Buying an existing business instead of starting a new business from scratch has many advantages. When you purchase an existing business, one of the most valuable items you’re buying is goodwill. Goodwill is the reputation and trust that has been built up over many years between the business and its customers and venders. It often takes many years of marketing and advertising to buildup a well respected and popular brand. As a result, when you buy an existing business, you can have a reasonable expectation of a certain level of cash flow, barring that you don’t mismanage things or that a major shift in the economic environment occurs that could negatively impact the business.
Some of the items that figure into the value of the goodwill of a business include: The business’ location, telephone number and website, trademarks and service marks, customer lists and vender lists, the lease agreement, the management, the sales team and other personnel. All of these items have been and will be the major determiner of the future success of the business. Ideally, you as a buyer can build upon this success by adding your skills, connections or new product or service lines.
Other things that you need to consider when evaluating the value of a business are the tangible things like real estate, facilities, machinery, equipment and inventory. In some cases the accounts receivables are also included in the sale of the business.
There are a number of standard ways to value a business. In most cases you will need to use a combination of these methods to come up with a number that is as accurate as possible. One popular method for getting a ballpark of a business’ value is to apply a “multiple” to the company’s discretionary cash flow. Discretionary cash flow is the total money generated in a year minus the cost of the necessary expenses. It is important to note that in most cases, discretionary cash flow is not the profit or loss listed on the companies tax return. It is common practice for business owners to deduct expenses that are not absolutely necessary for the operation of the company.
The multiples used to determine the value of a particular business differ depending on the business category. Certain types of businesses are in higher demand. As a result they will enjoy a higher multiple. Multiples used for appraising businesses are determined by taking an average of the multiples of discretionary cash flow that buyers were willing to pay for a business in a particular industry. There are numerous databases of multiples for various business categories. An example of a table multiples used in business valuations can be obtained from the following hyperlink: http://www.inc.com/valuation_media/2009/valuation-biz.html.
Another common way to get a ballpark appraisal of a business is to apply a multiple to the company’s annual gross revenue. This method, however, is less accurate since you are not taking in consideration the relative expenses. An example of a table of multiples using a company’s annual gross revenue can be obtained from this hyperlink:
Oftentimes the multiplier will be bumped up or down based on the particular circumstances of the company being appraised. For example, a company that has good market share that is steadily increasing would deserve a higher multiplier compared to a company with a small or declining market share. A business that enjoys strong patent and/or trademark protection would also deserve a higher multiplier. The more diversified a company’s product line is and the earlier they are in their product life cycle, often significantly bumps up the multiplier that determines a company’s value. A well diversified customer list also decreases the risk of a sudden loss of sales and would thereby increase the multiplier. Negatives such as, underfunded pension plans, pending litigation, pending governmental action, urgently needed investment in plant or equipment will usually be taken into account when determining a company’s value by decreasing the multiplier.
The above-mentioned methods for obtaining a ballpark idea of the value of a particular company are only two of many used by business appraisers. Only use these tools to get an approximate value! Once you’ve narrowed down your choices, its time to get the advice of a professional business broker that is working for you to make sure that you are not over-paying for a business.
If you are interested in purchasing an existing business, I would urge you to visit 4BizListings.com. On this site you can search by industry category and by geographic location for business opportunities that fit your skills and interest.