How do you value a business?
- Thread starter LED
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LED, there are numerous ways to value a business, and I can only give you the briefest outline here. It is worth taking your accountants advice.
Generally valuations depend on a combination of factors such as the value of assets less liabilities, and the reasonable expectation of future cash flow. This later component is the so called goodwill of the business and varies hugely according to the buyer's perception of risk. For example, the risk associated with many retail businesses is much higher than it was just a year ago, and values have dropped disproportionately.
No two valuers will come up with the same answer, however. Yes, there are some short cuts (such as multiples on profit) that people talk about, but again there is no standard and multiples vary hugely. As vvannmmaann correctly says, a business is only worth what someone will pay for it, and this is generally a lot less than an owner thinks its worth.
First understand precisely what is for sale - eg is stock included or the property, and what liabilities - eg potential bad debts. (NB. You will need to get an accountant to do due diligence on this before you finally agree any purchase - they should also be able to advise on valuations.)
Then work out the level of free cash flow at the end of each month once all costs have been considered and once you have factored in a salary for yourself. Is this a stable figure or is there a trend up or down or does it trend by season? What are the business risks?
Then look at how you would fund the purchase and the "cost" of the money either in terms of interest costs or loss of earning from money you have being tied up in the purchase. This will start to give you a sense of what the business is worth to you, but also work out what other similar businesses have sold for.
One thing is clear, however, we're still at the start of a brutal recession. There are not many buyers at the moment, so get the seller to justify the logic of his price and with a bit of probing you'll soon start to uncover the problem areas. It's a buyers market and cash is king, so negotiate hard!!
Hope this helps, good luck.
Generally valuations depend on a combination of factors such as the value of assets less liabilities, and the reasonable expectation of future cash flow. This later component is the so called goodwill of the business and varies hugely according to the buyer's perception of risk. For example, the risk associated with many retail businesses is much higher than it was just a year ago, and values have dropped disproportionately.
No two valuers will come up with the same answer, however. Yes, there are some short cuts (such as multiples on profit) that people talk about, but again there is no standard and multiples vary hugely. As vvannmmaann correctly says, a business is only worth what someone will pay for it, and this is generally a lot less than an owner thinks its worth.
First understand precisely what is for sale - eg is stock included or the property, and what liabilities - eg potential bad debts. (NB. You will need to get an accountant to do due diligence on this before you finally agree any purchase - they should also be able to advise on valuations.)
Then work out the level of free cash flow at the end of each month once all costs have been considered and once you have factored in a salary for yourself. Is this a stable figure or is there a trend up or down or does it trend by season? What are the business risks?
Then look at how you would fund the purchase and the "cost" of the money either in terms of interest costs or loss of earning from money you have being tied up in the purchase. This will start to give you a sense of what the business is worth to you, but also work out what other similar businesses have sold for.
One thing is clear, however, we're still at the start of a brutal recession. There are not many buyers at the moment, so get the seller to justify the logic of his price and with a bit of probing you'll soon start to uncover the problem areas. It's a buyers market and cash is king, so negotiate hard!!
Hope this helps, good luck.
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This is a very, very important point. It is highly likely that the accounts you are given by the current owner will be unaudited. It is not at all unknown for a small business owner to have two sets of books especially if a lot of cash passes through the business. Proceed carefully and with your eyes open and get proper professional advice.
"Goodwill" does have a technical meaning. Goodwill is the amount paid for the business over and above the value of its assets.
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There is a member on here called Jim Gold look him up
He will have more exposure to transactions of business sales that everybody on here so he will give you a good guide.
As others have said it still comes down to what you are willing to pay. There are many factors that are way to in depth to go into here and experienced buyers always have their own ways of valuing that may not suit others.
The big rule that over rules all others is
How long is it going to take to get the money you pay back?
Having purchased and started businesses I will always buy going forward as the payback is so much quicker if you buy correct.
What the pay back term is will be different for everyone some see it as a long term lifestyle term thing so the purchase price can be regained over many years. Others like myself will only consider purchases that can pay back in very short periods of time. At present I will consider 24 months but the record has been 1 month
He will have more exposure to transactions of business sales that everybody on here so he will give you a good guide.
As others have said it still comes down to what you are willing to pay. There are many factors that are way to in depth to go into here and experienced buyers always have their own ways of valuing that may not suit others.
The big rule that over rules all others is
How long is it going to take to get the money you pay back?
Having purchased and started businesses I will always buy going forward as the payback is so much quicker if you buy correct.
What the pay back term is will be different for everyone some see it as a long term lifestyle term thing so the purchase price can be regained over many years. Others like myself will only consider purchases that can pay back in very short periods of time. At present I will consider 24 months but the record has been 1 month
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