Terms you will see when buying / selling a small Business

Below are just a few of some basic terms that many First Time Business Buyers and Seller will see repeatedly during the process search for and selling a small business.

 

  1. Adjusted Net, Discretionary Earnings (DE) Seller’s Discretionary Earnings (SDE),  and Seller’s Discretionary Cash Flow (SDCF), all mean the same thing.  The earnings of a business enterprise prior to the following items: income taxes, non-operating income and expenses, nonrecurring income and expenses, depreciation and amortization, interest expense or income, one owner’s entire compensation, including benefits and any non-business or personal expenses paid by the business.
  2. Add-backs, All or a portion of expenses that are added back to net income in an effort to place the figures as close as possible to the economic earnings that were actually derived from the business. Think in terms of Discretionary Expenses Officers (Owners) Salary, one business can have a lower Officers Salary and higher profits and another can have a higher officer’s salary and a lower net profit. The amount of the officer’s salary is discretionary.
  3. Due Diligence, this refers to your inspection of not only the Business Books, Records, Bank Statements but also includes business contracts, lease review, licensing, legal use of premises just to name a few. This needs to be done with the Help of a Licensed Experienced CPA and a Licensed Attorney should complete the contracts review for you as well. If you purchased a Home or Commercial Building, you would hire an Inspector to Inspect the property, your Attorney and your CPA are you inspectors for the business you are buying.
  4. Accrual Basis Accounting, accounting method that recognizes income and expenses, when the business first acquires the right to receive the income, or the obligation to pay the expense. Companies with inventories are required to use the accrual method for tax purposes. Income is added when the Invoice goes out, (not when the check clears) and expenses are deducted when the bill comes in (not when the bill is paid).
  5. Cash Basis Accounting, A method of accounting wherein income and expenses are recognized, within the statements, when the business receives the income, or pays the expense.
  6. Depreciation, Depreciation is a method of spreading the cost of an asset over a specified period of time, typically the asset’s useful life.
  7. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)
  8. Medicare CHOW, Change of Ownership (CHOW) happens when a Medicare provider is being sold transferedto a buyer. The CHOW results in the transfer of the sellers Medicare Identification Number and provider agreement. 

 


Buying Selling Medical Clinic EBITDA vs SDE?

When Buying or Selling a Medical Practice: EBITDA vs SDE Which Metric do Buyers use when assessing the Purchase of a Medical Clinic? The answer is that it depends on the size of the Business and the buyer. First let’s define EBITDA, Earnings before Interest, Taxes, Depreciation, and Amortization. The way to Calculate this is to simply add those items from the financial statements. This method assumes a “Passive” (not working in the business) owner and investor for example.

SDE is the acronym for Sellers Discretionary Earnings, AKA Sellers Discretionary Cash Flow, Adjusted Net and a few other similar sounding names. This Metric includes all of the EBITDA items listed above but also Assumes a Full-Time working owner and includes the Sellers Discretionary Expense “add backs”. Examples might be Travel that is not necessary for the business, a company car, a retirement plan for the owner of the business just to name a few.

An individual Doctor looking to buy a Medical Practice to work in and own will be looking at SDE to calculate how much they will make. An example would be an Internal Medicine Practice with $800k in collections and the Full-Time working Doctor owner is making $350k after all the bills are paid. A buyer might pay 1 to 2.5 times (maybe more) of the SDE to purchase that practice.

A Large Group or Hospital looking to buy this same Practice will be a somewhat passive investor and will include a Doctors Salary of $200k in the expenses. They will also add general and administrative cost and where the SDE was $350k in this example, the EBITDA is now around $100k for the same Business. With the owner Doctor leaving, they will also want the seller to “earn out” of the business for the risk that the patients don’t like the new Doctor they place in the Practice. This means that if the Collections decrease after the sale, the seller receives less money for the business. The large group may pay 2 to 3 times (could be more for a Business that has $1mm+ in EBITDA) the EBITDA but the higher Multiple is on a much smaller Number. 3 Timed EBITDA of $100k in this example equals $300k price where 1.5 times SDE of $350k equals a price of $525k

Keep in mind this is the Same Business, Same Numbers, just a different point of view from different types of buyers. Your Business has a different value to different types of buyers.

The Bottom line is that you need find the best buyer to get the best price for your Business when it is time to sell. If you are thinking about selling your Medical Practice and are not happy with the offers you have received from large group buyers, call Vince LoCricchio CBI / BCI at 813 690-0109 for a free confidential consultation about buying or selling a Medical Practice or email Vince@HealthcareEnterpriseBrokers.com Member International Business Brokers Association, M&A Source and Business Brokers of Florida.