Purchase Price for an Existing Business - is there a formula?

[Feldon]

I am looking at all possibilities at the moment including setting up a retail business from scratch but am also considering buying an existing business providing it is profitable and is close to my ideal business idea.

I've found a few businesses that fit this criteria but the asking price can vary enormously, so ignoring the asking price as this might be wishful thinking on part of the seller, is there a way of working out a realistic and fair price to base an offer on? i.e net profit x ?

 

[Bob]

is there a way of working out a realistic and fair price to base an offer on? i.e net profit x ?

Not really except for quoted companies. Small business valuation is more of an art than a science. You just have to do your own calculations as to whether the business is likely to be a good return on your investment and carry out all the due diligence reviews to ensure that the figures are accurate

 

[Feldon]

Do you know how business transfer agents work out selling price, at least that will give me a starting point. I realize it is a bit of an art form and i have brought and sold retail shops before but that was a few years ago now and so might be a little out of touch.

 

[saffyyousaf]

I would look at how much it would cost you to set that business up from scratch.
I would look at turnover and profit of that business.
then add 2 years profit plus the set up cost and that's the value of that business or I wouldn't pay more than that.
this is my way and doesn't mean its right.

 

[KeithGreen]

Small retail businesses (owner run) are usually valued at 1-2 times net profit before tax plus stock at value.
They never usually sell for the asking price. Sometimes the stock is discounted also.
Remember to add all of your other costs to your calculations i.e. legal fees, possibly accounting fees, apportioned rent, any costs associated with transferring suppliers to yourself and so on.

 

[Pish_Pash]

Small retail businesses (owner run) are usually valued at 1-2 times net profit before tax plus stock at value..

That seems strange. Are you seriously telling me that I'm working 18 hours a day to create wealth for my family ...& then after say 3-4 of profitable trading, all I will get for the fruits of my labour is one years net profit?!

If that's the case, then anyone starting up their own business from scratch is totally lady gaga. If true, I should never have started a business, but instead should have let some other sucker do the donkey work getting a business up & established & then just chuck him a meagre 1 years net profit for his effort!

When looking at publicly quoted companies a PE ratio of 8 is considered cheap ...so imagine one share being in issue (as there is with my new company) ...comparably that'd be 8 x my net profit (ok, I realise that multiple would be a bit difficult to entice a buyer) so why the massive differential for a business that's up, running& spinning a profit. I'd have thought at least 3x net profit. therefore a buyer ponies up & after 3 years, he's quids in.

 

[Bob]

A lot also depends upon the type of business and whether any goodwill is freely transferable and attaches to the business or whether some or all of it is personal goodwill attaching to the proprietor

 

[Feldon]

I have decided to start from scratch, as having had my own retail businesses before, both purchased and started from scratch, I know that i would want to put my own mark on an existing business because i would not be happy with some aspect of it or wanted to improve it. Also i have seen a lot of businesses for sale on daltonsbusiness etc where the figures do not stack up. I've come to the conclusion that a lot of businesses for sale are not economically viable and certainly not worth the price they are asking for it. A lot seem to be desperate to just get back the money they have poured into what is basically a failed business. I have also seen many businesses for sale that the owner only purchased a couple of years ago or started then which always makes me suspicious. Why is it there are so many businesses for sale that states the reason for sale is: other business interests, owner emigrating, retirement sale (owner turns out to be younger than me, 47).
Having had a moment of weakness whilst considering purchasing an existing business and hopefully a profitable business from day one but at a considerable higher price than setting up a new business. Yes i know that there are also some genuine businesses for sale, but isn't half the fun building up a business from scratch and making your own dreams come true, not buying someone elses.

Hopefully now going through this exercise i have now found the right choice for me and have identified what i want to do, have found a location with no direct competition in the right sort of area, have a selection of suppliers lined up and have now identified a couple of retail shops that might be suitable, next stage going to book appointment with agent to view these two properties and hopefully set the ball rolling.

 

[Pish_Pash]

Personally, I wouldnt be alarmed over a reason such as owner emigrating (I might find myself in that situation) or other business interests (I myself have a few other things I'd like to startup).... indeed after 3 years, for some, you might say all the fun & zest has started to wane & it's time to move onto to pastures new. If after 3 years I've got a business say making a verified net profit of £100k per annum (& still growing) ...I'll be darned if I'd gift it to someone else for a lowly £100k + stock.

If that's what everyone is saying all I'll get, well I guess I'm in this for the long run! (& I guess I'm now on the lookout for such businesses myself - because with my example, after just 1yr I'm well quids in)

 

[Feldon]

That might as well be Pish Pish the reason it might be making £100K profit might be because of you and take you out of the equation and it might be a completely different story.

 

[Pish_Pash]

So the inference being is that whenever a person 'values' a potential business purchase he should factor in that he might be useless & profits will wane & therefore he should not pay the existing owner so much for the business?!

That doesn't cut much mustard...at the point of sale, the business in spinning a £100 net profit....if I were selling such a business, I'm not going to accept a low value for it, because the next guy might not be 'canny' or as good etc.

 

[AllUpHere]

So the inference being is that whenever a person 'values' a potential business purchase he should factor in that he might be useless & profits will wane & therefore he should not pay the existing owner so much for the business?!

That doesn't cut much mustard...at the point of sale, the business in spinning a £100 net profit....if I were selling such a business, I'm not going to accept a low value for it, because the next guy might not be 'canny' or as good etc.

It completely depends on the business type. I can easily do 100k profit per year, but my business (as a business) is worth nothing to anyone else.

 

[Talay]

Do you know how business transfer agents work out selling price, at least that will give me a starting point. I realize it is a bit of an art form and i have brought and sold retail shops before but that was a few years ago now and so might be a little out of touch.

They make it up, they cohort with the vendor to publish a fictitious "value" and a lie of a reason for sale and then hope to hook some fool into buying so they can get a sky high commission.

Some just publish whatever the vendor asks with no and I mean absolutely no checks.

It is not an art as most businesses for sale are not really businesses at all but glorified "jobs" where they could not stand alone if the vendor withdrew from the "business".

Some are ethical. The "art" is finding one.

 

[Talay]

That seems strange. Are you seriously telling me that I'm working 18 hours a day to create wealth for my family ...& then after say 3-4 of profitable trading, all I will get for the fruits of my labour is one years net profit?!

If that's the case, then anyone starting up their own business from scratch is totally lady gaga. If true, I should never have started a business, but instead should have let some other sucker do the donkey work getting a business up & established & then just chuck him a meagre 1 years net profit for his effort!

When looking at publicly quoted companies a PE ratio of 8 is considered cheap ...so imagine one share being in issue (as there is with my new company) ...comparably that'd be 8 x my net profit (ok, I realise that multiple would be a bit difficult to entice a buyer) so why the massive differential for a business that's up, running& spinning a profit. I'd have thought at least 3x net profit. therefore a buyer ponies up & after 3 years, he's quids in.

Surely your due diligence into the sector would have thrown up this spanner in your works ?

Is it a business or a jobs with some staff ? Probably a job really. If it is a true stand alone business with management and staff then you will be paying more. If it is a glorified job then the purchase price will be much much lower.

I'm negotiating to buy a 20+ year old business which turns over the thick end of £400k and net over £100k but the price is only around £100k. Why ? because the current owner works in the business and when you replace him, either with yourself or in my case with a manager, the net falls significantly.

Unfortunately, whilst I can manage more than one business at one time from an ownership point of view, I cannot yet physically manage multiple businesses at different sites all at the same time. Hence the need for managers and lower net profits.

 

[Pish_Pash]

What you speak of is more akin to an investment - you want to buy something & have someone else run it...& you're prepared to pay a premium for that scenario. Call me naive, but I'd have imagined most folks buying a business would expect to be involved heavily in business...whether a staff of 1 or a staff of 20...when the present owner leaves, the new buyer 'rolls up his sleeves' & enters into the business. Therefore - to my eyes at least - it doesn't matter whether it's a business of one person or not (just so long as the skills are transferable to the new owner)

As for buying a business that has a dependable £400k turnover & nets £100K....snap it up, cos in an environment of 1-2% returns for your money on deposit...even putting a manager in at £50k a year will sees 25x more than what you could get on deposit!

 

[Rhyl Lightworks]

Assuming the business is a bricks and mortar retail business doesn't which part of the country and where in that part of the country come into it?

 

[Talay]

What you speak of is more akin to an investment - you want to buy something & have someone else run it...& you're prepared to pay a premium for that scenario. Call me naive, but I'd have imagined most folks buying a business would expect to be involved heavily in business...whether a staff of 1 or a staff of 20...when the present owner leaves, the new buyer 'rolls up his sleeves' & enters into the business. Therefore - to my eyes at least - it doesn't matter whether it's a business of one person or not (just so long as the skills are transferable to the new owner)

As for buying a business that has a dependable £400k turnover & nets £100K....snap it up, cos in an environment of 1-2% returns for your money on deposit...even putting a manager in at £50k a year will sees 25x more than what you could get on deposit!

Your arguments are all over the shop but to assist:

All business is an investment

I am not paying a premium, I'm replying to your previous post where you don't understand how things are valued and more importantly, why.

To your eyes at least, it doesn't matter whether a business has a staff of 1 or 20 ? not sure you comprehend all the nuances of business, risk, reward, etc.

Lastly, your comparison of a return from a business versus putting the money on deposit is massively flawed. On the one hand we have zero risk versus significant business risk with hundreds of variables and significant forward liability. You also fatally fail to comprehend the opportunity cost of using that capital elsewhere and the cost of my time to set up, complete and manage the deal.

It isn't the same as Amazon, Ebay etc. when you have staff and so forth - the risks (and thus the rewards) and multiplied.

 

[Pish_Pash]

All business is an investment.

When most speak of investments, they talk of bonds, stocks, gold & even building societies. i.e. dump your money into the vehicle & then wait for a return. If you aren't going to be running the business (i.e. replacing the owner), then that makes your business purchase more akin to a pure 'investment' (as opposed to rolling your sleeves up & getting stuck in).

That's what I meant. Of course a business is an 'investment' - can you please take your patronising cap off?

I am not paying a premium, I'm replying to your previous post where you don't understand how things are valued and more importantly, why.

I was extrapolating that if you seek a lower purchase price for an 'owner run' business where you have to get involved, then you saying you expect to pay less .. so by default you are happy to pay more (a premium) in comparison for a business that is self running/self sufficient.

To your eyes at least, it doesn't matter whether a business has a staff of 1 or 20 ? not sure you comprehend all the nuances of business, risk, reward, etc.

My point was in response to your assertion that if it's an owner run business, it's worth less to you (your argument being you might not be able to run it as well). Whereas I think....it's a one in, one out scenario....if you buy a business the current owner leaves & you take over the reins - it's status quo.

Lastly, your comparison of a return from a business versus putting the money on deposit is massively flawed. On the one hand we have zero risk

Tell that to the people of Iceland or Cyprus

You also fatally fail to comprehend the opportunity cost of using that capital elsewhere and the cost of my time to set up, complete and manage the deal..

(seriously, take that cap off...it's getting on my t1ts) ....nobody died in the line of this discussion....

 

[KeithGreen]

I'm a bit late returning to the discussion but should maybe clarify my earlier post.

A small retail business making (say) £30k - £40k net profit to a working owner would be valued (IMHO) at 1-2 times net profit. Once you start getting into higher profit figures the multiple would usually increase, At £75k+ profit you can start to think about putting a manager in, but if you are paying him/her £40k the return would be £35k and this is the figure you would apply your multiple to.

Of course for the hypothetical business above making £75k profit the buyer may decide to run it him/herself and feel that a price of 3-4 times profit is worth it.

But the question asked at the start of this thread was about retail. I assumed a small retail business i.e. one shop with a working owner and maybe a couple or a few staff - hence my earlier reply.

 

[dooyoo]

When I was a kid I heard that on average investment should pay back 10% annually, and I have always thought that is the case. But it is only money invested, where you sit back and relax.
So if there is a small business and 1 guy is running it and claims he is making 40k a year. But actually puts in 60-80 hours per week, then you would need to see what is the average pay in that field for such a labour, let’s say in this case it would be 25k/year with /40hr/week and there is paid vacation and sick days and so on. So for me this business has no real value, besides the assets it has.
But on the other hand the person has found promises made agreements and found suppliers. Whatever you would pay for that labour invested +assets could be a realistic price. But it all depends, as a brand name alone can be worth something in some cases.
It would depend on many circumstances! Not that easy to apprise ones business.
But I think general rule if you can get your money back within 10 years doing nothing is a somewhat reasonable price.

 

[Philip Hoyle]

As said above, an owner-operated business will command a lot lower value, certainly goodwill in the 1-4 multiple of net profit territory plus stock and F&F at current market value.

You have to remove the owner and their family "notional" wages - so, say a corner shop, if it makes £75k profit by the owner, spouse and their kids running it for pocket money, in reality, if a proper paid manager and staff were used instead, there'd be virtually no profit, so it would be effectively worthless - maybe 1 times profit if you're lucky and can find someone who just wants to buy a job for himself and family.

If, however, that £75k profit was achieved after paying proper staff and management, and the owner and their family didn't take an active part, then it's more likely to sell for 3 times profits or higher. An even higher premium may be available if it was to be bought by a chain or someone who already had a few shops and wanted to add a successful one to his portfolio, to gain economies of scale etc.

At the end of the day, a "one man" business is always going to be very high risk for a buyer. The price will reflect that high risk. Most won't have robust systems, too much will be in their head, the "personal" relationship between the owner and his suppliers and customers will be hard to replicate.

Profit multiples of 6,8,10+ times profits are the stuff of economics textbooks and the stock market.

I agree with another earlier comment about the asking price being based on what the seller needs to sell it for rather than what it's worth. A lot of the time, they want to get back the price they paid for it a couple of years earlier when reality sets in and they realise they overpaid, or they need enough to pay off their loans and overdrafts. Very, very, rarely is it based on any meaningful formula - more like a guess.

And yes, the real prices achieved are often far lower than the asking price. A case I acted for on behalf of the buyer last year, the selling price was £110k and the agreed price was £50k being £25k upfront on purchase and the remaining £25k being repaid on loan at £5k per year for five years, interest free! We've just done the first years' accounts which have showed a £40k profit, so the price was effectively 1.25 net profits.

 

[Talay]

...

And yes, the real prices achieved are often far lower than the asking price. A case I acted for on behalf of the buyer last year, the selling price was £110k and the agreed price was £50k being £25k upfront on purchase and the remaining £25k being repaid on loan at £5k per year for five years, interest free! We've just done the first years' accounts which have showed a £40k profit, so the price was effectively 1.25 net profits.

Yes, often overlooked is the owner financing issue.

However, let's face it, any business requiring owner financing is saying two things:

1) the price being paid is higher than the "buy it now" price.
2) the purchaser is likely undercapitalised.

Earn out purchases are not uncommon for businesses where the owner works. Years ago I did one where it essentially cost nothing over 3 years except a little time. IMHO, owner financing from a buyer's perspective is not a bad thing if the premium to obtain it is not too onerous.