how do you figure out what a business is worth

[huggytree]

this is just something ive always thought about...thinking long term for when i want to retire someday...also thinking of the option of buying a competitor as they go out of business.

A co-worker years ago started on his own by buying a plumbing company instead of starting out cold like me....he bought it from a guy who was retiring...i like the idea of picking up all his customers.....since i still dont have many homeowner customers i think about buying up a competitor just to pickup his homeowner customers.....the equipment and stock is what it is..i can value that easily....but how do you determine the value of a small company based upon its current customers?

let say its a 1-3 man shop and you dont want the employees...just the business name and the phone number....id sell the equipment

this is not a real serious thing im considering, but if the opportunity comes along i may bite.....

a large plumbing company that i worked with sold his business just before the housing depression.....he had 40 guys and a good reputation....i always wondered what a business like that went for...i figured $1,000,000-$2,000,000

i also think a small company (1-3 employees) w/ equipment/stock would go for $50,000 range...depends alot on the equipment i know..

[orion_joel]

It is a really hard call to make what the value of a business is. There are many factors that come into play, including things like profit, assets, debts, equipment, stock and many other things.

The problem often lands, that the owner of a business will have an idea of what they believe the business to be worth, in many respect's this is a much different figure then what someone is willing to pay for it.

Often the price of a company is less based on the number of employee's equipment and stock and more so on the turnover and profit. While equipment and stock does come into it this is a fixed known portion, anything above this is often just a figure that is eventually settled, on to compensate the current owner. It can be based on expected income over X number of years, or many other ways, but it is a figure that inevitably will be different for every business.

[vangogh]

Bit of a guess here, but I would think you look at the company's assets and debts and some multiple of the previous year's revenue.

[Steve B]

Of course, there are TONS of things that affect this - but, I think, a multiple of annual revenue is used as a rule of thumb or a starting point. It could be a multiple of net profit after Cost of Goods Sold or some other common accounting benchmark.

I'm sure Evan or someone else is more familiar with this.

[billbenson]

There are other factors like will the new owner be able to run the business? My father bought a distributorship years ago and the best product lines jumped ship because he didn't really know the product line. If you build up your business and another plumber comes along and wants to buy it, will he be able to duplicate what you do and keep all your contacts?

Certainly its risky buying a web site / web business, even for someone who is web savvy. The new owner has to duplicate what the prior owner did. Again, the new owner may be knowledgeable (frequently not) but not have the contacts or skills for that particular type of site. The failure rate of these purchases is pretty high.

I think both of these are examples of things that will lower the value of many businesses. If you want to do this down the road, you should start tweaking the business so someone can easily take it over without failure. Just my opinion.

[nealrm]

A general rule of thumb is that a business is worth 5 to 10 times its yearly profit. However, other factors come into play. Does the business have large, untapped growth potential? Is it a growing or stable business. What is the local compention level? How much would it cost to recreate the same business?

[trackday]

I always heard that the business was worth 1.5 to 3x yearly profit, once you took into account all the non-standard 'income' items like vehicle and other bennies too.

[vangogh]

I never really believe any of the multiples. I've seen people state a business is worth anywhere from 1 x yearly to 15 x yearly. It really comes down to your business is worth what someone will pay for it. The multiples might vary by industry. Certain businesses you might expect to do better next year and others you'd expect to do worse.

A good example right now might be print newspapers. Most seem to be losing money at the moment, but I'm sure there are some that made money the last year. I'm not sure you'd give any paper a high multiple at the moment given where the industry seems headed. On the other hand a green tech industry might draw a higher multiple since the industry is only likely to get bigger in the years ahead.

[Business Attorney]

Vangogh is right in saying that multiples are all over the place, but i still generally see them as a starting point. In a normal economy, I would expect most established businesses to sell in a fairly narrow range of a multiple of the business' free cash flow (roughly net profits less any amounts that need to be plowed back in the business for capital expenses).

Although it varies widely between types of businesses, I would say that 5 to 8 times cash flow is a pretty typical range. If the purchase price is below 5x, the buyer is getting an expected 20%+ return on his investment, which would be on the high side for an established business. Above 8x cash, the buyer is only getting an expected 10-11% or less on his investment. Given that a small company is usually viewed as both more risky and less liquid than an investment in the stock market, and the market has historically returned about 8% compounded over any long period of time (except now!), a buyer should expect at least a 12% return for an investment in a private company.

Of course, there are many exceptions to the rules. You need to adjust the historic cash flow by adding back certain items (like the "company" boat) and subtract out certain items (like a reasonable salary for the owner if he took out his compensation as "profits" rather than as salary).

Also, while people often determine value based on historic cash flow, the real success of the investment will be based on future cash flow. As vangogh, pointed out, there are many reasons why the past is not a reasonable yardstick for the future. All those things should go into a determination of value.

Also, Steve B is right that in some industries prices are set as a multiple of revenue. In certain businesses, the initial costs of getting the business are high and the value is in the revenue stream. For example, several years ago I represented a company that was buying up small burglar alarm companies. Because most buyers of mom-and-pop alarm companies were bigger companies that were already in the business and had their own infrastructure, the rule of thumb for purchases in that industry was a multiple of "monthly recurring revenues." If a small company had $1,000,000 in revenues, it didn't really matter to the buyer whether the seller made $75,000 a year or $275,000 because the buyer knew what the million dollars in revenue would bring to his own bottom line.

The problem with rules of thumb is that you have to know when they are valid and when they need to be ignored.

[vangogh]

Thanks David. What's interesting is that all the multiples and all the other criteria are rules of thumb or guidelines. They aren't hard and fast rules. I'm sure those who buy companies have their own set of rules and may buy according to some formula, but ultimately a lot comes down to what the buyer wants.


The problem with rules of thumb is that you have to know when they are valid and when they need to be ignored.

Very true.

Another consideration is buying a business for reasons beyond the obvious. You may buy a business more to keep it away from a competitor for example.

Also when pricing some business may be a better fit for the buyer than another. Maybe the two businesses complement each other in a way where the whole becomes greater than the sum of its parts.

[nighthawk]

A business is only worth whatever someone is prepared to pay for it. To value it, you need to put on the buyers shoes, and look at how much you would be prepared to pay for such a business.

In most cases, if you are buying a business, you are doing so with the intention of making a profit out of it. You need to set a goal of how long you are prepared to go before you reclaim your investment - this is where the multiples come in.

Value would be a sum of all the assets, plus the money in the bank, then expected revenue over the period you identified above, ie over 5 years. Note that you would want to go off expected revenue - as vangogh pointed out, certain industries are in decline and this should be taken into account.

This should give you a rough idea of what a business is trully worth. This doesnt always work though, hype also plays a massive part in price. Take facebook for example, by the above equation it is worthless, they have little to no assets, and run at a loss, yet they are valued to be worth hundreds of millions.

[Mustang]

Here is a valuation table from Inc magazine that is published yearly. A lot of interesting info. Scroll down about halfway and click on "view map". It shows the multiples of various business in different industries that have sold recently. http://www.inc.com/valuation#self

[huggytree]

i found out there's a bunch of plumbers who are 90+ days late paying their bills....i wish i could find out who, so i could ask them about selling me their business. i would think one on the verge of going under would go pretty cheap...

i get their phone # and name.....im sure if theyve been around along time they would still be getting daily referal calls and return customer calls...thats what im looking for.

maybe its a stupid idea to buy a failing company just for the phone #???

or in this environment is it a smart way to get a customer base for a bargain?

[vangogh]

Interesting table Mustang. It's a little hard to read with so much data on it, but I'm going to save a copy for reference. I'm having a hard time knowing where I fit on the map. There are a handful of items that could represent me.

[orion_joel]

Huggy, While it may be true that they potentially could be getting on going calls, it is probably not something i would bet to much money on. In fact probably no money. If they are anything up to 90 days+ late paying their bills, the majority of the calls would more then likely be coming from debt collectors rather then potential clients. Another thing to consider if they cannot pay their bills, then maybe they were doing to much work they were not getting paid for because they did a shoddy job.

You may find that spending the equivalent in dollar value of time, cold calling the phone book may pay off better.

I think when it comes to business and buying business while all the multiples and assets and many other things might come into play. Another thing many people could in as well is the Potential future value, or potential future revenue. This can be very much seen with Twitter. Makes almost no money, except for venture capital, yet they have suitors left right and centre willing to pay hundreds of millions of dollars for the site.

[Steve B]

HT - I think you have a great idea to buy up an established business. And, you are certainly likely to have the potential of getting a bargain since there are so many in the construction business facing difficult times. I would think you could buy many plumbing businesses for the market value of their tools and van. I'm guessing many would be happy to just cash out on their stuff and retire or do something not related to construction.

Instead of paying them a premium for anything in addition to their assets (Their name & Phone #) - perhaps you could pay them a commission for the next year or two based on the jobs that come in via their phone number. They would have to trust that you will accurately do this - but, if you could agree to terms like this it takes away all the doubt about the future value of the company. Maybe they could get 10% for the first 2 years after the sale. After that - nothing. That's what I would propose.

Also - HT check your PM's.

[nealrm]

HT - remember, if you buy a business you also buy the debts. So instead of buying the business, just keep an eye open for when they close. Once they close, pick up their old number from the phone company.

[Steve B]

I don't think it's so easy to get the old phone number when they close. Phone numbers are in high demand these days (which is why new area codes have been added in the last decade or so) and are quickly given out. I wouldn't think this is a very practical strategy.

[Business Attorney]

HT - remember, if you buy a business you also buy the debts.

This is not true. Well over half of the deals that I have worked on involved someone buying "the business" by acquiring only all or selected assets of the business. You only end up with the trade debt if (1) you buy the entity such as a corporation or LLC or (2) you voluntarily assume the liabilities. The are a few specific types of liabilities that are more difficult to shed, but the basic concept is that you CAN buy assets such as tools, equipment, customer lists, telephone numbers, etc... without taking on the obligations to pay the business' debts.

[Spider]

The reverse might work, too, wouldn't it, David? Just to take over the business for zero, assume the debts, take the assets, and save the seller's credit rating. The seller gets to walk away from all his problems with a clean slate, sound credit rating and no bankruptcy. If the Seller has already been paying himself and saving, he may have out of the business all he wanted and the buyer gets a tax deduction for the losses.


Here's another basis for valuing a business that may produce a viable number, because it starts from what the existing owner thinks the business is worth and he probably knows better than anyone.

If the existing owner asks for 100,000, that means he would like to get 80,000, which means it is probably worth 60,000, so offer him 20,000 and split the difference in negotiation - 40,000.

(And that is only partly toungue-in-cheek!)

[Business Attorney]

The reverse might work, too, wouldn't it, David? Just to take over the business for zero, assume the debts, take the assets, and save the seller's credit rating. The seller gets to walk away from all his problems with a clean slate, sound credit rating and no bankruptcy. If the Seller has already been paying himself and saving, he may have out of the business all he wanted and the buyer gets a tax deduction for the losses.

Yes, often all or some of the debts are assumed as part of the deal, and the amount of the assumed debt is essentially part of the consideration paid for the assets. I just wanted to make the point that buying "the business" did not automatically mean that the buyer took on all of the obligations of the old business.

As for a tax deduction for paying the debts, that is generally not the case. Those are really the expenses of the old company. The buyer is simply paying the seller's creditors directly as part of the purchase price he is paying the seller for the assets.

[Spider]

...As for a tax deduction for paying the debts, that is generally not the case. Those are really the expenses of the old company. The buyer is simply paying the seller's creditors directly as part of the purchase price he is paying the seller for the assets.But this/these payment(s) to settle old debts are paid by the purchasing business before tax, isn't it? I mean (putting it as simply as I can) ---

... assume $1 million sales, 700,000 total costs = $300,000 profit, tax to be paid on 300,000.

Now buy a business for $100,000 + $50,000 to pay off old creditors ---

.... $1 million sales, $850,000 total costs (700,000 + 100,000 + 50,000) = $150,000 profit, tax to be paid on $150,000.

Notwithstanding a whole bunch of other tax and accounting considerations, isn't that basically how it would work?

[Business Attorney]

Frederick, neither the $100,000 you pay for the business nor the $50,000 you pay to the creditors of the old business is automatically deductible as an expense in the year of the purchase. The payment itself must be allocated to the cost basis of the assets.

If your $150,000 was for inventory, it would reduce your profits because it would be included in your cost of goods sold. However, if the $150,000 in combined payments was for tangible asset used in the business (like a printing press), you can only recover the the $150,000 eventually through depreciation expense over the entire useful life of the asset. If the $150,000 is for good will, customer lists or other intangible assets, you can only recover the $150,000 by amortizing it over 15 years.

[Spider]

Oh, Rats! It's those "other tax and accounting considerations" is why we hire accountants, eh?!

Whatever happened to good old cash in, cash out accounting?