| Buying a business is the quickest and fastest | | | | owner(s) less in total than fair market |
| route to entrepreneurship. | | | | compensation. |
| | | | |
| However, conflict often reigns during the | | | | The goal of the seller in using this approach |
| process of determining its price. Learn some | | | | is to get the best possible price for their |
| of the common methods of computing the value | | | | equipment, inventory, and other assets of the |
| of a business. | | | | business. This method is a summation of the |
| | | | following factors: Fair market value of fixed |
| Buying a business is the quickest and fastest | | | | assets and equipment (FMV/FA), or the price |
| route to entrepreneurship. | | | | you would pay to purchase the assets or |
| | | | equipment Leasehold improvements (LI), or |
| Instead of spending time pre-planning and | | | | modifications to space that would be |
| starting a business, you will have in your | | | | considered part of the property if you were |
| hands a business that may have already proven | | | | to sell it or not renew a lease. |
| viable. An existing business may come with a | | | | |
| solid customer base, supplier relationships, | | | | Owner benefit (OB), or the seller's |
| and even a well-developed brand. This is the | | | | discretionary cash for one year Inventory |
| best option for you if you want less hassles, | | | | (I), including raw materials, |
| less groping for strategies, and less | | | | work-in-progress, and finished goods or |
| mistakes compared to starting a business from | | | | products. |
| the ground up. | | | | |
| | | | 3. Capitalized Earnings. This method of |
| As the buyer, the process of setting the | | | | valuation is suitable for service companies |
| price is often the most challenging aspect of | | | | and other non-asset intensive businesses. |
| buying a business. This is often fraught with | | | | This method places no value on fixed assets |
| emotions and conflicts, as both the seller | | | | such as equipment, and takes into account a |
| and buyer have different ideas of what the | | | | greater number of intangibles. This valuation |
| business is worth. The party most prepared | | | | method is best used for non-asset intensive |
| with an assessment of the business' value | | | | businesses like service companies. |
| will have the upper hand during the | | | | |
| negotiations. | | | | The formula used to determine capitalized |
| | | | earnings is: Projected Earnings |
| While there are no hard-and-fast rules in | | | | Capitalization Rate = Price Where normal |
| setting the price of a business, certain | | | | earnings are used to estimate projected |
| factors figure prominently in its | | | | earnings, and capitalization rate is an |
| computation. One is the prevailing economic | | | | estimated risk level of investing in the |
| condition: the price of a business usually | | | | business compared with other investment |
| goes up during a growth period, but decreases | | | | instruments such as stocks or bonds. The |
| during times of recession or slow growth. | | | | capitalization rate is an average of several |
| | | | factors, and may include length of time the |
| Another factor is the reason why the seller | | | | company has been in business, length of time |
| wants out and how bad he or she wants to sell | | | | current owner has owned the business, reasons |
| the business. A seller who wants to sell the | | | | for selling, risk factors, profitability, |
| business as fast as possible is more likely | | | | location, barriers to entry and exit, level |
| to accept a discounted price. Word of | | | | of competition, industry potential, |
| warning, though: don't show how badly you | | | | technology, and others. |
| want to buy the business as the seller can | | | | |
| leverage this information against you during | | | | 4. Intangible Value. Some businesses, |
| negotiations. | | | | particularly those that are not |
| | | | asset-intensive, may be harder to quantify. |
| Determining the value of a business is more | | | | Service companies and dot-coms are examples |
| of an art than a science: it is not precise. | | | | of businesses where this kind of valuation |
| Several methods commonly used in calculating | | | | may work. In many cases, this involves |
| the value of a business are: 1. Multiplier or | | | | measuring the "goodwill" or psychological |
| market valuation. This method calculates the | | | | value of a business, rather than its |
| value of a business by using an "industry | | | | financial value. |
| average" sales figure as a multiplier. You | | | | |
| can use average monthly gross sales, monthly | | | | For example, the valuation of an executive |
| gross sales plus inventory, or after tax | | | | recruiting company may use the cost of |
| profits of comparable businesses in the | | | | recruiting an executive and use that |
| industry. For example, the seller of a | | | | calculation to determine the possible savings |
| business with annual sales of $250,000 may | | | | it will give to the buying company. The |
| peg the multiplier at 0.30 to generate a | | | | worth, therefore, of the executive recruiting |
| sales price of $75,000 (e.g. | | | | firm is not in its overhead systems (e.g. |
| | | | offices, computers, phones) but in its |
| $250,000 X 0.30 = $75,000). | | | | intrinsic value. |
| | | | |
| To determine the multiplier of the industry | | | | In the dot-com world, most of the fallen |
| of the business you're buying, contact your | | | | companies based the value of their businesses |
| trade association or consult the services of | | | | on their customer base. |
| a business appraiser. | | | | |
| | | | Customers with a high likelihood of being |
| You can also check out Richard Snowden's book | | | | retained are valuable in most industries. |
| "The Complete Guide to Buying a Business," | | | | Other industries where companies are bought |
| which lists the multipliers of some industry. | | | | and sold based upon the value of the customer |
| Snowden shows sample multipliers of some | | | | base include insurance agencies, advertising |
| industries below: Travel agencies - .05 to .1 | | | | agencies, payroll services, and bookkeeping |
| X annual gross sales Ad agencies - .75 X | | | | services. |
| annual gross sales Retail businesses - .75 to | | | | |
| 1.5 X annual net profit + inventory + | | | | 5. Owner benefit valuation. This formula |
| equipment It is, however, difficult to | | | | focuses on the seller's discretionary cash |
| substantiate multipliers. It can be a random | | | | flow and is used most often for valuing |
| number that may not truly reflect industry | | | | businesses whose value comes from their |
| realities. Since it deals with average | | | | ability to generate cash flow and profit. It |
| values, the formula does not take into | | | | uses a fairly simple formula -- you multiply |
| account the differences of businesses within | | | | the owner benefit times 2.2727 to get the |
| the industry. If a seller uses this approach, | | | | market value. The multiplier takes into |
| use the value only as an estimate but do not | | | | account standard figures such as a 10% return |
| rely too much on it. | | | | on investment, a living wage equal to 30% of |
| | | | owner benefit, and debt service of 25%. |
| 2. Asset Valuation. Some businesses are worth | | | | |
| no more than the value of their tangible | | | | 6. Return on Investment. The most common form |
| assets. If a company is asset-intensive, such | | | | of determining the value of a business is |
| as retail businesses and manufacturing | | | | through its return on investment, or the |
| companies, you can use the asset valuation | | | | amount of money the buyer will realize |
| method. | | | | compared to the performance of the business. |
| | | | Industry experts define a good buy if the |
| This is a particularly good method to use if | | | | business can provide you with a return on |
| the business is losing money or paying the | | | | your cash investment of 15 percent or more. |