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Thread: Calculating Net Revenue

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    Calculating Net Revenue

    I have a site I am preparing to sell and I want to make sure I am listing net revenue properly (to be accurate, but not incorrectly short change myself).

    The site is four years old and for about 1 year, I had to do heavy development (the website started as a part time gig then went full time). During that time of heavy development, I had to hire someone to handle the management of advertising (since I did not have the time). This person was paid 35% of gross direct ad sales.

    When I am calculating net revenue, should I count this "ad management" as an expense. My argument for not counting it, is that if I was not doing the development, the hours would be considered the "owners time". Which I haven't seen listed when looking at other PnL's.

    I will be listing the site for over $100k, so there will definitely be DD done by the buyer. I don't want to come across as being deceptive, so I am looking for a opinion how best to go about it.

    Thanks!

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    aka "bryanon"
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    You're on the right track but it's important to realise the difference between Net Revenue and Owner's Benefit (also called Owner's Discretionary Earnings, Adjusted Cash Flow etc.)

    Simply put - your Net Revenue is the amount of money that the business generated after expenses, regardless of whether these expenses should or shouldn't be taken into account when valuing the business. What makes the difference between Net Revenue and Owner's benefit is add-backs - these are expenses that were either one-off or not related to the business.

    At the end, your Profit & Loss statement will look something along the lines of:

    Gross Sales - $1,000
    CogS - $500
    Gross Revenue - $500

    Expenses - $300

    Net Revenue - $200

    Add-backs - $100

    Owner's Benefit - $300

    Hope this helps!
    Bryan

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    Administrator Clinton is a Premium Member
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    if I was not doing the development, the hours would be considered the "owners time". Which I haven't seen listed when looking at other PnL's.
    If others haven't done it that doesn't mean that you shouldn't either. Especially as you have made the payment. In the price bracket you're targeting buyers aren't stupid, they'll deduct the value of time spent. You might as well do it for them and come across as honest. I wrote this some years ago that may be of interest.
    Find the right business brokers to maximise the value you extract from your business and improve the chances of selling your business.

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    aka "bryanon"
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    Clinton,

    In an ideal world, all sellers (or rather, owner-operators) would calculate the time it takes for them to manage the business, take the average salary of such person, i.e. the cost of replacing themselves, and add this to their P&L statement as an expense. This would be fantastic as it would help buyers get an accurate overview of true finances when looking at any P&L statement, without having to dig deep into the inner workings of the business to find out how much money does the current owner (and often enough - his family) spend on the business on day to day basis.

    But unfortunately we don't live in an ideal world. Instead, we're stuck in an industry where owner responsibilities are considered a norm. This is largely dictated by brokers, and nearly ALL major brokers operate in the exact same way (owner responsibilities are not considered add-ins). This, unfortunately, puts new sellers in a situation where they MUST do the same thing, because else their business will look extremely unattractive and won't gain nearly the traction that it otherwise would, as whether you like it or not - many buyers make their first choice based solely on the multiple, and if the multiple is too high, they won't even request any additional information (even though the true profit multiple of a business that is selling at 4x but has owner responsibilities added in as add-backs is likely lower than that of a business selling at 3x but requires a full time commitment).

    What makes the situation even worse is that even though brokers are the ones who have created it, it's extremely difficult for a single broker (or even a few brokers) to change this "norm" and start adding owner responsibilities to their P&L statements. This is because of the same reason - if broker X would suddenly start doing this then it would create a situation where, on the surface, broker X seems to list properties at much higher prices than brokers Y and Z. Even though you and I know that it isn't really the case, the majority of buyers won't and therefore the broker in question would immediately lose some of their market share.

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    This is largely dictated by brokers, and nearly ALL major brokers operate in the exact same way (owner responsibilities are not considered add-ins).
    I would dispute this. If you're talking "website brokers" then ... maybe. But they constitute a tiny fraction of the market for businesses. Tiny, tiny, microscopic.

    In any case, my point is that at the higher prices buyers aren't the clueless novices that Flippa and others have cultivated at the bottom end of the market. At the bottom of the market, it's true, people go by "multiples" rather than having the intelligence to first ask "multiple of what?" Various site flipping "gurus", the whole MFF (made for Flippa) crowd, various "experts" earning money from advising buyers/sellers or creating tools for them and probably Flippa itself stand to gain from dumbing it down. But, as I said in my last post, the higher the price the less the buyer is going to be fooled by hiding cost of owner time ...whether in detailed analysis of the business or even first look filtering.

    When the owner-operator has actually made a physical payment to a third party - as in this case - any exclusion of that payment in profit calculations would, I feel, lose the seller some credibility with potential buyers.
    Find the right business brokers to maximise the value you extract from your business and improve the chances of selling your business.

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    aka "bryanon"
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    Offline brokerage / M&A isn't really my game so I'm in no position to argue what does or doesn't happen in this industry, however based on my (brief) conversations with various offline brokers, it appears that the industry does operate fairly similarly to the online acquisitions industry and even in the offline world, multiples are often applied to the owner's benefit figure, rather than to the net revenue / EBITDA.

    When the owner-operator has actually made a physical payment to a third party - as in this case - any exclusion of that payment in profit calculations would, I feel, lose the seller some credibility with potential buyers.
    Not at all. There are various completely legitimate reasons for add-backs and they happen ALL the time. Not including add-backs on the income statement would be sellers shooting themselves in the foot and driving towards a lower valuation than they deserve. Here are some examples:

    - Any one-off investments that are not likely to occur again
    - Ad campaigns that were tried historically but didn't result in any revenue and have been cancelled since.
    - Expenses that appear in the business's books but aren't related to the business itself (e.g. the seller expensing their personal travel, phone bills etc. for tax purposes)
    The list goes on ..

    At the end of the day though, like you say, the majority of buyers look at a business and the related owner responsibilities quite thoroughly prior to putting in an offer, and ultimately it's up to each and every buyer to decide what's a fair price (and what's the price that they're willing to pay). What I'm saying is that adding owner's salary into the main figures when the industry norm is disclosing it separately (note: disclosing it separately and "hiding it" are not the same) would simply hurt the seller in terms of the visibility that their business is going to get and therefore brokers tend to advise against it.

    Again - I'm not saying that this situation is ideal but at the same time we need to accept that it's the reality - at least at the present moment - and personally I can't see any feasible ways to solve the issue.

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    - Ad campaigns that were tried historically but didn't result in any revenue and have been cancelled since.
    Huh? So I can include only an arbitrary fraction of my rent because I don't use all of the office? Or a fraction of my hosting costs because I don't use all the GB of space provided? What next? If you paid for an ad campaign it's an expense. End of. No proper accountant would pass an audit of those accounts.

    - Any one-off investments that are not likely to occur again
    One off investments are capital expenditure. They don't go in the P&L.

    - Expenses that appear in the business's books but aren't related to the business itself (e.g. the seller expensing their personal travel, phone bills etc. for tax purposes)
    Blatant tax fraud. Many small businesses do this to some extent. But it's foolish to actually claim it in writing when negotiating with a potential buyer. You suck it up and take the hit in exchange for the small benefit you derived from cheating the tax man.
    Find the right business brokers to maximise the value you extract from your business and improve the chances of selling your business.

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    I think you're missing the point a little bit Clinton.

    No audit would ever be done on these numbers, nor have I ever seen owner's benefit in any tax documents or yearly operational reviews. It's a number that is used solely for determining the value of a particular business when it's being sold and nothing else, so references to the tax man or audit procedures aren't quite relevant.

    Either way, I'm not continuing this argument with you (nor did I ever want it to turn into one), as I don't represent a "side" here. I'm merely speaking from experience in how things are done by the vast majority of web business brokerages, and to the best of my knowledge a large number of offline brokers as well, rather than whether I personally believe it's the right way or the wrong way of doing things - which in this instance is completely irrelevant.

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    Thank you for clarifying Net Revenue and Owner's Benefit. I had my terminology incorrect. Also you guys summed up nicely the issue I was having:

    This, unfortunately, puts new sellers in a situation where they MUST do the same thing, because else their business will look extremely unattractive and won't gain nearly the traction that it otherwise would
    and
    any exclusion of that payment in profit calculations would, I feel, lose the seller some credibility with potential buyers.
    So, after getting a better understanding, I am planning on adding the "ad management" as an expense on the PnL. Then I will list it as an Add Back. Which leads me to a few other questions.
    1) How do you list the Add Backs on a PnL? Is listing by category sufficient? Should it reference another document with a better explanation of the Add Backs?

    2) Changing subjects slightly, Since I did most of the development on the site (which is separate than my time managing the site), should that be expensed separately, and/or listed as an Add Back? or is that considered a capital expenditure?

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    1. You don't do the adding back, it's up to a buyer to decide what to add back. I have no doubt though that brokers etc prefer doing it "for the buyer" The separate document is one way to go. Keeps things clean and prevents any accusations of accounting fraud.

    2. The development constitutes the infrastructure which forms the base for the revenue generation. Without that infrastructure there is no revenue. If that's the case then the infrastructure doesn't have any further value. When you build a house and it generates rental income and you then sell the house for a multiple of that rent you don't get any further money for the building work you put in.
    Find the right business brokers to maximise the value you extract from your business and improve the chances of selling your business.

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