns. Right? So let’s assume hundred and eighty thousand dollars net operating income, fifty four thousand dollars of tax paid. Assume it’s thirty percent in this example. So the retained earnings in in this example would be a hundred and twenty six thousand dollars. So what we’re gonna do is use that retained earnings number to calculate the goodwill that we’re gonna add to the balance sheet value to give us that balance sheet method valuation.

And my rule of thumb is I’m gonna apply to those retained earnings exactly half of the multiple that I’m gonna use for the EBITDA analysis. So we use three x in the previous example. So I’m gonna use half of that, which is one point five x. So what I’m saying to the seller is, look.

Your balance sheet’s worth half a million. That’s not liquidation value. We’ll talk about that later. So I’m gonna apply a goodwill of one and a half times your retained after tax income, and that’s gonna be a hundred and eighty nine thousand dollars.

So add the two together, that would be a six hundred and eighty nine thousand dollar valuation.

Now in nine times out of ten, the balance sheet method is gonna give you a lower answer than the method using the profit multiple. But where you’ve got businesses with massive, like, balance sheets but very, very low margins, so heavy industrial businesses, heavy transportation businesses, sometimes you’ll find that it’s it’s a more fair evaluation due to the balance sheet method than it is to do the profit multiple method. Now all of these trainings, including the models and all the detail and a million times more analysis than what I’ve just showed you, is in the deal maker CEO, training program. So definitely go back and watch that in a lot more detail where I break it down in a lot more detail with a lot more examples. Okay. So who wants to know how to do a discounted cash flow analysis?

John, we’ve never showed them this, have we? You’re on mute, John. Sorry. Yeah. We’ve we’ve talked about it before, but I don’t think we’ve ever given an example.

So this will be Last time I mentioned it on a call, somebody said, hey. Could you spend, like, five minutes one day just showing us what a discounted cash flow analysis looks like, how you actually build a model? So uncle Carl’s built you a discounted cash flow model. I don’t want anybody ever to use it.

Unless you’re gonna go work on Wall Street or you’re gonna get into the the venture capital industry, you don’t actually need to use a discounted cash flow model. I’m gonna show you what it is, but don’t ever use it. You could just have it for, for reference. But discounted cash flow model is there for businesses that are kinda really high growth.

And what you do is you forecast your cash flows into the future, minimum five years. You then gotta calculate something called the terminal value of all of the future cash flows beyond that five year period. You then need to apply a discount rate based on the risk of the deal, and then you add all that up to calculate net present value. And people are like, what the fuck is he talking about?

Like, what on earth is this? So so, guys, this is what you do on Wall Street. I’m gonna show you now. This is really, really interesting.

But don’t freak out with this stuff. I’m just showing it you. You don’t ever need to use it. But, so this is a discounted cash flow model.

Can everybody see that? Do I need to blow it up? They got a bit bigger. Yeah, Carl.

Okay. That’s my that’s my The way you’re doing discounted cash flow models, this is the deal that we looked at before. Right? So you start off with, your current revenue, and then you’re forecasting growth.

So let’s say we’re gonna buy this business, and we’re gonna grow this business at twenty five percent per year over the next five or six years. So we’re gonna go from two million to about seven point six million dollars in revenues. We know what our cost of goods sold are. Let’s let’s assume with our gross margin, that our gross margins are gonna come down a little bit as we grow this business.

We’re not gonna get economies of scale.

So that calculates automatically what the gross profits are. It’s all calculated for you. And then let’s assume as we grow, operating expenses as a percentage of revenue are gonna decrease because in businesses, as you grow them, some of your costs are fixed, like your overhead, so your your, let’s say, the lease for your facility. If you can expand within your current facility, you’re not paying a bigger lease just because you’re growing your revenue.

So there’s a lot of things in a business which are fixed costs, which don’t increase as the business scales. So as the business scales, we’re gonna get we’re gonna be able to sweat that overhead a little bit better. So whilst the overhead’s gonna go up, it’s gonna go down as a percentage of the sales. So it models all that.

And then we flow through from EBITDA. We we put in depreciation, amortization, interest. We calculate pretax income. Let’s assume we’re paying, say, twenty three percent tax at the moment.

As we scale, we might get a bit more efficient with that taxation, so our tax will come down. So it calculates what our net income is. And then we’ve also got to look at how the balance sheet is gonna flex, what’s the net working capital in the business. As that working capital changes going forward, that’s going to impact the cash flows.

And then all businesses need capital expenditure. So let’s assume two percent of annual revenue is CapEx going through that business. And then what the model does is it works out all the cash flows for you. Says, well, okay.

Let’s calculate free cash flow. So we know the EBITDA, less interest, depreciation, amortization, less tax, and less the changes in the net working capital as we grow the business. We calculate operating cash flow. Then we know what the investing cash flow is.

That’s the CapEx.

And then at the moment in time, there’s no financing cash flow. There’s no financing going through this deal. But, obviously, if you were gonna do a leverage buyout, there was gonna be some financing going through it. So it would calculate all that. So what the model does is it calculates. It tells us what all of our free cash flow is, and then we need to apply a discount rate because we’re not one hundred percent guaranteed we’re gonna get that cash flow. So we need to apply a discount rate to discount those cash flows to present day value, and they compound.

So the discount rate four years from now is four times that compounding discount rate. So what the model does is it calculates all those discounted cash flows, then applies multiple of the cash flows. Uh-huh. And they just Can you mute, please, John, everybody?

Sorry. I’m not a host, Carl, so I can’t. Okay. Alright. Guys, can you mute? That will be awesome.

So you we go through. We calculate that that terminal value. That gets discounted, and then we add all that up. So if we were building the discounted cash flow model of the deal I’ve just shown you, we’re coming up with a much higher valuation.

It’s about one point eight million dollars, but it’s reflecting a lot of that growth than what we put into it. So, again, you don’t need to remember this, but this is how you would do a discounted cash flow valuation for a business like this. Wanted to show it you because we talk about it all the time. We’ve never taught you how to do it because you actually don’t need to know it, and I’ll explain why you don’t need to know it, a little bit later.

So that’s a discounted cash flow model. What we’ve then got is something very, very similar, which is called the capitalized earnings method model. Again, you don’t really need to know what that is. It’s identical to a DCF model, but it’s where you’ve got very predictable cash flows, no real growth outside of inflation, and you have a much lower risk factor, which tends to be more the kind of the weighted cost of capital that your business has in order to financially engineer itself.

So built a capital earnings model in here as well. So very, very similar, but you’ll see the growth is just limited to inflation. Inflation’s about six point four percent right now. Let’s assume over six years, the growth goes back down to kinda one percent.

Everything else is identical, but then what we’re doing is we’re putting in a lower discount rate. So the discount rate’s a lot lower. That would reflect, you know, the kind of cost of capital that this business might have in debt or equity and all those different things. So that gives us a much lower valuation, which is very, very similar to the valuation we used before when we used the pure multiple of EBITDA.

So, normally, a capital earnings model will give you a similar valuation than just applying the kind of market rate multiple for the profit and working out the equity value in that way. So you’re all probably freaking out about this stuff like, oh my god. Like, this is like Wall Street bananas. But, hey, I just wanted to show you how it works for those of you that were interested in this.

But rest assured, you never need to calculate this, when you’re doing your own deals. So let’s go back to the slides.

The final valuation I wanna share with you, which is really easy to do and it’s very, very important, is liquidation value. Now what’s interesting with liquidation value is the most common exit strategy for baby boomers. So over sixty percent of baby boomers, when they sell their businesses, just close the door and turn off the lights. Right?

It kills their legacy. They have to layer off their employees. They have to let down their customers. And liquidation value is based on a percentage of that balance sheet net asset value.

So our jobs as dealmakers is to go out and find these baby boomers and buy their companies using creative financing before they ever get to a liquidation value scenario. Because better for us to buy the business and keep it going rather than the seller ship the business down, and walk away. So when we’re doing liquidation value, we’re looking at that net asset value of the balance sheet, the owner’s equity, but we’re gonna apply an eighty percent factor on that because why eighty percent? Well, in an ideal world, the owner’s not gonna get a hundred percent of their asset value.

Right? They’re not. Not all their receivables are gonna pay out. All their inventory is not gonna be, a full value.

They they might have a higher fixed asset value than what’s on their balance sheet depending on how aggressive they’ve done depreciation.

But out of the hundreds and hundreds of deals I’ve done, generally, you could take about eighty percent of the balance sheet value as its liquidation value. It’s the same with liabilities.

If you sell your assets at a discount and you, you know, you you probably can’t do this with the IRS, but if you call all your, your suppliers that have accounts payable due and you call them up, if you pay them straight away, they’re probably gonna give you a discount. And there’ll there’ll be an early termination discount for paying off bank loans and leases and all those different things. So so, generally, we’re looking at about eighty percent of the value of the balance sheet, for liquidation value. So in our example, we know the balance sheet was about half a million dollars.

We’re gonna turn eighty percent of the assets into cash. We’re gonna repay eighty percent of liabilities via negotiation. So the business is now completely debt free. All there is in that business is about four hundred thousand dollars, which is the net cash left.

So that’s the liquidation value. And that’s gonna become really important when we get into transfer value in a minute.

So let’s summarize those five valuation methods. We were around a million dollars when we looked at EBITDA multiples. We were six hundred and eighty nine thousand dollars when we did the balance sheet method, which is the balance sheet value plus the goodwill. The discounted cash flow analysis gave us just under one point eight. The capitalized earnings method gave us just under one point two, and the liquidation value of the balance sheet was four hundred thousand dollars. If we plot those on a chart and we use the data provided by the Exit Planning Institute, only one percent of of deals in our kind of sweet spot, the kind of one to five million range, only one percent of those deals ever get done in a DCF analysis.

Only two percent ever get done in a capitalized earnings method analysis. Eight percent of deals get valued through the balance sheet method. Twenty seven percent of deals get valued through EBITDA multiples, and sixty two percent of deals, sellers just close the doors and turn off the lights. So all they’re getting is their liquidation value.

So your job, DealMaker, because your mission, should you choose to accept it, is go and find those deals. Go and find those sellers that if they don’t sell the business to me or you or anybody else, they’re just gonna close it down. That’s the game that I want you to play. Awesome, guys.

Now that you have all of your financial statements in place and can properly value a business, now you’re gonna wanna learn how to structure the deal, which may change depending on how much you’re putting down at the closing table. So you definitely, definitely don’t wanna miss this next episode in our valuation class. Click here to watch that now right now.