Working out the value of any business is a long and complicated task requiring a lot of expertise. There’s much to consider but there really is only one question you need to ask yourself: what’s it worth to you?
Dreaming of running a boutique B&B in Toronto is all very well but the price tag needs to be looked at in the context of your own personal life and finances and the reality of how you would run the business day-to-day.
Consider carefully if the potential return is really worth your time and money or maybe, on reflection, someone else’s?
The following five questions should help you make up your mind:
1. What's driven the past success of the business – are you in a position to maintain this?
Talk honestly with the current owners, and try to glean from them details such as how many hours they put in, what their clientele is like and what the day to day expenses of the business are, as well as its specific attributes.
Andy Cagnetta, CEO at Transworld Business Brokers says:
‘It is incredibly important to know the real value drivers...like intangibles. They could be location, price, products, vendors, customer mix, name, website, marketing, niche....it could be a combination of them all, like a good recipe. Leave one ingredient out of a good cake and it will fall flat.’
Have you lawyers check out business’ history – you may discover some skeletons in the closet, such as past periods of financial difficulty, which might help clarify the reality of running things.
If you intend to make some changes to the business, ask yourself if they will actually improve profit or if they are simply an aesthetic indulgence.
There’s no point taking on an establishment that has a roaring trade in burgers, with a loyal clientele, and trying to introduce haute cuisine.
The value of a business is very often tied up with its current practices: ask yourself if you will be happy to maintain the status-quo, or, if not, what financially viable changes might look like.
2. How does the future look in your chosen industry?
There are many industries that are in a state of transition, or facing some challenges in the current economic climate. If you were thinking of buying a petrol station or hotel, for example, it would be worth looking at current trends and predictions for these markets.
Bruce Hakutizwi,International Manager at BusinessesForSale.com says,
'The market approach to buying a business is fairly subjective: its focus is not on cash flow or predicted ROI but simply the potential market based on current demand.'
What worked before for previous owners may not apply to your future business.
Also, think about the location. Are there any plans for the area or developments that might be detrimental to your potential business or create unwanted competition?
The key question you need to ask yourself in this factor of assessing value is ‘will I be able to grow?’
3. Have you really got the funds to buy this business?
It’s tempting, when you really want something, to be less than honest with yourself about whether it’s affordable.
That new pair of shoes or a slap-up meal is one thing, but a new business is quite another.
Whatever cash you have available, through personal funds, loans or external investment, should not be seen as entirely for the business purchase.
You will need a portion of this pot to cover additional transfer and set-up costs, as a buffer during possible delays or teething problems, and possibly to fund the business if your aim is to turn it around.
The total amount of available funds, less the running costs (including interest payments and loan repayments), will define what your top purchase price can be.
Spend some time projecting annual cash-flow and do the maths. The new business will be of no worth to you if you can’t afford to operate it well.
4. Do you know the three magic words? (Return On Investment)
Having ticked the above boxes, you should be able to paint a fairly detailed picture of how much money you might make.
Try and make a realistic projection of how much net profit you will make annually for the next five years. How does this figure sit next to the amount you will need to invest in the business, despite its existing assets?
For me the bottom line is the bottom line. Profits trump everything in valuation. I could care less about assets if they don't drive profits.' says Cagnetta.
You really don’t want to arrive ten years down the track with a lot more grey hair, only to discover you would have been better off putting your money in a high earning interest account and hanging out your ‘gone fishin’ sign.
5. Is it worth the risk?
It's worth being honest with yourself about what you can feasibly take on.
For example, as a business buyer faced with two options, which of these would you choose: a landscape gardening business that makes $500,000 a year where you would have to wake up at 5am every day, manage a large team of workers, deal with issues like weather and labour shortages, or a retail business that makes the same amount annually, that's open Monday to Friday, 9-5, has four office workers, a low inventory and a niche clientèle?
'The easier it is for a new owner to acquire the business and continue the earnings stream, the more valuable the business.’ says Cagnetta.
Obviously, if your choice to buy a particular business is a lifestyle decision, then you can afford to adjust your notion of value accordingly.
Buying a farm and campsite, for example, where your primary incentives are getting out of a highly stressful city job (and avoiding a heart attack), having more fresh air and space for the kids and access to good, affordable schools will mean that you, personally, will be prepared to pay more for that business than the next person.
In all situations, however, it’s important to look closely at the financial history of the business and how it might fair under your ownership, bearing in mind your actual available funds and current personal circumstances.
One buyer’s ‘happy ever after’ could well be another’s worst nightmare, so be sure to know your limitations as well as your assets well before you start looking for your dream business.