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How much is my business worth

Valuing a Business

So, what do you think it’s worth?

The very first question I receive after agreeing on contract specifics.

“So how much do you think we can get”

The truth is there is no sure-fire way to value a business for buying and selling purposes. The true value is the perceived value to a buyer who is ready, willing, and able to buy it.

Business valuation is a mix of art and science. The goal is to find a fair price that satisfies the seller and is in line with the current market.

There are several reasons for valuing a business. Businesses are valued for estate and tax purposes, divorce settlements, and for raising capital. For these needs I would strongly recommend engaging a registered valuer.

Valuation discussions in this article are purely for the purpose of buying or selling a business.

Valuation Methods

  1. Quick Estimate
  2. Market Average
  3. Capitalised Earning
  4. Excess Earning
  5. Cash Flow.
  6. Tangible Assets/Cost to Create.
  7. Intangible Assets

1. Quick Estimate

Often used as a guide to the valuation of a small business. It is only a useful starting point as few buyers will pay one year’s earnings before proprietor’s drawings, interest, tax and depreciation (EBPITD).

Useful for strong branded businesses with a real goodwill factor and transferable long-term contracts. Can also be used for a national franchise or business with high demand

Quick Estimate:

Price of Business = (Plant & equipment + 1 year’s EBPITD.) plus Stock at

Valuation (Cost).

Business which handles a national product and has an exclusive distributorship, produces $100,000 Net Profit (earnings before proprietor’s drawings, interest, tax and depreciation (EBPITD). The plant and equipment are valued at $150,000. The stock on hand cost $60,000. The distributorship is transferable.

Price of Business = $100,000 + $150,000 = $250,000 plus S.A.V $60,000 = total price $310,000

2. Market Average

One of the most common approaches to small business valuation, that I see a lot of brokers use.

The problem with these and all rule of thumb formulas is that they are statistically derived from the sale of many businesses of their type.

You may take statistics for 2 years across 100 lotto shops. Then average the selling price and you have a market average selling price.

However, some of those lotto shops may have sold for twice the market value while others were a quarter of the norm.

We are also aware there can be great variations over a year, particularly if there was an anomaly in one of the years (Covid prices).

In a lot of cases the average is done with nothing more statistical than

“Other like businesses in your area are selling for this”

Market averages may be accurate for those businesses whose performances are on par with the average. The business with expenses and profits that are right on target with industry averages may well sell for a price in line with market averages.

Market averages are a good starting point for valuation. Check to see how closely your firm’s financial performance stacks up to the market averages.

3. Capitalised Earning

Capitalisation refers to the return on investment that is expected by an investor.

The capitalisation rate is determined by learning what the risk of investment in the business would be in comparison to other investments

Capitalisation rates of 20% to 50% are common for a small business calculation. That is, buyers will look for a return on their investment of 10% to 50% (depending on risk) in buying a business after a suitable wage is deducted from the EBPITD.

Best for valuation of businesses that have fixed assets with low wage impact.

A vending machine has been collecting money at the rate of about $86,500 per year steadily for ten years with very little variation. It is likely to continue to collect money at this rate indefinitely.

At the 20% low risk rate, for someone to earn the same $86,500 per year the vending machine earns, an investment of $432,500 ($432,500*20%=$86,500) would be required. Therefore, the amusement machine business value is in the area of $432,500.

This does not include a fair salary for the new business owner

Let’s assume a $30,000 salary to manage the machine.

$86,500 Net Profit (earnings before proprietor’s drawings, interest, tax and

$30,000 Wage depreciation (EBPITD)).

$56,500 divided by 20% = $282,500 being the business value

4. Excess Earning

Like the capitalisation method. The difference is that it splits off return on assets from other earnings.

Let’s assume a vending company has tangible assets of $120,000.

The owner takes $30,000pa as salary

After paying the salary of $30,000 from his $86,500 net (EBPITD) The business has earnings of $56,500 net.

Assume a reasonable return on Tangible Assets of 15% per year

A reasonable number here should be based on industry averages for return on assets adjusted to current economic conditions.

Alternatively, an appropriate return on asset figure is to use a rate 3 to 4 points above the current bank rate for a small business loan, or about 6 points above the current prime rate.

Business profits are derived from the tangible assets of the business ($120,000 x 15%= $18,000) The other $38,500 ($56,500­$18,000=$38,500) in earnings are the excess earnings).

This $38,500 excess earning number is typically multiplied by a factor of 2 to 5, based on such factors as the level of risk involved in the business, the attractiveness of the business and the industry, competitiveness, and growth potential. The higher the factor used, the higher the estimate of the business will be

Assume the business is better than average in these factors and assign a multiplier of 4. Therefore, the value of this business can be determined as follows:

  1. Fair market value of tangible equipment (plant & equipment) Equals $120,000
  2. Total Earnings Equals $56,500
  3. Earnings attributed to Tangible Assets ($120,000*15%) Equals $18,000
  4. Excess Earnings (B – C) ($56,500 – $18,000 = $38,500)
    Equals $38,500
  5. Value of excess earnings (D X multiplier) ($38,500 x 4) Equals $154,000
  6. Estimated Total Value (Tangible Assets plus value of excess earnings) Equals 120,000 + $154,000 = $274,000 Being the Business Value

5. Cash Flow.

Ideal in valuing online businesses that have no real equipment nor stock overhead but generates revenue through no asset sales.

Businesses can be evaluated by determining how much of a loan the net profit will support. That is, they will look at the net profit (EBPITD)) and subtract from this net profit an estimated annual amount for equipment replacement. They will also adjust the net profit by subtracting a fair salary or at least an acceptable salary for the new owner.

The adjusted net profit number is used as a benchmark to measure the firm’s ability to service debt. If the adjusted cash flow is, for example, $100,000 and prevailing interest rates are 10%, and the buyer wants to amortize the loan over 5 years, the maximum a buyer is willing to pay for the firm would be about $253,000. This is the loan payment that $100,000 would support over 5 years.

6. Tangible Assets/Cost to create

Used when a business is worth no more than the value of its tangible assets. This would be the case for some businesses that are losing money or paying the owner’s less than fair market compensation.

Valued at the best possible price for the asset list. Also take into consideration any leasehold renovations you have done.

When buyers do an evaluation, they should consider the costs to create what you already have in place and buy accordingly.

Very applicable to restaurants and cafés, where the general fit out costs can run as high as $250,00 before you open the doors.

Unfortunately, it is very rare you will recoup all these initial costs but need to be factored into your sell price.

When selling a software business, many buyers will purchase the licenses and copyrights as the time to develop themselves can take years or not at all.

They will buy the business based on their projected costs

7. Intangible Assets

Based upon the buyer’s buying a wanted intangible asset versus creating it. Many times, buying can be a cost efficient and time saving alternative.

Commonly used in the acquisition of a customer base. Customers with a high likelihood of being retained are valuable in most industries.

Consider an accounting firm with a $100,000pa turnover.

No. of clients, client break up:

  • SMSF -1
  • Trusts -11
  • Partnerships -3
  • Business -44
  • Individuals284

Because of the large individual customer ratio, the value may only be 70% of the total revenue.

An increase in SMSF or business can increase this value to 100% of the turnover

This approach can also apply to insurance agencies, employment agencies, real-estate agencies (property management), advertising agencies, payroll services, and bookkeeping services.

Primarily businesses that are bought and sold for their customer base.

Conclusion

There is no golden bullet to valuing a business sales price.

The above is differing approaches to get an estimated value.

Ultimately if you can explain an in-depth approach to how the business value was decided, you will be in a much better place in achieving a satisfactory sale.

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Buying a Business

Buying a Business

The beginning of a journey

Starting your own business can be one of the most exciting times you will have in your work career. It can also be the most stressful.

Doing your research and following a system can certainly help relieve some of that stress.

Firstly analyse the reasons why you are doing this

  • If you had a bad day at work and want to leave your boss
  • You think it will be easy
  • You want to work set hours
  • My friends make good many working for themselves

You are probably not doing it for the right reasons

  • If you want the freedom to develop your own ideas
  • You understand workdays can be 24 hours
  • You are looking for long term financial independence
  • The thought of small business excites you

Congratulations. This is a great start.

Starting from scratch

Most people’s first thoughts are generally to take their skills and build a business from scratch. You can develop your own ideas and build the company from the beginning in your image.

You may have an idea that is unique to the sector you are targeting, making finding something established impossible.

This is the unicorn that everyone is looking for.

There can also be distinct disadvantages. Building a customer base, promotion of the brand, finding employees and most importantly, establishing cashflow all without reputation takes more time than most realise.

This can also make it very hard to access finance for expansion

Existing Business

If you have done your research, buying an existing business is less risky than starting your own.

The initial establishment has been done with an established customer base, employees will be in place and familiar with day to day operations.

Proven financial records will be available, with cashflow concerns lessened by having an existing market for your products/services.

Buying a business can also give you access to any patents or copyrights, databases and social media. All of these can be very profitable for the incoming owner

Of course, there are downsides. Cost is always the first hurdle. But consider financing from banks or investors are generally easier accessed when you have a proven track record.

You may lose some clients who are attached to the previous owner, staff may leave or react badly to new owners, inventory or methods may be outdated.

Ensuring you have the right business comes down to you. Getting as much information as possible will alleviate these concerns.

The right business

I’m buying a bar

Ok. So I’m guilty of this. Having a love of music and talking to people, this seemed the perfect fit.

Having never tapped a keg, made a cocktail or cooked for an audience, should have rang some warning bells. But above all of this, not having worked in hospitality was the biggest learning curve.

It was an intense two and a half years of learning. The biggest being. Hospitality is really hard work.

Buying the perfect business starts with choosing the right type of business for you.

Give a lot of thought to the business you want to be in

  • are you physically, financially and emotionally suited to the business
  • have the necessary skills, experience, time, resources, vision and commitment to make this business a success
  • will benefit from this opportunity, bearing in mind your personal circumstances.
  • the geographical area where you want to own a business

Once you’ve chosen a region and an industry to focus on and determined your price point. Its time to see what’s on offer. Business for sale sites are generally the best way to start. Many recommend local papers. I would discount this as most areas no longer have local papers.

Not all businesses are listed for sale. In fact some businesses don’t think about selling until someone asks. The right offer at the right time can certainly provoke interest.

Contact a business broker. The assistance brokers can offer, especially for first-time buyers, can prove invaluable

  • Prescreening. Brokers will have obtained financial statements, contracts and settled on a fair selling price with the seller. Staffing, assets and possible expansion possibilities will also be available.
  • Helping you pinpoint your interest. Finding your skills, interests, geographical preferences and budgets, then helps select the right business for you. With the help of a broker, you may discover that an industry you had never considered is the ideal one for you.
  • Negotiating.  They help both parties stay focused on the ultimate goal and smooth over any problems that may arise.
  • Assisting with paperwork. Staying up to date with the latest laws and regulations affecting everything from licenses and permits to financing and escrow. Working with a broker reduces the risk that you’ll neglect some crucial form, fee or step in the process.

Analysing the business

Get out your microscope

Our analysis starts with some basic questions.

  • Why is this business for sale?
  • What is the general perception of the industry and the businesses position in it
  • What is the future outlook
  • Is the business profitable Will it continue to be profitable?

Assess the company’s reputation and the strength of its business relationships. Talk to existing customers, suppliers and vendors about their relationships.

Look to social media accounts. You will find a wealth of information on customer feedback, business history and penetration in their market.

Once you have satisfied your initial analysis. Examine the asking price to potential returns. Assessments should include financial health, earnings history as well as tangible and intangible assets.

Request a copy of

  • financial statements
  • balance sheets
  • income statements
  • BAS statements
  • Cash flow statements
  • Legal contracts (leases, patents, etc)

It’s always advisable to have your accounting team examine all the above. This will give you a thorough understanding of the business to determine the likelihood of its future success.

Stespar Business Services can also conduct full credit checks to reveal any payment defaults, holds on assets or legal proceedings.

When due diligence is done, you will know just what you are buying and from whom.

Due Diligence

Gathering Information. Evaluate

Before making an offer. Make sure you are fully informed of everything

Inventory. You should have a list of all things that are offered in the sale. Now is the time to do an inspection of the premise and confirm the list. Take a copy to the site, check it off against your list. Take lots of pictures.

You should know the

  • Status of inventory,
  • What’s currently on hand
  • How old is it?
  • What is its quality?
  • What condition is it in?

You don’t have to accept the value of this inventory: it is subject to negotiation. If you feel it is not in line with what you would like to sell, or if it is not compatible with your target market, then bring those points up in negotiations.

2. Assets. This includes all products, office equipment and assets of the business. Take into consideration all the inventory information but include

  • Are the assets purchased or leased?
  • Have investments been made on improvements and maintenance?
  • What changes will you have to make to suit your

3. Contracts and legal. This list can be exhaustive. Here are some of the most important to consider.

  • lease and purchase agreements,
  • distribution agreements,
  • subcontractor agreements,
  • sales contracts,
  • employment agreements
  • business name statements,
  • articles of incorporation,
  • registered trademarks,
  • copyrights, patents, etc.

If you’re considering a business with valuable intellectual property, have an attorney evaluate it. In the case of a property lease, investigate the steps to transfer, how long it runs, its terms, and if the landlord needs to give permission for transfer

4. Inc. If the company is a corporation, where is it registered, are there any decisions against it or pending or is it foreign owned

5. Tax returns. Some small business charge against the business for personal needs. Go through statements and spend the time with your accountant to isolate these charges

6. Financial statements. Compare statements, including all books and financial records, to their tax returns. Have your accountant compare these ratios to other businesses in your industry

7. Sales records. Evaluate the monthly sales records for the past 36 months or more. If more than one product, break down by product. What is the cash ratio of all sales? How do these compare with industry norms?

Who contributes to the revenue of the business? Does one customer give 100% sales or are there multiple customers contributing. What is the breakdown for top 10 customers?

8. Liabilities. Has the owner used assets such as capital equipment or accounts receivable as collateral to secure short-term loans, if there are liens by creditors against assets, lawsuits, or other claims? Are there any unrecorded liabilities such as employee benefit claims, out-of-court settlements being paid off?

9. All accounts. Break them down by 30 days, 60 days, 90 days and beyond. Checking the age of receivables/payables is important in determining how well cash flows through the company.

You should also make a list of the top 10 accounts and check their creditworthiness.

If there are payables older than 90 days. Check if any security on property has been registered

 10. History.  Is the industry or market segment growing or declining or stagnant? Disruption across industries is rapidly changing market sectors (Think Blockbuster or films for cameras)

11. Location Location Location.  This is especially important to retailers, who draw most of their business from the primary trading area. Is the market you cater to primarily located in one area? Are there are any special requirements for delivering the product, or any transportation difficulties encountered by the business in getting the product to market?

12. Reputation. How is the business perceived by your customers? Everyone believes they are doing a great job. But not everyone agrees with you. Check social media comments. Talk to the industry or customers of the business if possible

13. Customer by owner. Are the customers of the business related to the owner or have a loyalty that will take them elsewhere once the owner leaves? If a major client is close to the owner, they may take the opportunity to change camps one the owner is gone

14. Employees. Last on the list but the most important asset to any business.

Keeping staff is always preferable when coming into a new venture. It is important to get an idea of who will stay with the company one the owner leaves

Look at the management practices of the company and know the wages of all employees and their length of employment. Examine any management-employee contracts that exist, as well as details of employee benefit plans.

The Offer

“It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.” Warren Buffet

No decision is more emotionally charged. No decision needs less emotion than any other when deciding upon a price for a business.

The owner has one idea of how much the business is worth, that is usually based on the time they have spent, financials, debt owed, retirement needed the blood sweat and tears they have shed.

The buyer will typically have another viewpoint.

Frankly they can’t value your time and hard work, what you need in retirement or the debts you have incurred

The buyer wants to negotiate the very best price they can for the assets involved and a chance to recuperate their initial purchase price in 18 months.

Each party is dealing from a different perspective and usually with high emotion.

Remember price is a very hard element to assess. It is up to the buyer to consider factors that will influence price, such as

  • economic conditions.
  • Motivation
  • How badly does the seller want out?
  • Does the seller have many personal financial problems?
  • Is there a partnership break down?

Deciding on a price, however, is just the first step in negotiating the sale.

Remember, you have the option to walk away from a negotiation at any point in the process if you don’t like the way things are going.

Just because you spent a month looking at something doesn’t mean you have to buy it. You have no obligation.

Mistakes. We all make them

Anxiety, impatience, emotion, or lack of research isn’t going to help you buy a business. Take your time. Recognize that there’s always time to reflect on the business that’s for sale.

Some of the more common mistakes are:

  • Buying on price. Buyers need to consider ROI. If you’re going to invest $20,000 in a business that returns a five-percent net, you’re better off putting your money in stocks. Usually if a price is too good to be true, It generally is
  • Cash. Some buyers use all their cash for the down payment on the business. They fail to predict future cash flow and possible contingencies that might require more capital. You need cash to operate and grow your business. How else will you ensure you’re able to purchase supplies, pay your rent, advertise, hire employees or take care of the myriad other business activities that require money?
  • Verify all data. Many business buyers accept all the information and data given to them by the seller at face value. Use your team to verify everything. You pay accountants and solicitors for a reason. They are the very best at analysing the fine print without emotion getting in the way.
  • Overextending. New business owners often overestimate their revenue during the first year and take on unduly large payments to finance the buyout. Revenue can be affected in the first year of any operation, non-recurring costs such as equipment failures, employee turnover, etc. Ensuring you are within your payment structure is crucial for any business
  • Sellers are human too. People sell businesses for many reasons. Because it’s for sale doesn’t mean they are desperate or need to sell it to you.

Often, the buyer will be cold, rigid and hard-headed.

Just because you have some money and may be interested in purchasing the business, that doesn’t mean that you aren’t going to have to give a little in the process of negotiation.

Transition

To ensure a smooth transition, start the process before the deal is done. Spend some time talking to key employees, customers and suppliers before you take over; tell them about your plans and ideas for the business’s future.

Most sellers will help you in a transition period during which they train you in operating the business. This period can range from a few weeks to six months or longer. After the one-on-one training period, many sellers will agree to be available for phone consultation. Make sure you and the seller agree on how this training will be handled and write it into your contract.