The Value of a Business
"9-Keys" is an insightful series of "How To's" that addresses vital issues that any business owner can benefit from. They are:
5) THE VALUE OF A
BUSINESS
Despite accepted formulas for determining the value
of a business, buyers may accept almost any reasonable selling price if they
have time to pay it with low interest. If a seller becomes fixed on a price that
a buyer considers greater than current cash value, the buyer, given more years
at an interest rate lower than prime, might still find the offer acceptable.
While bargaining on price may not work, terms can sometimes settle the
issue.
Since earnings averages are so
important in structuring a guideline for establishing a selling price, the buyer
must determine the true profit. Some business owners overstate their inventories
to show higher profits on statements submitted to their creditors. Even more
business owners understate assets to avoid taxes. Many overstate or understate
assets unwittingly because of poor bookkeeping.
Many business people show little
profit but draw salaries far in excess of their job contribution to the company.
Others show profits by not drawing sufficient salary to justify their time,
talent; and efforts. A business owner we know was an $80,000 a year executive
with a major corporation that downsized. Now, he only draws $50,000 and works 80
hours a week in contrast to the 55 hours he worked as an executive. A true
evaluation would show that he is paying $30,000 a year to work 25 hours a week
more than he did before.
At the other extreme, We know
business owners who were drawing two and a half times the amount a replacement
would cost. Keeping incompetents on the payroll also subtracts from profits. In
another company we analyzed, the payroll included two relatives and the owner's
friend, who were all incompetent. They could have been easily-replaced by one
competent person at half the combined salaries of the three, improving the
company's operating performance.
With what he would have saved in
salaries, the buyer was able to meet the seven times earnings price asked by the
seller.
When asked by clients to help sell their companies or buy someone else's company, the first thing we do is analyze the real profit potential, for nothing else is as important.
Often, the unsophisticated think
the selling price of their business should be at least what is listed on the
balance sheet as net worth or equity. This is a misleading figure. A business
can have an enormously high net worth listed on financial statements, having
acquired real estate during the 1980s, which could not be sold today for more
than a fraction of that worth.
Some business owners who have
been only breaking even in recent years cannot understand why the $ 100,000
worth of fixtures and equipment they acquired in previous years is suddenly
worth so little to anyone else. Fixtures, equipment, know-how, or anything else
are only bought to produce profit. No matter how great sellers may think these
items are, unless the buyer sees profit potential in utilizing them, they are
worthless. Careful buyers consider the real profit average and trends before
purchase and relate all factors to the profit potential.
They buy only that which can
translate into return on the investment, or can be sold separately without
interfering with business operations.
The buyer must objectively study
the selling company just as sellers often fantasize about the value of their
companies, overly optimistic buyers think that they will do better with the
company than the prior owner did. Whatever faults were observed in the former
owner's methods might not be as bad as the new owner's methods. Wary buyers
should consider that the prior owner was trying as hard as he or she could to be
effective, and that the new owner may not do better.
By Christopher John Gullotta,
Attorney at Law
The information above is general in nature
and does not constitute legal advice. Do not attempt to solve your individual
and fact problems, based upon this general
information.
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