How Do You Value a Business For Sale?

How Do You Value a Business For Sale?

What is a Small Business?
Although the term is somewhat malleable depending upon where you live, a “small business” is generally considered to be one that is privately owned and operated – that is, not a public company listed on any sort of stock exchange – with fewer than 100 employees (or fewer than 50 in the European Union). The U.S. government further defines an enterprise as a small business based upon annual sales, but this will vary by category and only comes into play in order to qualify for small-business set-asides when bidding on government jobs.

Buying a Small Business for Sale
Businesses for sale are all around us. This could include the dry cleaner’s shop where the owner wants to retire, the corner restaurant whose owners are interested in buying a bigger place downtown, or the mobile dog-cleaning service with a proprietor who’s tired of driving all over the city. There are a number of factors to consider when buying a small business, and plenty of questions to ask once you have settled on a couple of possibilities. Learn as much as you can before taking the big leap.

Examine the Financials
Check over the company’s profit-and-loss sheets and cash flow statements. You should know everything there is to know about how much money has come into the business, where it went, and what are the projections for future earnings. Enlist the services of an accountant or CPA to assist with these efforts. Pay special attention to the company’s liabilities, as new owners usually acquire these along with the company’s assets. The due diligence package should also include the company’s income tax returns, legal filings, articles of incorporation, and information on lawsuits both past and pending.

Understand Why the Business is For Sale
Everyone has his or her own reason for wanting to sell a business. Retirement is a popular choice, as is the desire to change fields, move to a different city, or use the funds to purchase a larger business elsewhere. But the reason you hear may not necessarily be the truth. You will want to carefully explore this situation and avoid taking the seller’s word without question. Is there an ongoing problem between the owner and employees, or is their relationship so tight that everyone plans to abandon ship when the business finally gets sold? Is the location a poor one, or possibly so terrific that a major competitor is planning to open up across the street in a few months? Knowing these things before you sign on the dotted line can prevent you from making a huge mistake.

Observe the Business in Action
Hang around for a week and see if the traffic matches the claims made by the seller. Chat with customers and find out what they like about the business and what they would like to see changed. Scope out the competition, see how they operate, and compare the kind of traffic they enjoy with that of the business you’re thinking of buying.

Determine the Value of the Business and Line Up Financing
The seller will have placed a price on the business. As the buyer, you are responsible for determining whether it is a fair price. Here you may wish to consult a local business broker, as they oftentimes have a better handle on valuation issues, which can vary depending upon the type of business and the industry in which it operates. Fast-growing companies will normally sell for a higher price, as the potential for greater future earnings is factored into the equation. You will then need to determine if the price is something you can handle financially. Your banker and accountant will be of considerable assistance here, as each helps you to reconcile monthly net earnings against the cost of buying a small business.

Ask For the Seller’s Help
Under most circumstances, the seller wants out at least as much as you want in. If you plan to meet the asking price – or at least provide a reasonable negotiating position – it never hurts to ask the owner to provide some of the financing. You will probably get better terms from the seller than you would from a bank, including a lower interest rate and longer payback term, and the seller will therefore be motivated to see you succeed. To that end, you may even ask the owner to stay on for a while – receiving a fair consultant’s fee, of course – to help with the transition period and make sure you know what you’re doing as the new owner.