Valuation by net profit...

[TinTin10]

Is there any way to roughly judge the value of a business based purely on its net profit?

 

[Scalloway]

How to do a business valuation based on profit multiplier. However this is only one of several methods of valuation.

http://smallbusiness.chron.com/business-valuation-based-profit-multiplier-36490.html

 

[Clinton]

Is there any way to roughly judge the value of a business based purely on its net profit?

No.

You can't "roughly judge" the value of a business!

 

[TinTin10]

No.

You can't "roughly judge" the value of a business!

Ok. Says in that article that 'there is no such thing as an accurate valuation of a business' either!

So how do I/how much is it going to cost me to get the idea of the value of a business I may be looking to purchase !

 

[Scalloway]

1. Decide how much you want to pay for it
2. Ask the owner how much they want for it
3. If 2 is greater 1 negotiate until you meet in the middle.

 

[Clinton]

So how do I/how much is it going to cost me to get the idea of the value of a business I may be looking to purchase !

If you don't know how much the business is worth to you, then my advice is to not buy the business.

For large deals you call in the corporate finance team, the risk assessors (and other professionals) to calculate free cash flow / liquidity, various financial ratios and to quantify areas of risk and the probabiity of those risks materialising. Then you put it all into a computer, together with your cost of capital, deal execution costs, risk mitigation inputs (earn-outs, seller note etc) and other information. The compuer calculates lots of other numbers for you.

Then you ignore all of that and go with whatever figure your gut tells you.

But, sure, you can pay a qualified valuer to come up with a valuation report. It ain't cheap. If you have a four figure sum you're willing to throw at a valuation, send me a DM and I'll introduce you to qualified valuers (as I've stopped doing valuations myself - they take too much time to do properly).

Ok. Says in that article that 'there is no such thing as an accurate valuation of a business' either!

I know, I wrote that article.

 

[TinTin10]

If you don't know how much the business is worth to you, then my advice is to not buy the business.

For large deals you call in the corporate finance team, the risk assessors (and other professionals) to calculate free cash flow / liquidity, various financial ratios and to quantify areas of risk and the probabiity of those risks materialising. Then you put it all into a computer, together with your cost of capital, deal execution costs, risk mitigation inputs (earn-outs, seller note etc) and other information. The compuer calculates lots of other numbers for you.

Then you ignore all of that and go with whatever figure your gut tells you.

But, sure, you can pay a qualified valuer to come up with a valuation report. It ain't cheap. If you have a four figure sum you're willing to throw at a valuation, send me a DM and I'll introduce you to qualified valuers (as I've stopped doing valuations myself - they take too much time to do properly).


I know, I wrote that article.

Thanks for explaining that.

The business, to me, is essentially a fully operational version of what I am trying to build in another part of the country. So I could definitely benefit from the knowledge and experience that would be passed along with the business, so as I can avoid those mistakes in any further branches.

To give you an idea, the business turns over around 230k. Net profit on this is 75k. I have been offered the business for 150k.

 

[KAC]

Is it a limited company or a sole trader? Is the net profit after tax? Is it after a salary for the owner or is the £75K the return before a reward for the owner's time and risk? Would you be acquiring any fixed assets? Does the business rely on the input of the owner? Will any customers leave after the sale and if so why?

 

[Clinton]

Net profit is kind of a pointless figure unless you know what it comprises, what was included and what was left out. Ideally, you need to redo the accounts and calculate what profit the business is really generating. The figures supplied to Companies House / HMRC are rubbish at telling you the state of the business!

@KAC asks some good questions. I could come up with another 100 or so essential questions to get the investigation started. There's a lot to be checked out when buying a business!

If you haven't bought a business before I would strongly urge you to hire someone to assist, someone who knows what they're doing. (I'm fully booked up at present so probably wouldn't be able to help but I could take a quick question or two here or on the phone.)

 

[TinTin10]

I thought this might be an easier way! Seems as though I was sorely mistaken!

The 75 without the owner taking salary, however it is after the senior managers salary. The owner oversees the business remotely.
It has just taken on a new 5 year lease on the location.
Physical assets would be included, no premises as such but a kiosk and all the necessary equipment to operate the business.
The brand will remain, so I dont think customers would leave if the business were to change hands, as id look to continue with the original staff.

@Clinton - would it be sufficient for my own accountant to go through the books? Or would you suggest someone who mainly deals with these types of situations?

Thanks for all your input all.

 

[ethical PR]

If the 75k is without the owner taking the salary, then it's not net profit.

Say the owner takes 60K (not unreasonable for a business owner) you would be looking at 15K not attractive for a business that employs senior managers.

 

[Clinton]

@Clinton - would it be sufficient for my own accountant to go through the books?

Yikes!

Two problems there. First, no, the average accountant is geared to services such as saving businesses taxes, he is not a forensic expert!

Secondly, the accounts are but one small part of the due diligence. There are operational matters that need to be examined, employee contracts that need to be vetted, personal guarantees the owner has given out that need to be rescinded, a lease contract that needs to be examined for ease of assignment (and then assigned) ...like I said, at least one hundred things that need to be checked out!

The 75 without the owner taking salary...

Then those profit figures are even further away from the true state of affairs.

 

[TinTin10]

Wow.....looks like il just stick to my own business for the meantime then! \

Thanks for the help.

 

[Clinton]

You shouldn't be put off buying a business, you just need to appreciate that you need the right advice. Buying a business is a big deal, and complicated. If you've never done it before you need to hire the right adviser. That costs money. Pay well, get the best. It would be a mistake to try and do it on your own.

Buying a business is still the best way to expand. Done properly, inorganic growth is the cheapest way to grow a business.

 

[TinTin10]

You shouldn't be put off buying a business, you just need to appreciate that you need the right advice. Buying a business is a big deal, and complicated. If you've never done it before you need to hire the right adviser. That costs money. Pay well, get the best. It would be a mistake to try and do it on your own.

Buying a business is still the best way to expand. Done properly, inorganic growth is the cheapest way to grow a business.

Could you give me a ball park figure?

 

[SteveHa]

I actually you can get a decent idea of a company's value using one of the established methods (multiple of EBITDA etc.), but that will not give an indication of a company's worth. It's worth can only be established by the offering of, and acceptance of a price at which it will be purchased.

 

[quikshop]

I was surprised and really quite sad this weekend to see a business I tried to buy last year plastered with closing down signs and the shop advertised as leasehold available.

I offered 1*net profit plus a net profit share of revenue from existing stock over the first 12 months of trading. It would have netted the owner circa £50k in total but his broker was insisting on a £90k up front purchase.

Poor fella will be walking away with broken dreams from his 'retirement' business and a load of old stock he'll no doubt offload for peanuts or nothing at all.

That's the first time I've been unable to get passed the emotional value of a long time proprietor of the business, but I've always had to overcome an element of that.

As others have said, the worth of a business is what you are prepared to pay for it in return for its revenue, assets, brand awareness, reputation, customer dbase, potential synergies etc.

 

[Clinton]

I actually you can get a decent idea of a company's value using one of the established methods (multiple of EBITDA etc.),

I beg to differ.

An "established" method - like multiple of EBITDA - is largely nonsense, especially in the context of smaller businesses. EBITDA itself is highly discredited as a measure of anything useful, but close your eyes to that flaw and you still have major problems with these "established" methods especially as risk is highly variable from one small business to the next and, unlike with larger businesses, is highly subjective. Risk is, of course, is a major component in value calculations.

And that's before we come those assets whose value is not fully represented in the earnings.

I've had some interesting discussions on valuation with a lot of highly qualified valuers and have spoken with world experts on the subject - like Prof Damodaran and Chris Mercer and Chris Thorne, Technical Director of the International Valuation Standards Council (who has kindly written an article for my website) - and the more I speak with people like these the more I realise that those "established" methods are really just ridiculous, silly, dumbed down rules of thumb that are themselves worthless. This is a personal bug bear - business owners who've heard some rubbish about the value of a business being 5x net profits (or 8x or 3x or whatever) and who then think they know the market value of their own business.

Could you give me a ball park figure?

No. Let's put it this way, if you need to ask the price you probably can't afford it. Good advisers cost a lot of money. I know a few and they work for UHNWI, family offices and the like. They are not cost effective if you're looking to invest just a couple of hundred thousand. For smaller businesses you may find a good buyside broker or have a friend who has bought a few businesses and can advise on the deal (together with a good accountant and solicitor), but I can't give you a figure or a "ball park" when it comes to cost.

 

[Deleted member 59730]

A business is worth what you can improve on. If your idea is to leave it as it is why bother?

 

[TinTin10]

No. Let's put it this way, if you need to ask the price you probably can't afford it. Good advisers cost a lot of money.

Ah....so if youre rich then you dont really ask how much services are going to cost you?

Got it. Appreciated the input til now.

 

[Clinton]

Ah....so if youre rich then you dont really ask how much services are going to cost you?

You got it in one.

For someone looking for the perfect "mid-cap" (£100 million or so) investment opportunity, and who has well defined criteria for what he wants in an acquisition target, it doesn't matter too much whether the adviser charges £50K or £250K. The important thing to the investor is finding the right person rather than starting with the right fee. Once they find the right person they'll pay whatever that person's standard fees are (in addition to all the other fees they pay to legal, corporate finance and other professionals).

There are a few such advisers who operate in the lower mid-market space (under £10 million) but I don't know anyone who advertises services in this area for the micro businesses (under £1m).

 

[Clinton]

A business is worth what you can improve on. If your idea is to leave it as it is why bother?

There are several good reasons.

For one, spreading risk - buying a business is a related sector builds resilience.

Sometimes it's to get your hands on their customer list so you can target those customers with your own products.

Another one: I've bought businesses for their deteriorating assets. For example, many years ago I bought a Windows 98 support website. This was after ME and XP were released. The site was still earning money but it was on a downward trajectory. Earnings kept dropping till they eventually reached £0, but that was fine as the price I paid was calculated based on that expectation. I made about 3x the price I paid for that business.

There are all kinds of reasons to buy a business and leave it as it is.

 

[The Byre]

We have had a spate of these questions about buying micro-businesses lately and TBH, @Clinton has outlined the dilemma - due diligence know-how is expensive and totally out of the question for buying small retail units, or on-line shops selling under £1m p.a.

Even first class due diligence is no guarantee that something vital will be missed. I guy I know sold his Manchester electronics company for a few million to a US international and they had a whole team of MBAs crawling all over everything - but they still missed the fact that all the intellectual property (mostly patents and designs) were either on a limited lease from a friend, or had been parked in another company and had less than five years to run, before the contracts ran out.

So as Cinton says - read those contracts and talk to everybody in and around the business about what could really be going on!

One thing I can say is that your figures seem strange - net profit of over 30% is massive, yet this goldmine is being sold for just two years of net profit! Why are the owners selling a goldmine? Something somewhere is not being included in those figures! Something is being hidden - your job is to find whatever it is that they are hiding. Either that, or the meaning of the words 'net profit' is being bent out of all recognition!

But then maybe this is the chance of a life time, but you know what they say - if it looks too good to be true . . .

Tip 1: When I look at a company, the very first thing I do is look at the people involved, check their trading history, look at what other companies they own or have owned in the past and check their credit history. I am looking for the typical warning signs such as a string of failed companies, delinquent liquidations, any sign of them being dodgy or trying to hide who they are and what they are really up to. If anything looks even slightly fishy, I don't want to deal with them.

Tip 2: It is the dream of every owner of an SME to build up a company to a certain size and then inflate the value by fair means or foul and sell the thing off to the first poor sap that comes along!

 

[Deleted member 59730]

Sometimes it's to get your hands on their customer list so you can target those customers with your own products.

Exactly my point!

 

[TinTin10]

Thanks all for the input.

Think ive got some work to do here!