Business Article - Price a Business When Buying
Buying a business is both exhilarating and confusing. Costs are usually high and very greatly between businesses. Every prospective buyer enters the market with a rough figure they are hoping to pay, and the ultimate goal is to assume a company that will yield high profits for the smallest investment possible. Purchasing an already-established business will allow you to avoid the hassles of startup costs and inventory, and allow you to focus on more immediate marketing and profit making.
Prices are always negotiable. Most business owners with the business in the market are eager to sell because the longer it under their name, the longer they are required to pay taxes, bills, and other common expenses on it.
Deciding on the type of business you wish to purchase and then making a list of possible choices is generally the way to start. However, before a proposal can be made, you need to know if the current price is fair or too high, and within what range you can negotiate before driving the price ridiculously low.
Determine its Market Value
Market value will show the direct value of a specific business based on the current industry market. Using this method to determine the set price for the company you wish to buy is a fairly common one, and is usually the first figure determined when valuing a business.
The market value is based on a series of figures and calculations based on both the business itself and the current market trends. Once a figure has been determined, comparing it to other businesses of similar status in the same industry will be useful in deciding if the price is fair.
Before making the calculations, the type of income figure you use will need to be determined and used for all businesses involved. For example, the figure can be based on gross income, net income, gross of net income + inventory, etc. Whatever figure used, the key is to using that same figure for the comparison businesses. Comparing one market value price based on gross income will have incorrect results when compared to a different business who market value is determined by gross income + inventory.
The Market Value is derived via the multiplication of an industry multiplier to the sales figure used. So, for example, if the industry multiplier is currently .25 and the income figure is £150,000, the market value will be determined as £37,500.
The industry multiplier varies over time. The most current one can be determined by contacting a business appraiser. There are some suggested rough figures for the multiplier based on the industry the business falls under. For example, a retail business will usually have a multiplier between .75 and 1.5. However, these figures are usually never ideal, and the actual multiplier may vary greatly.
The problem with using market value is that it does not take into consideration the value of the one specific business within its industry. A business within an industry by be worth substantially more or less than the general figure indicates. Because of this reason, it's usually best to use the Market Value as nothing more than a generic idea of where your business sits value-wise.
Tangible Assets
Sometimes, a business has next to no current monthly earnings, either through lack of sales or a neutralization due to a profit-to-debt ratio. Value may also be used to assess value if the company is based primarily on its assets, such as large factories with large quantities of expensive machinery. If either of these proves to be the case, the worth of the business if based on its tangible assets alone. Tangible assets are assets that are physical, and can be both seen and touched. This includes items such as cars, machinery, computers, stock, inventory, real estate, etc.
The value of tangible assets can be determined by one of several methods. One common method is to price their fair market value, as known as FMV or FM. Another would be to determine how much it would cost for you to personally purchase the equipment in its current physical condition. For example, if all the equipment falls into a range of 1 – 4 years old, and all rate at a physical condition of good – very good, how much would it cost for you to purchase them all? This method is usually very good and can lead a person to the most accurate price.
Capitalized Earnings
If the company you are considering is not tangible asset intensive, or deals with the service industry where profit is largely determined by the number of customers/sales, than basing its worth on capitalized earnings is usually the best method.
Capitalized earnings place absolutely no value on tangible assets, so if the company does own a fair amount of expensive assets, the derived figure + the amount it would cost to purchase those items are often more accurate. Capitalized earnings are determined by the very simple method of the anticipated earnings divided by capitalization rate. Estimated earnings are usually the same as total earnings, and the capitalization rate is usually the estimated risk of investing with the business.
Capitalized earnings take into account a wide array of intangibles, unlike other methods of calculating worth. The length the business has been running, the profit growth, number of shareholders, reason for selling, and many more factors are all considered when determining a fair price. Because of everything taken into consideration, this method of valuing has the highest potential for a good figure of worth.
Intangible Value
Some businesses, mainly dot com companies, use intangible value to determine their worth. Because things like tangible assets are completely nil, intangibles may be the only option for arriving at a fair price for the company.
Things like customer base and the number of long term customers retained are usually the main intangible analysed when the potential purchase of a company is analysed.
Owner Benefits Value
Some companies are valued only on their ability to generate cash. To these companies, tangible assets and other areas of money are not important. If the company needs to generate cash and does so consistently and in high amounts, it is worth a lot. In contrast, a company that fails to generate a substantial amount, or that has a variable amount of earning monthly, is generally considered to be worth less.
This method of valuing is the most simple, and requires no market research or income assessments. To derive the company's worth, simply multiply the owners benefit with 2.2727. The resulting figure is the market value, or estimated value of the company.
Return on Investment
Finally, the last method for determining the cost of a company is the return on investment amount. The return on investment is the amount of money the company generates in return for the amount it invests (its profit). This method, while perhaps not the most concise, is often the one most used.
To determine if the return on investment is good or not, analyse the current amount spent per month by the amount that is returned. Any company making 15% or more in return on investment is considered a good company.
If the company has a good return on investment, proceeding to use one of the above methods in addition to the current will result in a good idea of what the companies base price should be.
As can be seen, there are many methods for determining the price that should be offered on a business. The methods all vary in calculation and consideration, and methods used will each return different results. The best method is based on the company that you wish to buy. If the company is largely composed of tangible assets, than using that method of calculation is ideal. In contrast, using a method that relies on tangibles when the company has almost none is considered an incorrect and ignorant move.
If you are unsure of how to proceed with the calculations and which is best for the prospective business, contacting a professional with the names of the businesses and contact info will likely be the best move. Improperly estimating the worth of a business could result in lost interest when you move to make a proposal, and may also result in the seller thinking you are purposely trying to pay an extremely low price. If you appear ignorant of the process as a whole, the seller may decide that you are too much of risk to proceed with. On the other hand, demonstrating a large amount of knowledge in this area, as well as the willingness to negotiate, will be viewed favourably and will work in your advantage.