What happens when the SDE is negative?
What happens when the SDE is negative? The higher the multiplier which contains all the good things to increase business value drives the SDE further down, which intuitively is not right.
Thank you for your question!
If I am understanding your question correctly, you are asking how to value a business with negative seller discretionary earnings (SDE).
SDE can be a great tool for valuing a business, however, it does not work well – as you have pointed out – when a company’s SDE is negative. In the case of a negative SDE, a business should be valued another way.
There are several different approaches that can be taken to value a business with negative earnings. One approach is an asset-based approach, where a business’s earnings are essentially ignored, and it is instead valued based on its assets. These can include tangible assets (such as inventory, property, equipment) and intangible assets (like its customer base, reputation, location).
To calculate a company’s value based on assets, take the fair market value of all assets, and deduct any liabilities (debt that is attached to those assets). So, if a company has $250,000 worth of assets, and total liabilites of $100,000, that company’s valuation would be $150,000.
Other approaches, such as a market-based approach (which is similar to the comparable homes model applied in real estate) may be used, and may be combined with an asset-based approach to arrive at a valuation.
I hope this answers your question!
Robert @ FitSmallBusiness
Thanks, Robert. I was watching an episode of “The Profit” on CNBC last week and Marcus Lamonis was asking a business owner the value of his company. He quoted a really high value and Marcus did a five second calculation using assets, debt, earnings and the multiplier of “3” which totally destroyed his assessment. The earnings were positive though so it started me thinking of the multiplier and what if earnings were negative.