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The Elements of Valuation When Buying a Business

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Accurately valuing a small business can be challenging for prospective business buyers, but it is an important part of the selling process that encompasses many factors.

Cash Flow – In real estate, a buyer’s main focus is location. In business acquisitions, it is cash flow.  Small businesses are often priced using a multiple of cash flow.

Asset Value – Many buyers want to know how much of the business price is determined by hard assets, so getting an equipment appraisal can help the valuation of the overall business.

Inventory – Inventory is essential to the operation of a business, but too much inventory can have a negative impact on the selling price. Strive to maintain optimal inventory levels.

 Accounts Receivable and Accounts Payable – When a small business is valued based on a multiple of cash flow, hard assets and inventory are usually included in the sale price. If accounts receivable and accounts payable are included the price will be adjusted based on net values.

Asset vs. Stock Purchase – A stock purchase is best used for larger or publicly held corporations. For small businesses, asset purchases are better for both the buyer and seller.

Years in Business – Buyers often equate longevity in business to less risk. While it may not be true, all other things being equal, a 15-year-old firm may sell more quickly and for more money than a 5-year-old firm with similar financials.

Employees – Quality, quantity and tenure of employees can have an influence on the value of a company.

Reason for Selling – The top reasons buyers find reasonable and acceptable are retirement and illness.

Length of training – It is standard procedure for a seller to train the new owner in the operation of the business. The training period will usually be a month or two, although length of time will vary based on a number of factors. Be aware, though, that some buyers will want the seller out of the operation as soon as possible.

Customer Base and Supplier Base – “Don’t put all your eggs in one basket” is good advice. Having one or two customers account for a majority of the business might make the business easier to operate, but it represents great risk. As a general rule, a company should not have any one customer represent more than 15% of the company’s total cash flow.

Business Type – Some types of businesses are more attractive than others to prospective buyers. The four primary types of businesses, listed in order of desirability, are: Manufacturing, Wholesale, Service and Retail.

Additional Factors – Market strength, industry growth, appearance, location, and 0wner involvement can all influence the value of a business to a prospective buyer.

Summary

A good broker can help the buyer make a wise decision at the various crossroads of the acquisition process.

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