Why you should substract $300,000 from SDE to replace an active owner
March 29, 2024
by a searcher from Universitat Pompeu Fabra in Manila, Metro Manila, Philippines
After 30+ transactions, we decided to add an expense to the SDE of $300,000 if the owner is still active in the building.
You can replace them for possibly $150,000, but the kind of mentality it takes when a problem comes up and the headaches if someone leaves the team or something urgent happens is at least another $150,000 a year in mental capacity for ownership.
When do we apply this rule?
- If the owner is still the GM
- If the general manager is related to the owner
- If the general manager has been in the business for less than 2 full fiscal years
- If family members are working in the business (most likely need to be replaced)
- If the passive owner has been doing sales and going to conferences
The business is doing $5MM in revenue and $700k SDE? Not worth $2MM, its worth $1MM. The business is doing $8MM and $1MM SDE but the owner holds most relationships and he has been doing the sales himself? Business is not worth $3MM, it's worth $1.5MM.
This is why most businesses under $500,000 SDE are worth less than $500K and we would never buy them for more than that.
What do you think about this?
from Boise State University in 800 W Main St, Boise, ID 83702, USA
Also a business with $700M SDE using SDE rule of thumb (after adjusting SDE for discretionary expenses and owner's salary to current fair market salary for the particular industry) will likely fall between 2 to 3 times SDE. However, a valuation needs to be done be a credentialed valuator. You have to adjust the owner's salary to estimated fair market salary (and yes there are databases to find this info.)
. If an owner has all the relationships, and no one else can assume them, there is a case for applying a discount to the price. However, how do you make a case for what your second example is "worth"? Every situation is different. There is no broadbrush formula to determine the value of all businesses. Research must be done and analytical thinking applied.
from Clemson University in Raleigh, NC, USA