Buying an IT company: How much is it worth?

[deguza]

Hello All:

How much would an IT (Information Technology) company be worth?


Serves small busineses.
Makes around $100K /year (What the SBA calls "SDE, Seller’s Discretionary Earnings" figure)).
Owner claims great potential.
Clients throughout the US and one in Canada.
One employee and hands-on owner.


Deguza
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Details

My cousin is looking into buying an IT company. He is good with computers but does not have much finance and business experience. I have MBA and he thought I could help him. However, appraising what a company is worth is not something I know, so I decided to ask here and other forums.

So far I got some statistics from a SBA affiliate organization. I and my cousin then attended a seminar offered by them. It was very useful but we still cannot get market values for this type of business. The person giving the seminar has also said that evaluating IT company is difficult.

[Spider]

You will need to consider many more aspects than you have disclosed here, but a primary calculation might be --

To receive a passive income of $100,000 pa. you would need to invest $2 million at 5%. Now, what do you mean by "makes $100,000"? - is that $100,000 in sales, in gross profit, in net profit? If net profit, the $2 million would be a good starting point.

If the $100,000 pa is gross profit, you need to deduct overhead and all other costs, to determine net profit and recalculate for the value of the net income.

Likewise, if the sales are $100,000 pa. Also consider if the owner has paid himself a salary or whether that "makes $100,000" is the owner's income. If $100,000 a reasonable income for the work that has to be done, then any price you pay for the company is simply buying yourself a job!

In this case, I wouldn't consider the company itself to have much value at all, beyond the value of inventory, furniture and fixtures.

You need a lot more information to determine a value than you have provided.

As to it being a difficult exercise to determine the value of this company, I do not agree. It is quite easy, once you have the details. It is easy because your job is not to determine what the company should be worth on the open market - it is only to determine what you are prepared to pay for it. And that is a very different exercise.

[deguza]

$100K is the Sellers Discretionary Earnings.

Profit and some adjustments:

- Take out the owner's salary
- Put in the unpaid spouse's salary
- Put depreciation amortization back
- Put interest on loans back

Here is a more eloquent definition from Internet:

"SDE is calculated by adding to the most recent full year’s Net Income Before Taxes (NIBT): Amortization, Depreciation, Interest, Owner’s compensation, Owner’s benefits, Non-business related expenses, and onetime-only expenses.
If there is more than one working owner, a hypothetical salary will be subtracted for the lowest paid working partner.
Business Appraisers, in their analysis"

I am hearing 3x SDE, the current owner is hoping 5x SDE.

Thanks

[vangogh]

A few thoughts. I take it the owner won't be staying on with the business, but will he be willing to stay on for a few months to help with the transition as your cousin takes over? How about the one employee? Will he guarantee that he's staying?

I ask because you say your cousin is good with computers. Being good with computers isn't the same as being able to run an IT company. I'm good with computers too. In fact I'd say I'm very good with them. I'll even go as far to say I'm much better with computers than most people on the planet. And yet I wouldn't know how to run an IT company.

Your cousin could find himself with a lot of customers and no employees. Is he prepared for that? Does he know other people he can hire?

Another question to ask is what guarantee do you have that the customers will stay on? Your cousin would be buying a business where only one of two people would be having interaction with the clients. They may be clients because they like those two people.

I'm a web designer and developer. Many of my clients stay with me, because they like me personally and we work well together. The most valuable asset in my business is me. If I were to sell the value leaves with the sale.

You have to look at what exactly would your cousin be buying and what is the value of those things. If the value of this company is mainly the owner and the one additional employee keep in mind that a lot and possibly most of the value leaves with the sale.

I would definitely make sure the owner commits to 3-6 months of staying on after the sale to help with the transition. If he does that your cousin likely keeps the clients. If he doesn't there's a greater chance some or even most of the clients leave. I'd also make sure the owner signs something where he can't open a new IT business for a certain period of time. Otherwise he could easily take back most of the client list.