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How to Value and Sell a Distribution Business

Jeff Baxter Jr.

Sellers Business Valuation Seller Articles Valuation

If you’re the owner of a successful distribution company, then you may have started wondering about what your business is worth, and what it would look like to sell it.  

Selling your distribution company may be a great option for you if you’re nearing retirement, or if you’re just ready to let someone else take the reins. Even if this isn’t you yet, it’s never too early to start thinking about what it will take to sell.

At MidStreet, we've helped several owners of distribution companies through the process of selling, so we're familiar with the factors that impact their values.

In this blog, we’ll talk about how your distribution company is valued, the factors that impact its value, who you should consider selling to, and how much an M&A advisor will charge you for their services.  

Let’s get started. 

Multiple of SDE or Multiple of EBITDA  

The best way to value your business is to use a multiple of seller's discretionary earnings (SDE) or a multiple of earnings before interest, taxes, depreciation, and amortization (EBITDA), which looks like this:  

Seller's Discretionary Earnings x Industry Multiple = Business Value 

OR 

EBITDA x Industry Multiple = Business Value 

We'll look more closely at industry multiples shortly, but to give you a better idea of whether you should use a multiple of SDE or a multiple of EBITDA to value your business, let’s break down both methods and explain when each is used.  

Seller’s Discretionary Earnings (SDE) 

SDE represents the total financial benefit that an owner can expect to receive from their business. It is typically used to value businesses doing less than $15 million in revenue.

To calculate SDE, you'll start with your net profit and begin adding back certain expenses like an owner’s salary, benefits, interest expense, depreciation, and any one-time expenses. After factoring in these items (called “add-backs”), you’ll arrive at your business’s SDE.   

This method is useful because it adds back any expenses that are tied to the current owner (like their own depreciation schedule and salary), allowing a buyer to better understand the true financial benefit that comes with a business.  

To learn more about seller’s discretionary earnings (SDE), check out our complete guide to SDE in which we walk you through calculating your SDE and explain why various expenses are added back.  

EBITDA   

Earnings before interest, taxes, depreciation and amortization (EBITDA) is another valuation method that is similar to SDE in that it also contains several “add-backs.” The main difference here is that EBITDA is used to value larger businesses, and therefore assumes that the buyer won’t be the owner-operator. 

Instead of adding back the current owner’s salary, EBITDA adds-back a fair market value manager’s salary. The value that results from these add-backs represents your business’s EBITDA.

Like SDE, EBITDA is beneficial to calculate because it allows you to compare your company’s value with other companies, giving you a better idea of what it’s worth.    

If you’d like a more in-depth explanation, check out our complete guide to EBITDA in which we cover everything you need to know about EBITDA from start to finish.  

Multiple  

Once you’ve determined your business’s SDE or EBITDA, it’s time to apply the appropriate multiple for your industry. Industry multiples are determined by looking at comparable sales of other distribution companies that are similar in size and location.   

A good multiple range to expect your distribution business to be valued at would be: 2-4 times SDE or 4-6 times EBITDA.

If your business is more comparable to distribution companies with high multiples, then it’s likely that your multiple will be on the higher end. The same goes with lower multiples.   

If you’re somewhere in the middle, it’s possible that an average multiple will be applied.

When you get a business valuation, you'll get a range of possible multiples from the least expected value to the highest. This helps to give you a maximum and minimum expectation for the value of your business, although the multiple you actually sell for is highly dependent upon the buyer.  

How Not to Value Your Distribution Company  

Unfortunately, many business owners have been misled throughout their careers into thinking that an acceptable valuation method involves some percentage or multiple of their revenues.   

This just isn’t accurate.  

We’ve seen companies doing close to $20 million in revenue with less than $1 million in earnings. Using the multiple of revenue method (1-1.5 times revenue), that business would be valued at $20-$30 million. No one is going to pay that amount for a business only generating $1 million in earnings.   

Therefore, whether you’re a smaller business valued using SDE, or a larger company valued using EBITDA, a multiple of earnings method is the best way to get an accurate valuation.   

It's also important to apply the right multiple to the earnings stream you select.

If you’re using SDE as your measure of profit, you must use an SDE multiple, not an EBITDA multiple. This is the most common mistake we see where well-intentioned advice misleads owners on the multiple they can expect. 

Factors that Impact a Distribution Company's Value

While your business’s earnings are by far the main driving force behind a valuation, there are other things to consider when valuing a distribution company.

Let's take a look at some of the factors that impact a distribution company's value. 

Vendor Relationships   

The distribution industry is extremely competitive, with market saturation creating lots of competition for business. Having good relationships with key vendors helps to set your company apart and helps to increase its value.    

If a potential buyer sees in the confidential information memorandum (CIM) created for your business that you have several reliable vendors who continuously supply the products you need, or that you have contracts with vendors in your service area, it can convince them that your distribution business is able to remain competitive in a saturated industry.   

Customer Relationships  

Another value-driver for your distribution company is the quality of your customer relationships.   

When a Quality of Earnings (QoE) is performed on your business, one of the things that will be under scrutiny is your customer churn rate and if your customers have any contracts.  

If your customer base is reliable, and you have long-term customer contracts, then your distribution company will have more earning potential, making it far more attractive to potential buyers.   

Value-Added Services  

Perhaps one of the best ways to stand out and boost your distribution company’s value is by offering value-added services. This is a great way to compete with larger distributors, who usually can’t customize their services due to the scale at which they operate.   

Value-added services don’t just allow you to differentiate your services; they also allow you to increase your revenue. Some good examples of value-added services that we’ve seen help distributors stand out are:  

  • Product kitting  
  • Repackaging  
  • Vendor managed inventory  
  • Order fulfillment  
  • Warehousing  

Buyers for Your Distribution Business 

Since distribution companies can vary greatly in size and earnings, they are open to different kinds of buyers, including individual, strategic, and financial buyers.

Let’s take a look at what each of these buyers brings to the table for your business.    

Individual Buyers 

An individual buyer is usually a person who is going through the SBA’s loan program to acquire a business. It is likely that they have either owned a business before or have held some sort of high-level management position in another distribution company.  

Individual buyers are often as excited about buying your distribution business as you are about selling it, which can make the deal go much more smoothly.   

They are also much less sophisticated in their due diligence process than other types of buyers, which also creates a smoother deal with less stress on you as the deal is conducted.  

On the other hand, individual buyers are less flexible than financial or strategic buyers, and typically don’t have access to as much capital.

You will also be required to go through the SBA 7a loan process with them, which can be extremely detailed and time consuming.  

Strategic Buyers 

A strategic buyer is a business within your industry (or a related industry) who wants to acquire your business to expand their current operations.  

Strategic buyers can be great for distribution businesses because distributors present several levels of value to them through synergies, including expanding their service areas, filling gaps in their distribution processes, and helping them expand their services.   

This means that there could be a bidding war for your company if several strategic buyers see it as a worthwhile investment, which will drive up your company’s value.

Additionally, strategic buyers are often willing to pay a premium for your distribution company because it is adding value to their current operations.  

Contrastingly, going with a strategic buyer can present problems in a few areas. One potential pitfall of selling to a strategic buyer is that they may lay off some of your current employees once your business is acquired.

Since the strategic buyer already has someone managing their books, marketing, and other processes, anyone holding one of those positions in your business may be in jeopardy of losing their job.   

Another pitfall of selling to a strategic buyer is the possibility of a confidentiality breach. Since strategic buyers are either already in your industry or one that is closely related, it is possible that if a deal falls through, a competitor could be walking away with information they can use against you.

Financial Buyers 

Selling your distribution company to a private equity group (PEG) can be a great option for you if you’re doing $1 million in EBITDA or more and would like to continue working in the business for the next few years.   

PEGs are often looking to buy businesses that have an owner who wants to continue running the company, but needs additional funding to help it grow. Their goal is to purchase your business, grow it using their funding and your experience, and then sell it for a profit in 3-7 years.   

When you sell to a PEG, you'll likely have the option to roll over a portion of the purchase price back into the business. If you roll over 20% of your purchase price, that means you’ll still have a 20% stake in the company.   

Since private equity’s main goal is to grow and sell your business, they could potentially turn your 20% stake into a payday for you that is equal to or greater than the first purchase price you got for your business, dramatically increasing the total amount you receive. 

So, if you’ve been thinking about implementing those value-added services to grow the company, but don’t quite have the capital to make it happen, a PEG could be what helps you take your distribution business to the next level.   

Remember though, without your majority stake in the business, you won’t have as much say over how it’s operated. If you’re not willing to allow your buyer to take over the way your distribution company is managed, then selling it to a PEG may not be the best option.   

How Much Does Selling Your Distribution Company Cost?  

Now that you know a little more about how to value your distribution company and who the potential buyers could be, you may be wondering about how much it costs to sell. Like many things in a business sale, there isn’t a straightforward answer.   

The broker or advisor fees that come with selling your business depend on several factors, but deal size is the number one factor that determines what you’ll pay.  

If you own a “main street” distribution company (doing less than $1 million in revenue), then you can expect to pay a business broker 8-10% of the transaction value.   

If you own a “MidStreet” distribution company (doing $1-25 million in revenue) then an M&A advisor will likely charge you 6-8% for deals closer to $1-4 million, 4-6% on deals between $5-10 million, and 2-4% on deals closer to $20-25 million.  

If you own a lower-middle market or middle market distribution company (doing more than $25 million in revenue) an M&A advisor is likely to charge 2-4% of the transaction value, which remains consistent until transaction values near $100 million (middle market businesses).   

Finding the Right Intermediary  

You’ve put in a lot of time and effort to grow your distribution company to where it is today. To make all that effort financially worthwhile, you should shop around for the right intermediary who will also put in the time and effort it takes to get you the best buyer and purchase price possible. 

When considering who to hire for representation or when you're trying to find the right buyer, you’re going to experience lots of emotions: some good and some... not so good.

To learn more about the feelings you can anticipate when selling your business, check out our blog “The Emotions of Selling Your Business.” In it, we address some of the common feelings, fears, and general concerns that business owners have when it comes time to sell.  

We also encourage you to check out our blogs “SDE vs EBITDA: What’s the Difference?” and “What Are Comps and How Are They Used to Value Your Business?” for even more helpful information on how to value and sell your distribution company.  

If you still have questions, don’t hesitate to contact us today. We’d love to hear from you and answer whatever questions you may have!

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