How To Value A Business
Understanding the value of the business you want to buy is kind of a no-brainer. It’s unlikely you’re going to throw down a massive chunk of change without any idea of profit you can expect to generate in return. (But if you are doing that, you should still read this because you need it more than most.)
Before we dive in, the most important thing to keep in mind is to keep things simple. It can be very easy to overcomplicate and over-analyze every minute detail ad nauseam. This will likely leave you feeling overwhelmed, unmotivated, and bowing out before you get to the fun part. Focus on the pieces that matter most to you.
The second most important thing to keep in mind is that there is no single right or wrong way to determine the value of a business. Yes, some factors will weigh more heavily than others (profits, for example), but depending on the industry, the market, the seller, and even you as the buyer, there are many things to consider.
Below we’ve laid out 5 “areas of understanding” to help you determine the value of the business you want to buy.
- Understand their Competition and Motivation:
- Utilize sites like www.bizbuysell.com to compare other businesses within the same industry, size, revenue, and area.
- How long has their business been on the market? Why hasn’t it sold yet? Is the seller not genuinely motivated to let it go? Are they asking too much? Or is it just a business nobody wants to touch with a ten-foot pole?
- This information can be used to help you knock down the amount you offer without sacrificing the value you get in return.
- Understand their Profit:
- Focus on TRUE profit. This means taking into account taxes, payroll, expenses, etc.
- The value should be based on current profits, not forecasted projections. It’s fun to imagine the “what-ifs,” but it shouldn’t affect the valuation of the business.
- Understand their Financials:
- What are their top expenses?
- What assets do they hold? What about liabilities?
- What are their Capital Expenditures? (Funds needed to upgrade or maintain
- What are their profits over the last five years? (Just because last year was a bumper crop doesn’t mean its value shouldn’t be based on that information alone. We want averages.)
- Do you see any trends, good or bad?
- What does cash flow look like? How much is needed to keep things running?
- Understand their Debt and Credit Score:
- Check their credit reports through reporting agencies Experian or Equifax. But don’t rely on just one; information may vary across the bureaus. We recommend checking out this site for more information on understanding the scores and their implications.
- What type of debt do they have? Will you be taking on unpaid bills?
- Understand their Customers:
- Buying a business also means buying its customers.
- What’s the ratio of new customers to repeat customers?
- How much do they spend on marketing and advertising each year, and how many new customers does that generate?
- How many customers did they lose? They may have earned 50 new customers over the last year, but if they lost 40, they didn’t come out that far ahead.
- Do they rely too heavily on a small handful of customers? If one of those customers were to take their business elsewhere, would it have a significant, negative impact on their sales?
- What are the demographics of their current client base? Are there missed opportunities to market to? Could that be used to your advantage once you take over? (Remember, don’t rely too heavily on the what-ifs, but it’s definitely something to consider.)
- Have their customer shopping habits changed over time? (More sales online versus in-store, etc.) Do they notice any trends?
Some Final Advice
Read through this list a few times. Start narrowing down to areas you find most applicable and what information matters to YOU as the buyer. Then make your own list and dive in. Because there’s no “one right way” to value a business, it leaves a lot of gray areas. Creating your own valuation system will help you stay pragmatic in your approach, focused on what matters, and aware of the big picture.