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  • Dec 23rd, 2014 2:52 pm
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[OP]
Newbie
Dec 19, 2014
23 posts
2 upvotes
North York, ON

how much a small business worth

Does anyone know a simple formula to buy a small business? How much I should pay to take over an existing small business.
Thanks!
11 replies
Sr. Member
Nov 5, 2013
624 posts
122 upvotes
The price can be based on its net assets, or its earnings/cash flows.

Valuation techniques
Some of the most common techniques used to calculate a business value include:
Capitalization of typical net earnings: A value can be attributed to future earnings resulting from the acquisition. To obtain the going concern value, a capitalization multiple is applied to these earnings and non-operating assets are added.
Capitalization of typical cash flows: The same as above with the exception that cash flows, rather than earnings, are capitalized.
Discounting of expected future cash flows: Consists of determining the most likely future cash flows and discounting them at the valuation date.
Determination of adjusted net assets: Liabilities are subtracted from the determined fair-market value of the assets. It is used for businesses, such as those in the real estate sector, whose value is asset-related rather than operations-related.

http://www.bdc.ca/EN/articles-tools/sta ... mpany.aspx
Deal Addict
Aug 20, 2007
1863 posts
624 upvotes
Kitchener
I would suggest that you pay any where from 2 dollars to 5 million dollars. :facepalm: Really, you expect anyone here to be able to answer this question considering we don't know the revenue, cashflow, income, industry mulitples, etc?
[OP]
Newbie
Dec 19, 2014
23 posts
2 upvotes
North York, ON
The revenue is roughly 500 to 600k per year. Net profit is 150k. It is a retail store.
Deal Addict
Oct 2, 2006
1270 posts
236 upvotes
Dec 22nd, 2014 8:18 pm

SnowmanOLAF wrote:
Dec 22nd, 2014 7:20 pm
The revenue is roughly 500 to 600k per year. Net profit is 150k. It is a retail store.
Valuation multiples for small business is often 1x to 2x profit so 150k to 300k, but again we don't know enough to make a good evaluation with the info you give us.
[OP]
Newbie
Dec 19, 2014
23 posts
2 upvotes
North York, ON
Please advise what other information I need to collect?
Let me list the following info I know:
1. Franchised retail business
2. inventory 80-100k
3. total asset including inventory and rent is 250k
4. profit has potential to growth 10% each year
Deal Addict
User avatar
Nov 17, 2004
2333 posts
648 upvotes
When you say net profit, is that after paying management staff (including current owner) as well? Or is that the owner's take?

Are you planning on running it yourself? Or just investing in it and hiring others to run it for you?

I think that also plays a huge impact on how you can calculate the business's value.
[OP]
Newbie
Dec 19, 2014
23 posts
2 upvotes
North York, ON
The net profit is how much the owner can get deduct all the expenses, not including the owner's salary.
Deal Addict
Oct 29, 2010
4271 posts
624 upvotes
SnowmanOLAF wrote:
Dec 22nd, 2014 10:45 pm
The net profit is how much the owner can get deduct all the expenses, not including the owner's salary.
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?
You also need to think about risk, just because today it's profitable, doesn't mean it will remain like that.
My family has a business that made close to 500k profit in 2010. After that it was a snowball until last year it actually lost money. It's not because we didn't do our job right, it's because the market changed so much that it became impossible to charge the same prices. Add that with the fact of raising cost of doing business, large commitments to keep up with the demand of 2011 and from a situation where you have an income of 60k+ per month, it went all the way down to 5k-10k per month.

Lastly, business is worth only as much as someone is willing to pay. I can throw numbers in the air for a whole year, if nobody is willing to pony up even 50k for the place, it's not going to help you what you think the place is worth. The truth is, you can have a good business and still get close to 0 responses about buying it.
Deal Addict
Aug 28, 2007
1860 posts
256 upvotes
Calgary
Everyone 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.
Deal Addict
User avatar
Aug 17, 2008
1180 posts
113 upvotes
Just Confused wrote:
Dec 23rd, 2014 11:22 am
Everyone 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.
Some great points here.

But I wonder about your #4... the whole point of valuation is to assess the value of the future.
Deal Addict
Aug 28, 2007
1860 posts
256 upvotes
Calgary
bruizeman wrote:
Dec 23rd, 2014 1:52 pm
Some great points here.

But I wonder about your #4... the whole point of valuation is to assess the value of the future.
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.

Let's say we have some business we have decided to value at $100K. That is not necessarily what the "offer" price or even the eventual "sale" price of the business will be. The vendor could be overlooking an alternate customer target or channel due to his poor marketing skills, that you may know inside & out. Or maybe he has no Internet presence and you're a website guru. Or maybe he is going through a divorce. Or maybe he is moving to Australia and needs to dump his business in 30 days. Or the local mill or factory has just closed down and his former customers are now all unemployed. Or maybe you know an alternate use for his product that presents an untapped opportunity. Or he has 3 employees sitting around because he doesn't have the courage to initiate a layoff. The list is almost endless. This step is just as important and has as many variables (both tangible and intangible) as the valuation step. So you may start with a lowball bid of $50K because of the mill closure or divorce. Or you may put your walk-away price at $150K because you know how to save $60K in automated labour costs.

I guess the main thing to remember is to not get emotionally involved. Opportunities are like streetcars... there is always another one coming along. Don't rush into anything.

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