Valuing a business (as a buyer)

trf197

We are in the early stages of considering purchasing a business. We visited a couple of businesses for sale while staying with family at Christmas and one in particular looks interesting. We have requested initial financial information through the brokers and received P+L statements for 2011, 12 and 13.

Having looked up the process for purchasing a business online it seems that the typical order is

- make an offer and have it accepted
- get funding approved in principle (including a RICS red book valuation using lenders valuer)
- appoint solicitor and accountant for due diligence
- proceed with sale

We have already begun discussion with ASC (a commercial funding broker) about getting the required funding. The broker seemed confident that we would be able to finance a purchase up to £200,000 with a deposit of around £60,000.

My initial questions involve deciding on a suitable offer:

- Why would I put in an offer for the business before having an independent valuation?
- If I am supposed to come up with an offer before the valuation on what basis? The business has a freehold property with a value of £100-120,000. The P+L shows EBITDA around 11-12k per year on a turnover of £180k, plus director salaries (one active part-time, one passive) of around £20k. I can identify reasonably straightforward savings (which would involve me working full-time and my wife (a would-be co-director) working part-time) in the region of a further £20k per year. I think, based on the historic numbers I have seen, that between the two of us we could extract a total income (salary+dividends) in the region of 35-40k p.a. after tax. (We would of course then plan to grow the business further).

I saw somewhere a suggestion that freehold value plus 1.5-2.5 x EBITDA could be used but it was old (c.2009) and I wonder if it was influenced by the financial situation at the time. I also wonder how Director salaries should be factored in to the valuation.

The asking price is £195,000 (reduced from £225,000).

Any advice or opinions gratefully received.

Pennywise

If you can only hope to get a pre tax profit of £40k between the two of you working in the business, I'd say that it's only worth the value of the buildings. Two people can earn that kind of money in normal "jobs" so what is the "premium" of running the business? The goodwill element of a business is the "premium" and can vary between 1-3 times the annual profits (but after adjusting for reasonable management wage of the owners). If it makes £12k after management/owners wages, then that would suggest a goodwill element of £12-£36k which is so low you wouldn't really factor it in.

zygurat789

Look at it this wa (just one of many)
You've bought a freehold for £100k, so you've paid £95K for an investment which pays c£11K or just over 11.5% although I would bring depreciation into the calculation.

derbylass

Hi, trf

Can I make a suggestion? If you haven't got an accountant, appoint one to look at the books and also ask for a trading statement for 2014 from the vendor.
DL

trf197

If you can only hope to get a pre tax profit of £40k between the two of you working in the business, I'd say that it's only worth the value of the buildings. Two people can earn that kind of money in normal "jobs" so what is the "premium" of running the business?

Thanks Pennywise for this. There are a number of reasons why the two of us are considering this move, beyond the money to be earned. However, we also believe that there are opportunities in this particular industry, in the longer term, to grow the business further.

Can I make a suggestion? If you haven't got an accountant, appoint one to look at the books and also ask for a trading statement for 2014 from the vendor.

Thanks derbylass. Can any old accountant do this or should I be looking for something in particular?

derbylass

Hi,
I would get some quotes, I have an accountant as I am self employed and would recommend the network he is in but I cannot post any links.
If you can send a pm, I will help.
Otherwise, call some local accountants who provide services for local businesses - there is no specialty as such, and get a quote. It could be well worth the money as this is a big purchase and your future. In the past, I have sourced businesses for clients and I have always got an accountant to look at the books.

DL

Pennywise

trf197 wrote: »

Can any old accountant do this or should I be looking for something in particular?

Just beware that the term "accountant" isn't protected so anyone can call themselves one and trade as an accountancy practice, whether or not they have experience, qualifications, insurance, etc.

Unless you can get a referral from a trusted colleague, try to look out for "chartered" firms - there are several "chartered" bodies who are regulatory bodies and ensure that their firms are properly experienced, qualified, insurance, are fit and proper, etc. "Chartered" accountants should only do work for which they are capable, so shouldn't agree to do anything outside their scope of ability.

Most decent firm will give a short free consultation, to give you the chance of checking them out to make sure they sound as if they know what they're doing and provide you with a quote. If you don't get the right vibes, walk away and try somewhere else. Plenty of competition, so make sure you get the right one for you.

For illustration only, a couple of years ago, I had a new client who was thinking of buying a business - the price was £100k for goodwill and equipment only which she thought was fair, so was thinking of offering £90k!. For £495, I evaluated the business, reviewed the last three years' accounts, and gave the client quite a comprehensive crib list of things to negotiate together with pros and cons she needed to think over. In particular, the profit was only £40k, so I pointed out that £100k was way over the top, and suggested an offer of £40k all in. They settled on £50k payable in stages over 3 years, so that was a saving of £40k compared with what she was thinking of paying - quite a success!

somethingcorporate

Pennywise wrote: »

For illustration only, a couple of years ago, I had a new client who was thinking of buying a business - the price was £100k for goodwill and equipment only which she thought was fair, so was thinking of offering £90k!. For £495, I evaluated the business, reviewed the last three years' accounts, and gave the client quite a comprehensive crib list of things to negotiate together with pros and cons she needed to think over. In particular, the profit was only £40k, so I pointed out that £100k was way over the top, and suggested an offer of £40k all in. They settled on £50k payable in stages over 3 years, so that was a saving of £40k compared with what she was thinking of paying - quite a success!

This shows that some people can negotiate and others cannot!

Paying (just over) ones year's profit for a business and for 3 years is an amazingly crafted deal from the buyers point of view.

I've been close to a couple of recent M&As in my company and the "norm" is significantly higher based on EBITDA (although this is quite a crude approach to buying a business, as the OP has already taken into account).

CKhalvashi

somethingcorporate wrote: »

This shows that some people can negotiate and others cannot!

Paying (just over) ones year's profit for a business and for 3 years is an amazingly crafted deal from the buyers point of view.

However it would also depend on how motivated the seller is.

When I sold a 49% share of a company in 2009, I wasn't desperate to sell, as I wasn't in the office much and it was providing an income. We settled for £120k against an income of about £30k a year, with about £70k overall equity. The other shareholder settled on similar terms.

3 years later when they messed it up, they were desperate to avoid PG's kicking in. We paid £10k to them for £80k of equity in the company (100% of shares), put another £25k in ourselves to sort the cashflow issues out, before selling 49% to the other shareholder from before 2009 for £125k, 3 months later. This was packaged at £200 upfront plus £800 a week for 3 years, largely as she'd used part of the original money to pay off a large chunk of her mortgage.

We'll be paid in full in October, and someone that we know offers good customer service is running the company on a day-to-day basis, with a vested interest in the long term success, with the knowledge we will offer financial backing if necesary, so a very good deal all round IMO.

Pennywise

somethingcorporate wrote: »

Paying (just over) ones year's profit for a business and for 3 years is an amazingly crafted deal from the buyers point of view.

Not really, it's pretty much normal where the business is operated and managed by the owner. Too many people forget to factor in a reasonable wage for the owner, and once you've done that, the profit comes right down so the 2-3 times profit is likewise massively reduced. In my case, the £50k was indeed 2-3 times the annual profit less a reasonable wage for it's management.

It's completely different for larger businesses that aren't so dependent on their owners, i.e. where they have staff administering and managing it. Then indeed you aren't reducing the profits by a management wage.

bris

In this climate you can expect a downturn, 40k for salaries in the past may be gone now so don't buy on past accounts. You need to know whats happening right now and TBH a business that is only paying that amount is not worth the trouble.


The property may also be a problem, you need to look at the property and know what would happen to it if the business folded. Is it a good location would it re sell easy or have a decent rent return and could it even be re let or sold without sitting for years. These questions need looked at because commercial property in quieter locations are now a money pit you don't want to go down.


People who sell businesses do it for good reason, some retire but beware the ones who are just getting off the sinking ship.