Valuations for Buying a Business
How hard can it be to come up with valuations for buying a business? Well, it's a lot more difficult than putting a valuation on a house but for most small businesses, it can be done with a few simple formulas and the right information. Before you go forward and read the information below on valuations for buying a business, it is important that you have already prepared yourself to buy and find a business. To make sure you are ready for the information on this page, please look at the Preparation and Finding a Business pages first. (Get a head start by picking up a free report on preparing to buy a business.)
Valuations for Buying a Business- Don't Miss the Chance You need to understand that if the business was appealing enough to get you this far, then you should come up with an offer to the Seller. If you are going to completely insult them by low balling well below market value, don’t do it, but you really don’t know what they will accept without putting some kind of offer on the table. This is an automatic missed opportunity if you don’t give it a shot.
Valuations for Buying a Business- Why Me? Coming up with valuations for buying a business is the one thing that almost all first time business buyers do not do well. If you are asking "why should I have to come up with valuations and appraisals for buying a business", the answer is that it us ultimately your decision to put a price tag on the business that makes sense to you. The asking price that you saw came from either the seller or a broker. And it is just that... an asking price. If the asking price came from the seller, it is likely way off base. If from a broker, it is most likely pretty accurate using generals valuation rules. But that doesn't mean it doesn't lean towards the seller. You need to come up with a price range that works for you. Hence, the plural "valuations for buying a business" and not just one appraisal price.
Valuations for Buying a Business- Who Can Help? There are a variety of resource you can tap to help with your valuations for buying a business. Some are better than others but there is no need to wing it on your own. The best person to go to is a business broker that is not involved with the seller of the business or a business advisor that is up to speed with small business appraisals and the current business buying market. A business buying savvy accountant may be able to give you some insight also, but I would steer clear or take this advice with a grain of salt. Either way, your ability to gather all of the information possible during the Finding a Business phase is the key.
Valuations for Buying a Business- Can I Really Do It Myself? If you want to completely go at it alone in creating valuations for buying a business, then using basic rules of thumb techniques is the way to go. I recommend using the rules of thumb that involve owner discretionary cash flow (ODCF) multipliers. They are the most accurate value indicators for most, but not all, small businesses and provide different multipliers for different industries. In general the multipliers will be in the range of 1.75 to 3.5 times the ODCF. Most won't be less but some can be more depending on the industry and other positive factors such as location, time in business and so on. For those business where ODCF is the best indicator, I recommend using my Valuation Calculation Sheets including my own ODCF-Goodwill Valuation Method SM, which can be found in the toolkit below. Also in the toolkit are cheat sheets for different industries that include methods of valuation other than ODCF as well as pitfalls and positive/negative issues to look for.
Valuations for Buying a Business- What Information Do I Need? When you conducted your review of the business from the Finding a Business stage, you gathered enough information to at least perform preliminary appraisals for buying a business. Ultimately, 3 years worth of Profit & Loss (P&L) reports would be ideal, but that will be rare at this stage. If you happened to get it during your initial review of the business, that's great. But if not, a general P&L from the previous year or the last 12 months will do. This is the typical information you will get from a business profile that goes along with the business listing. Further information from the review that will be of use are things such as:
Valuations for Buying a Business- An Example Here is a typical example on valuations for buying a business. PLEASE BE AWARE that this is very simplified and I go over it and many more tricks of the trade in the full ebook and the toolkit: A deli business is on the market for $300,000 and it was attractive enough for you to get to the point of coming up with an appraisal price range. The owner's discretionary cash flow (ODCF) is $135,000. You perform your valuation using a rule of thumb ODCF multiplier of 2. The price seems to make sense at a max of $270,000. Let’s say you determined there are factors in your research that lower the value of the business such as the need to replace some of the equipment at $10,000. Now you think a max offer of $260,000 would make more sense. In this case, you decide that a low end of $245,000 is not out of the question and is a good starting point.
Valuations for Buying a Business- What Do I Do with My Offer Range? Well, now you have a reasonable offer with your valid reasons behind it. Theoretically, you have come up with an offer range you can live with and it makes sense, so go for it. The seller just might take it. If the seller balks all the way up to the top of your range, then you move on. The decision by the seller will tell you if he/she is unreasonable or not and if they are someone you don’t want to deal with anyway. Maybe the seller's mind will change before you find another suitable deal. Or maybe he will come up with a counter offer. You will never know if you don’t put it out there. Don’t make assumptions.
Valuations for Buying a Business- What's Next? The actual offer is usually made verbally through a broker and will lead to a written Letter of Intent (LOI) if the offer is deemed reasonable by the seller. If you are dealing directly with a seller, then you will begin negotiations with the seller at this point verbally and hopefully agree on a price that will lead to a written LOI. The LOI is a non-binding agreement that allows you to start a due diligence period in which you will have the chance to "prove" the claims of the seller by getting more financial info and seeing the business in action from behind the scenes. With this additional info from due diligence, you should perform more valuations for buying this business to see if you need to adjust your offer. For more information on the next step in the buying process, go to the Letter of Intent page of this site. If you're ready right now to get into true business valuations and can't wait, get the tools that serious buyers are using below:
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