You want to start a business by buying an existing company. After considering the pros and cons of the various businesses for sale on the market, you have narrowed down your choice to one business. It is time to make an offer. How much is the business for sale worth, and how do you do a business valuation?
When you buy a business, you calculate the economic value of the business. Analyze the benefits you can get from it, particularly its future earnings potential. Will the business provide you an acceptable return on your investment? How much can you expect to make from the business based on its performance in the past?
A business valuation can point out the strengths and weaknesses of the business for sale, and you will need it when you apply for a loan to purchase the business.
What to Consider When Valuing a Business
- During a period of economic growth, the price of businesses goes up. In comparison, the price drops during times of recession. Gather industry reports, reviews and data about the industry you are getting into. How is the performance of the industry in recent years in comparison to the performance of the business for sale? Look at similar businesses for sale and those that have recently sold to help you in your business valuation.
- Study the financial performance of the business through its balance sheets, income statements, expenses, business loans, depreciation and amortization for the past 3 to 5 years. You can more or less predict the future of a business from the past financial performance. Find out if there is a historical pattern of growth. Is there a season when the business generates more sales? Does it have a wide customer base or does the business rely on only a few customers? Are the records of the business organized and complete? If they are not, think twice about buying it.
- Calculate the cost to replace the assets in the same or similar condition, or as new replacements. Assets should generate revenue. If a business has many assets but does not make much money, negotiate for a lower asset value.
- Consider the intangible assets such as brand value, customer base, and goodwill. How will you value patents, licenses and agreements held by the company?
- What are the future financial requirements of the business? How much are the debt repayment and operating expenses?
- If you are buying a “service” company such as a professional practice, one-man business or consultancy business, find out if the seller is “the business”. In some instances, customers become repeat clients because of the personalized service given by a specific person in the business. If you lose this person, you could lose customers too.
- Work with your accountant or business broker to determine the value of the business and the acceptable ROI. The rate of return and annual earnings forecast would influence the price that you are willing to pay for the business. Choose business valuation experts who specialize in the particular industry you are buying into.
- Business valuations are subjective. Find out how the seller determined his or her asking price.
- Factor in how long the business is in operation, the number of employees it has, the equipment, supplies, inventory and its present condition.
Your business valuation should quantify what you would get out of the business. The factors you consider in valuing a business varies according to the type of business. One business is different from another. Be sure you are not overpaying.
Remember that the asking price of the seller is not the actual purchase price. The seller’s valuation of the business is very different from the buyer’s. How would you calculate the value of the company’s intangible assets?
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