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