Buying a small business

[hele27]

I have looked at a business to buy and now at the stage I want to make an offer, I need to get an evaluation of the plant and work out how much the tangible assets are worth. But how do I work out what to offer for goodwill and intangible assets?

[Rosco]

Hi,

Get some real good advice from an accountant and lawyer who specialise in this area. Buying a business is a minefield! Here is a couple of things to watch out for
- Is the business really making a profit, or just a wage for the owner. If just a wage, then Goodwill should be very low
- Lease conditions and term
- Is the information shown to you reasonable. Lots of sale figures are doctored!
- Reliance on the current owner.
- Barriers to entry - rather than buying, could you just set up the same business for a lot less?
- Staff - always difficult during a change over
- don't expect to change it hugely. Everyone buys a business saying it is doing say $100,000, but with all my great ideas it will increase to $150,000. Often this never happens!
- I would personally suggest keeping away from Cafe's, as most struggle to pay the owner a low salary, and really don't make a profit for the cost. Also extremely hard industry for newby's.

The buyer normally wants the plant and equipment as high as possible, so that you can depreciate it. The vendor normally wants it low to reduce depreication recovery. Actually putting a true value on it can be quite hard and would depend on the industry.
Goodwill is basiclaly whats left. ie if you agree to buy for $100,000 and the tangible assets are $50,000, then the goodwill is $50,000


Hopefully that helps a little

Ross

[jedimaster]

I have looked at a business to buy and now at the stage I want to make an offer, I need to get an evaluation of the plant and work out how much the tangible assets are worth. But how do I work out what to offer for goodwill and intangible assets?

My only advice is to for gods sake don't be hesitant to shell out a couple grand to get a lawyer or accountant to do a thourough due diligence for you

[hele27]

I am ok to go to an accountant, in fact I have a list of questions from my accountant. I wanted to find out what the goodwill was valued at first. But it seems that I should go to my accountant first about this. Plus if the goodwill is the same value as the tangible assets or plant. At present the tangible is $45k and the goodwill is $75K

[Rosco]

Hi,

Generally when you are looking at a business you know the listing price. If you know the tangible assets value, then the other part of the equation is the goodwill. So in your case it seems the asking price is $120k, and goodwill $75k of this.

Generally businesses are valued as a whole. There are a few different business valuation methods, but the main is a return on profits. So for example if a business was reasonably good, a valuer assessed a return on investment required of 33% and the net profit (after fair owners salary) $40k, then this = $120k price. ($40,000 / .33 = $120,000 approximately). Otherwise if there is no real profits, it might just be value of plant/equipment and other assets, plus say $10k for customer list, the fact the business is already running etc.

That is the theory on how a business is valued, but a sellor is most likely going to pick a figure they are happy with and think they can get for it. It might be nothing to do with a valuation and just a figure they have picked out of the sky. So your question on how the goodwill was valued isn't a great one. It is likely to be the value to make up the sale value from the value of the tangible assets, but the more important question is how was the whole business valued. You can ask a vendor for this, but don't be surprised if there is no technical valuation done, and could just be the price they set.

Ross

[Tan]

Careful which accountant you pick. Remember most have never been self employed and are wage slaves (not a bad thing in itself) and are therefore ignorant of many issues regarding day to day running of a business. They are trained to do a set of accounts, not on how staff are going to act, compliance issues etc.

No offence Rosco, you seem to have a good idea how the world turns around.

[Ivan McIntosh]

A good accountant is a must, but Rosco has given you the bare basics. The crucial point is to deduct what you as an owner would earn as a fair salary first before you assess what real profit the business makes. Often the profit is less....which, really, makes the business mostly worthless except for fixtures, fittings and stock as Rosco points out...and maybe not even that.

Another area I would take care with is stock valuation. In the case of, say, a dairy, you often won't have records of the actual cost price of the exact stock left on the shelves, and will need to agree on a percentage discount to the retail price to reflect a deemed stock cost transferred and paid for on settlement. The correct percentage to be applied, which may change depending on stock age, is a fertile ground for argument right on the date of settlement, with consequent delayed settlement and all sorts of problems flowing on from that. If possible, get the percentages included in the agreement special conditions.

[Neongreen]

If I may derail this thread very slightly, maybe I can ask something I've been wondering for awhile now. I understand the typical going multiplier is 3x yearly profit. Hypothetically speaking, if I ran my own business, and earned say $200k per year of profit from a very steady income source(say subscriptions or something), would it be possible to achieve a better multiplier? Something like 6x? Or does a business typically need some other quality, e.g. only needing to put in 4 or so hours a week? What if it gets sold to a company who can integrate it into their systems without hiring extra staff? Will that push up the worth to the buyer?

I've wondered this since it seems a great way to make piles of money is to be able to build profitable businesses and sell them, due to lack of tax involved.

[Winston001]

If I may derail this thread very slightly, maybe I can ask something I've been wondering for awhile now. I understand the typical going multiplier is 3x yearly profit. Hypothetically speaking, if I ran my own business, and earned say $200k per year of profit from a very steady income source(say subscriptions or something), would it be possible to achieve a better multiplier? Something like 6x?

You can use any multiplier you like but that doesn't mean a buyer will agree with you. Goodwill essentially represents the cost of buying an established business as opposed to setting up a new business from scratch.

Or does a business typically need some other quality, e.g. only needing to put in 4 or so hours a week? What if it gets sold to a company who can integrate it into their systems without hiring extra staff? Will that push up the worth to the buyer?

Yes, a business which runs itself leaving the owner free to earn other income is certainly attractive - but rare in my experience.

As for the buyer gaining an advantage, yes that can certainly be an attractive element to gain a higher price. But the buyer will know this and resist paying over the odds.

Where you do see this happening is if the business is in a key location or adds significant value to the buyer. A simple example is a farmer buying the farm next door - it is worth more to him than other buyers.

Another situation is where there is a valuable franchise or brand with the business. I recall a Honda dealership being sold for silly money simply because of Honda: the new owner backed himself and became very successful.

I've wondered this since it seems a great way to make piles of money is to be able to build profitable businesses and sell them, due to lack of tax involved.

LOL if life was that easy we'd all be setting up businesses and selling them.

[Neongreen]

I appreciate the response Winston. I totally understand something is only worth what a buyer is willing to pay. I suppose the idea of selling to someone who can just absorb it into their current business (e.g. farm analogy) would be the best way to achieve value. This is the reason I picked the $200k profit example, as I was thinking the larger the profit the higher the multiple.

As for setting up profitable businesses, this isn't really something I find overly difficult. Just seems like changing from the business being my job to my job being the business might lead to a higher overall income.

[Rosco]

Hi Neongreen,

A couple of points

1) If you start to have a pattern of buying and selling businesses, then the gains become taxable.

2) Simple example of valuing a business

Profit before tax and owners remuneration - say $200k
Less fair market salary to owner (vendor always says they do no work etc etc, but in reality do lots) - say $100k
Profit remaining $100k which is the business real profit.

To value a business we look at future maintainable earnings, but as the future is hard to predict you normally go on last fews years average trading, putting more of a weighting on the last year.

Then you need to figure out the return on investment required for the business. Bad business might be 100%, ie you need to make the same profit in a year as the purchase price. 50% return, is still a bad business, and might be relient on the owner. As the businesses get better, bigger, franchises and less relient on the owner, then the return required decreases. Ie a subway might be able to pretty much run itself, has franchise systems, so the buyer might require a lower return on investment. 30 -40% is probably the norm, with a really good business getting down to 25%.

If you invert the %, you get the multiplier. ie 33% = 3 times the profit. 25% = 4 times the profit. The multiplier is just an easy way of looking at it, but it is really based on the return on investment % required.

Some industries have their own return on investment, based on the industry. For example, motels might be extremely sort after, so require a lower return on investment, or effectively they are worth more.

Say the business is pretty good, and the industry is good, the return required might be 33%. So if profit after owner is $100k, then it is worth $300k. This includes all plant, vehicles etc and is the total price.

It is hard to work out the return on investment required, and often a business broker has statistics on these, and can provide them.

Ross

[mattinvestor]

You need to consult with a lawyer, accountant and other professionals. Before you buy a business you must make sure the business makes money and is a good investment.