Small Business Valuation PrimerWritten by Rudy LeCorps
For simplicity's sake, this article will assume that buyer will be acquiring a single business with possibly more than one location (for example a small Laundromat business with two locations). In addition, we will not be covering valuation techniques for businesses where more than one product line or service will be acquired. For purpose of this discussion, we will assume simplest of all cases. For example if a buyer is acquiring a retail business, that business will be assumed to sell one type of product (for example, children's clothing). This book is also assuming that its reader will be buying, or intends to buy, a small business that is privately held and valued at $1MM or less. Finally, we will be focusing on valuing a business that is not going to be turned around, but will continue to operate (or grow) as purchased, under new owner. A business that is failing and in need of an experienced buyer to re-structure and turn it around, or fix it, has to be valued using a different set of valuation metrics. Note that even though there are many ways to value a business, to keep things simple, and in light of its audience, this book will be using a straight forward multiple of earnings (net income) method to help a buyer arrive at a value that is as close as possible to intrinsic value of business. But keep in mind that in end a business' value is equal to what a buyer is willing to pay and a seller willing to accept. To analyze a business, we begin by collecting and reorganizing its accounting and financial statements. Below is a list of essential documents that need to be gathered and analyzed. To make this analysis worthwhile, financials statements for at least past three years must be available, preferably on a monthly basis. We recommend buying a business that has been operating (and has been profitable) for at least three full years: Valuation Document Collection ======================================================================== Item No.Document DescriptionDate Collected ======================================================================== Income statement (Profit and Loss) Balance sheet (Assets and Liabilities) Cash flow statement Monthly bank statements Equipment list with replacement value List of customers and contracts (with length of time left on contracts) Employee roster with description of responsibility and salary information Owners' percentage interest along with salary and benefits information (health, insurance, company car, etc) Copy of lease agreement Lines of credit, if applicable ======================================================================== Note that most brokers and owners will require that you sign a confidentiality agreement and put down a "good-faith" (different from a down payment) deposit before you are given access to such confidential information. That is normal procedure and you should be ready to remit at least 0.50% of your offer price (not owner's asking price) to broker to be put in escrow. Some brokers use a fixed amount (e.g. $1,000). That amount is used as proof that you are serious about buying business and will either be: -Deducted from final sale price if you buy business, or -Refunded to you in full by broker, if you decide to not proceed with acquisitionWorking With The Financial Statements A few words of caution: Some brokers will provide you with both original financials as well as their version of a set of re-cast financials for business they are trying to sell. Do not rely on these numbers to make your offer. Brokers generally try to inflate asking price in order to increase their fee. Unless you can hire your own valuation specialist, follow instructions in this section to do your own analysis of business. Owners of privately held businesses are very motivated to pay least amount of taxes possible. To achieve that goal, and to extent permitted by accounting standards, they manipulate their expense accounts in order to show on paper that business is making least amount of profit possible. That, in turn, lowers their tax liability on business' net income. To objectively value a business, its financials have to be reconstructed, or re-calculated. That is, adjustments have to be made to reflect true profit potential of that business. Such adjustments are sometimes called add backs. Examples of such abnormal expense items by business owners include extremely large bonuses or salaries to themselves, above-market rent space from a building that is family-owned, and company cars that are used for personal use. Sometimes such expenses may include illegitimate items such as salaries for non-working family members, family vacations marked as business trips, and personal expenses charged to company. This leads us to conclude that some of these expenses have to be adjusted or re-calculated in context. The prospective buyer can do that by using either (or both) of following: §Good business judgment based on experience in industry, or §Standard expense multiples (or ratios) for industry in question The simplest and cheapest way to get such industry data is to review comparable data from publicly held companies that are in same industry or line of business. Such information is freely available on Internet and can be downloaded from web sites such as Yahoo!Finance, sec.gov, or any financial web site for which there is no fee for reviewing such information. In addition, all publicly traded companies have their financials posted on their own web site under "Investor Relations". For example, if you're planning to buy a retail clothing business, you may want to look at income statements of companies such as Gap, Inc., Abercrombie & Fitch Co., Children's Place Retail S, Chico's FAS, Inc., etc., and taking an average of their individual ratios. Unless buyer can purchase data for such an analysis, information obtained from financials statements of publicly held companies are most accurate way to measure industry ratios (even IRS agrees with this valuation method through its Revenue Ruling 59-60). The rationale behind it is that public companies have to try extremely hard to keep expenses in line. That is because they have a duty to report to their shareholders, in addition to helping raise their stock price by encouraging investors to buy shares of company. That effectively results in more realistic numbers when it comes to business expenses. Multiples are usually calculated by dividing actual line item expense, either by company's total revenue, or net income, as long as you keep divider same throughout exercise. For example, to create a ratio for Travel & Entertainment (T&E) buyer can divide total amount spent on T&E by total company revenue. This ratio can then be applied to your own analysis by multiplying it to T&E expense of your acquisition target. The difference from number supplied by Owner and result from applying ratio would be used as a T&E add back to be added to net income. The above step has to be done for each add back item. In illustration table included in this section, buyer's analyst used following add back items for analysis: §Salary / Compensation §Repairs / Maintenance §Office Expenses §T&E §Automobile §Personal Insurance §Family Relations §Misc. Expenses Sample Ratio Calculation Table ======================================================================== Ratio Computation Table For 3 Companies & 1 Expense Line (e.g. Office Expenses) Company 1Company 2Company 3Average Ratio ======================================================================== Exp. LineExp1Exp2Exp3 Revenue (or Net Income)Rev1Rev2Rev3 RatioR1=(Exp1/Rev1)R2=(Exp2/Rev2)R3=(Exp3/Rev3)(R1+R2+R3) / 3 ========================================================================
| | Creating Your Own Luck Written by Nan S. Russell
Losing my job in last recession of last century, I discovered first hand power of creating your own luck. A week later, I decided to locate an interim position while I looked for a "real” one. Accepting a temporary position at minimum wage in an industry I knew little about, I decided way to enjoy position was to learn everything I could and contribution all that I could. I poured over manuals in my down time, developed processes to expedite work, trained new employees, volunteered for additional assignments, and did anything that needed to be done. Four weeks into a ten week job, I was unexpectedly offered my first management position.If I had listened to my friends cautioning me that taking a minimum wage position was career suicide, if I had been concerned about accepting a job "beneath” my education or experience level, or if I had only done what was expected, I would have missed an opportunity that led to five promotions in next seven years. It has been my experience over years, while climbing corporate ladder to Vice President of a multi-billion dollar company, that opportunity is everywhere and anywhere. Often, it’s in unexpected places for those who differentiate themselves in workplace. People who do what is expected of them, do it very well, "and then some” have opportunities arise that others never do. And people who set their ego aside, contributing everything they can to task at hand, often create their own luck. That’s because initiative is a powerful commodity in workplace.
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