The methodology outlined below is a simplified approach, and since buying a business is a very important step and each individual’s circumstances are different, I highly recommend that you speak with a professional advisor familiar with your personal situation and needs. before entering into any binding contract.

VALUE A COMPANY: CRITICAL POINTS

1. There is no right or wrong amount: there is only what you are willing to pay and what the seller is willing to accept; nothing else is relevant.
2. The amount to be paid is based on the CASH you can realistically expect to generate from the business in future years (there are many valuation methods available, from complicated mathematical formulas to a simple percentage of sales. These methods do a good check cross of the suggested method below).

HOW MUCH TO PAY – THE METHODOLOGY

STEP 1: STANDARD BENEFIT

Calculate a “normalized” annual cash profit (before taxes) that the business is likely to make next year based on its past history. This is usually done by starting with last year’s annual earnings and making adjustments for items.

• incurred last year but will not be incurred next year
• will be incurred next year but not incurred last year
• Non-monetary items

Examples of items you could adjust

INCREASE PROFIT BY

• Any wages or benefits paid to the business owner (or people related to the business owner) that will not continue when you own the business. This is not just wages, but retirement, medical benefits, motor vehicles, non-business (or slightly commercial) travel, etc.
• Interest paid and any other financial costs (for which you will not be responsible)
• Depreciation and any other element that is not cash
• Any non-recurring expenses that occurred in the previous year (for example, legal fees in a case that is now settled)
• The expected annual profit of any new (major) customer not included in last year’s sales.

DECREASE EARNINGS IN

• Market salary and benefits payable to you and any partner / relationship who will work in the business (the amount is what you would be paid if the business was owned by a 3^rd party and not necessarily what you will actually get paid)
• Any expenses that will be incurred in future years that are not included in last year’s earnings (for example, business moved to a more expensive location 3 months ago; decrease profit to reflect new rent for the next 12 months less what was paid last year)
• Any income earned last year that would be considered abnormal or likely not to occur next year (eg, a large client was lost to a competitor, a “special” job that will not occur again)
• If there is likely to be a significant capital expense (new equipment) over the next 3-4 years, then an adjustment should be made (usually the cost of the equipment divided by the estimated years it will be used in the business).

At the end of this stage we will have a value that represents the NORMALIZED CASH BENEFIT. This is the amount of profit before income taxes the business is expected to make next year if it continues to operate as it has in the past.

STEP 2: SELECT AN APPROPRIATE MULTIPLE

Books have been written on which multiples to select and why, but here is a RULE OF THE THUMB that has served me well through many purchases. There are 2 ranges

• Smaller business (profit less than $ 100,000) 2 to 3
• Medium Businesses (Earnings $ 100,000 to $ 500,000) 3 to 4

(This methodology is not suitable for larger companies)

STEP 3: CALCULATE THE RANGE OF ASSESSMENT

Multiply the NORMALIZED GAIN calculated in Step 1 by the MULTIPLES in Step 2.

For example, if you had a normalized profit of $ 150,000, the valuation range would be $ 450,000 to $ 600,000.

STEP 4: REDUCE THE RANGE OF ASSESSMENT

To further narrow the range, compile a list of factors that enhance or detract from the certainty that you will get the normalized profit amount calculated in Step 1. Each certainty-enhancing factor will support paying a higher amount in the range. , each factor that detracts from the certainty that supports the payment of an amount less in the range. Depending on the number and importance of the factors in each category, you can adjust the range to the bottom, middle, or top of the previously calculated range.

Examples of factors include

1. Age of business

A business that has been around for 20 years is likely to have more secure earnings and more established in a market than a business that has been around for 2 years.

2. Company size

Generally, the larger the business, the more likely it is to survive any negative events.

3. Certainty of the income stream

There are many items that can enhance or detract from income, including

• Does the income occur naturally each year (for example, an accounting firm that typically sees the same clients for their tax returns each year) V’s woodworking business that receives the majority of its internet advertising clients or in yellow pages?
• Is your revenue made up of a large number of smaller customers or a few larger customers? While larger clients may be more profitable, they are at higher business risk if they take their business elsewhere.

Four. Required working capital

The higher the required working capital (Debtors + Inventory – Creditors), the less you want to pay. Compare 2 identical businesses, the first requires you to have an inventory of $ 200,000, the second has an agreement with suppliers to ship directly to customers. At a minimum, you save $ 200,000 in interest, plus the additional staff needed to receive, pack, and ship stocks, take inventories, and more.

5. Economic factors

What is the outlook for the next 2-3 years? If the economy or industry is likely to worsen, your assessment should be more conservative.

6. Market position / competitors

How safe is the business? Are there many competitors in the industry (many competitors reduce profit margins), are there new competitors and how difficult is it for a new competitor to enter the market, what impact would a new competitor have? have in business.

7. Industry

Is the market growing or shrinking?

For example, there are 2 companies that make identical profits, one sells mobile phone technology and the other sells fax machines. The mobile phone business is likely to grow stronger in the future, and therefore you are likely to pay more than you would for the fax machine business, which is old technology and declining sales.

These are just a selection of the factors and there may be others that are highly relevant (perhaps specific to your deal) and these should be taken into account as well.

FACTORS YOU SHOULD NOT INCLUDE

There are two special factors you may be tempted to include, but shouldn’t

1. How the business will improve

Perhaps you have a special skill, contacts, or knowledge that is making you more profitable than the business is currently making. Surely that will allow you to pay more for the business – Yes … and No

Yes, it will increase profits and add value to the business …

No, you shouldn’t pay more for the business for that. This is the additional profit you are generating for the business, why should you pay the current owner? – has done nothing. The value you add to the business is what you should receive when you SELL the business, do not pay this to the current owner.

two. Future opportunities for business

The owner has explained to you how the business has many wonderful upsell opportunities, but he hasn’t had the time or money to pursue it.

This will increase future earnings so you can pay more, WRONG!

• it hasn’t happened yet and it may not happen for many reasons, even if it does, it’s never as easy as the current owner tells you (if it was, you would have found a way and you wouldn’t be selling the business)
• If it happens, you will be the one to make it happen, why should you get something for this?

OTHER TIPS

• Do not engage in a conversation with the seller about how you arrived at the purchase price. This will turn into a spiral where you shouldn’t add this back, did you include that, and the multiple should be greater … this is not helpful. You have calculated a price that you will pay and that is all the seller needs to know. Of course, there will likely be a negotiation process, so allow yourself room to go up from your first offer).
• Get an accountant to help you with due diligence
• By bringing the purchase price between the assets, in most countries the best fiscal result will be to put the maximum value of the assets in the following order
  • Inventory
  • Equipment and other depreciable items
  • Goodwill (as low as possible)
• For the seller it is generally better the other way around and I have seen offers where the contract is left blank in this area, with each party filling in its own values ​​later; consult with your lawyer
• Deduct any increase in employee entitlements from the purchase price (e.g. annual leave, long-term vacation)
• While it is always preferable for the previous owner to stay in business for a transfer period, if you are assuming his role, in practice it is often best to let him go as soon as you are comfortable with the business.

DENY: Many of the comments in this publication are general in nature and anyone wishing to apply the information to practical circumstances should seek professional advice to independently verify their interpretation and the applicability of the information to their circumstances. The author expressly disclaims all responsibility and liability towards any person, whether buyer or reader of this publication or not, with respect to anything, and the consequences of anything done by said person in confidence, whether totally or partially in all or part of the content of this publication.