how much a small business worth
Dec 22nd, 2014 6:58 pm
Dec 22nd, 2014 7:06 pm
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Dec 22nd, 2014 7:20 pm
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Dec 22nd, 2014 9:28 pm
Dec 22nd, 2014 10:45 pm
Dec 23rd, 2014 9:44 am
What they mean, deduct all the salaries to the bare minimum and assume that the owner is the only one who works. Assuming that's possible, what would be the net profit?
Dec 23rd, 2014 11:22 am
Dec 23rd, 2014 1:52 pm
Some great points here.Just Confused wrote: ↑Dec 23rd, 2014 11:22 amEveryone has rules of thumb for a quick ball-park starting point. Personally mine are 1 x sales and/or 2 x earnings. Naturally, they need to be dramatically modified based on industry, type of business, maturity of the business, timing in their business cycle, quality & quantity of their customer list, geographic location, links to other local or regional economic factors, etc. etc.
The biggest challenge is always the state of the financials on which you are basing your estimates. Really small, start-up, businesses can eye-openers to first time buyers, but information quality definitely improves (by necessity) once the business is established for a number of years.
At many small businesses, the owner has been so focused on start-up growth they have ignored good record-keeping. That means details can be sketchy at best. Additionally, some small business owners do not even understand what information is important to keep. They co-mingle funds, lose receipts and invoices, ignore tax liabilities, don't record cash transactions, can be oblivious to liabilities, mix owner-draws with capital loans and infusions. There are some really funny situations and you wonder how such a businessperson has survived childhood. Many don't even have tax returns prepared by accountants, so even their CRA filings are unreliable. And those that are filed by accountants may only be their best guesses of their accountant as to what really happened. If you're lucky the owner will provide a basic spreadsheet and sometimes it is just notes on scrap paper. In many cases, they are not trying to be nefarious, criminal or deceive you, but rather they are just too inexperienced to prepare their business information properly for the sales process. On the other hand, there are a few questionable characters out there trying to rip you off. However, I've found they are glaringly obvious to an honest, knowledgeable business person. They always have well-prepared financials but when you look at their ratios, they don't make sense and your alarm bells will go off .
Your challenge is to separate the owner's personal activities in the financials from the legitimate business activities that would occur under your management. Your need to call on your own experience to make a judgement call from the data available and come up with an offer price. In some respects these dubious owners may be selling a diamond-in-the-rough at a bargain price and in other cases they are so far up in the clouds you can move on to your next opportunity very quickly.
To the OP on your list:
1/ a franchise is helpful because he will have been forced to comply with the franchisor rules. Lots of corroborating information would be available from the franchisor and other peer franchisees.
2/ The inventory shouldn't have a $20K spread - he should have an exact number on hand. Is that retail or wholesale price on the inventory? Inspect this inventory. Does the visible quantity match his claim? Does it correspond to his sales? (i.e has he sold 80% red widgets last year and his inventory is 80% green widgets) Look at any expiry dates on his inventory. When was the inventory last counted and validated; probably last Jan 1?? What is his markup on that inventory?
3/ Rent is not an asset (unless it has been prepaid by that amount). BTW: Look at his lease contract commitments.
4/ This is a scary comment on your part... you're already getting emotionally involved. Don't think potential. Instead you are going to calculate a cold, hard, value of this business today so you can pay a fair price for what he is selling you. You don't include future growth in your calculation... that is what you control once you've bought a business.
Dec 23rd, 2014 2:52 pm
Agreed. But they shouldn't be combined at the same time. Step 1: You calculate what you understand to be the value of the item at this time. Step 2: You decide on a negotiating strategy, an offer price, and a final limit price beyond which you'll walk away from the deal.