The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: Hayden Frys Mustache on September 05, 2015, 08:52:06 AM
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Hello Friends,
I'm looking to purchase a small business and before I get into some of the particulars, I wanted to do some research on proper business valuation. Does anyone have suggestions for books/blogs/podcasts or have any direct experience they'd like to share on this topic?
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Hello Friends,
I'm looking to purchase a small business and before I get into some of the particulars, I wanted to do some research on proper business valuation. Does anyone have suggestions for books/blogs/podcasts or have any direct experience they'd like to share on this topic?
Not sure on a good resource, but I'm glad you are doing this research before you dump a bunch of money into it.
My recommendation would be that if you can't understand the entire financial structure of the business and how it makes money (and what money you could pull out of it) you shouldn't but it.
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Aswath Damodaran is a Finance professor at NYU Stern Business School and is very generous with his resources/materials. He has a blog, as well as records lectures and writes books. Just do a Google search of him and you should have lots of material. Good luck.
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Perhaps the most difficult bit is valuing the "goodwill", those indefinable elements that are why the existing business is worth more than the simple sum of all the assets and discounted future income stream. Depending on sector and location that can be a big sum or none at all.
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Here's a banker's advice, I look at these deals occasionally when people want to buy a business with debt:
The business is ultimately worth what you're willing to pay and what they're willing to sell it for, its as simple as that. Once a business is worth/sells for about $25mil, it gets into a competitive bid process and establish a much better market.
There's some metrics to consider, but on a smallish business, three times its annual cash flow is a good starting point for negotiation. Take Net Income, then add back Depreciation and Interest Expense as they report on their Tax Returns. You should ignore any other "addbacks" and also look at officer's salary to see if the wages they're pulling out of the business are equivalent to the time they put in. If a broker is selling the business, they'll practically create "addbacks" to inflate the value.
For example, if you're buying a restaurant and you're going to act as the manager, you shouldn't include the $60,000/year in wages paid to a manager. That's compensation for your time. If they don't sell the business, they have to pay someone else that money to run it.
Is it a business that the seller could potentially leave and compete with you on? How many years will you require in a non-compete?
If you plan on financing it (which I wouldn't recommend), then an SBA loan is going to require a valuation. I don't think they're worth the paper they're written on typically.
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Here's a banker's advice, I look at these deals occasionally when people want to buy a business with debt:
The business is ultimately worth what you're willing to pay and what they're willing to sell it for, its as simple as that. Once a business is worth/sells for about $25mil, it gets into a competitive bid process and establish a much better market.
There's some metrics to consider, but on a smallish business, three times its annual cash flow is a good starting point for negotiation. Take Net Income, then add back Depreciation and Interest Expense as they report on their Tax Returns. You should ignore any other "addbacks" and also look at officer's salary to see if the wages they're pulling out of the business are equivalent to the time they put in. If a broker is selling the business, they'll practically create "addbacks" to inflate the value.
For example, if you're buying a restaurant and you're going to act as the manager, you shouldn't include the $60,000/year in wages paid to a manager. That's compensation for your time. If they don't sell the business, they have to pay someone else that money to run it.
Is it a business that the seller could potentially leave and compete with you on? How many years will you require in a non-compete?
If you plan on financing it (which I wouldn't recommend), then an SBA loan is going to require a valuation. I don't think they're worth the paper they're written on typically.
Appreciate the feedback -
The business is a side-hustle for a semi-retired gentleman who's probably looking for a succession plan. I approached him about his willingness to sell, so he wasn't out shopping it, and there probably isn't a long list of buyers. The gist of the business is that he provides statistics and raw data for industry members who are willing to pay a subscription fee for the TPS reports, which are arranged in a way that saves the subscription-paying company time for market analysis. As far as I can tell, this is the only pay-for service that is currently providing this data, although the data come from public documents. The value is in the subscriptions, software and his knowledge, so I would want a period of time where he and his wife/employee) could train me/another employee on what he knows. The software needs some modernizing, but would complement my main hustle quite nicely.
As far as no-compete....5 years would put him into his early 70s and he does consulting work on the side - I don't forsee him wanting back in.