This post by Bill Sims
Here is a question that our clients often ask: “My husband and I are thinking about buying a local business. The current owner has a price in mind. My husband seems to think it’s a good deal, but it seems high to me. How do we figure out what a fair price would be?”
Purchasing an existing business can be a great way to launch yourself into the world of commerce. Since the business is up and running you can be saved much of the hard work and risk involved in starting up a new venture. The equipment, inventory, procedures, employees, and even customers, are already in place. Of course this is why the current owners may want more for the business than just the value of the assets. They have worked very hard to put all this together.
First you need to work through the tough decisions concerning the lifestyle changes, personal commitment necessary, potential impacts to your family’s well being, and risks to your mental health that may come from owning your own business.
You should also find out why the current owner is selling the business. Is it to retire, or change careers? Maybe it is a partnership that has fallen apart. Keep a keen eye out for businesses that are failing, and the owner is looking to hand the problem off to someone else.
Once you have convinced yourself that ownership of this business is for you, you need to look at the valuation process.
Typically a business may be worth from 2 to 3 ¼ times the adjusted annual cash flow. Determining that “adjusted annual cash flow” is the real trick. To figure this out you will have a fair amount of research and homework to complete. In business this is called a “due diligence” study.
You must get the current owner to give you the profit and loss records for the past 24-36 months, tax returns representing the same period, a current balance sheet, copies of the utility bills and other major expenses, bills from suppliers, and a listing of the inventory and equipment to be conveyed in the sale. Using these documents you can obtain and verify the profits and expenses of the business.
With all of this information your primary goal is to figure out how much money the business will make if you are running it. You will want to look closely at how much the current owners have been taking out of the business and how many perks and extra expenses may be included in the costs. Look for trends; has the business been growing, holding steady or decreasing, and what are the reasons for those trends.
Another area you will want to look closely at are the assets of the business. What is the real value of the equipment and the inventory. Is the inventory current, will you be able to use or sell it, or is much of it outdated and worthless? If the transaction is to include property or a building you may want to look at that portion of the purchase from only a real estate perspective. It’s as if you are making two purchases, one for the business and one for the property.
Once you have looked carefully over all this information you will begin to understand the real value of this existing business. Armed with your new knowledge you should talk with your attorney, accountant, banker, perhaps other business owners to get their guidance and advice. But remember, that this is your decision and only you can decide whether a business is for you.
We have a good publication about buying and selling a business in the toolbox publications on our own site, right here. It more fully explains this transaction from both the buyer and sellers point of view.
You might also want to look up information on buying a business at www.sba.gov or at the Kaufmann Foundation’s Biz Info Library. These websites have extensive libraries of information that can really help you complete your due diligence study.
If you’d like to talk with someone about this, call us and make an appointment, that’s what we are here for.