Small Manufacturer Valuation in .NET

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$400,000 paid through the business itself) Depreciation-sheltered income seems more than adequate to live comfortably, the historical cash stream steadily growing, and the factor of risk greatly reduced after the fth year Not your traditional leveraged buyout but representative of the type of leverage sought by quite a few moneyed buyers Give and take between buyers and sellers is almost always necessary to do deals; therefore, give-and-take scenarios are also necessary even when estimating value for just one of the parties In this case, we ve taken something additional from the buyer in the way of strapping cash ows Now it s time to seek something additional from the seller Obviously, he or she has an option for rejecting this buyer, but if he or she wants to do this particular deal, something now has to give on their end and we can assume that the only thing left is seller nancing
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Seller s Potential Cash Bene t Cash Down Payment Bank Financing Receipts Gross Cash at Closing $ 250,000 350,000 $ 600,000*
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*From which must be deducted capital gains and other taxes Structured appropriately, the deal quali es as an installment sale with the proceeds in seller nancing put off regarding taxes until later periods
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Projected Annual Principal/Interest Payments Projected Cash to Seller By End of Fifth Year Gross Cash At Closing Add: Principal Payment Add: Interest Payment Pretax Five-Year Proceeds
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$ 101,986 $ 600,000 400,000 109,929 $1,109,929
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This is not the all-cash deal expected by the seller but, based on the buyer s willingness, is all that the seller can get in this deal Restrictive nancing conditions decrease values When push comes to shove, the buyer in our case might nally come up with a few more dollars or pledge personal assets to some degree, but probably not for the whole $400,000 shortfall This being a real case from my les, I can tell you the answer The seller ultimately relented on all cash at closing, nanced $400,000, and stuck by his $1,000,000 price Buyer and seller closed on their deal
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Offering Price Less: Down Payment Less: Financing Uncovered Debt $1,000,000 250,000 750,000 0
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The Valuation Exercise Cash Flow (commonly used last completed year, assuming that conditions of the business warrant such) Less: Principal/Interest Cash Flow Free of Debt
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$ 204,639 147,119 $ 57,520
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It is not common for buyers to forthrightly consider the amortization of debt (building up of equity through mortgage payments) in their process, no more than it is routine for homeowners to consider this factor when buying the home They hear about it, perhaps know about it, but it s not part of their purchasing rationale In part, this is because equity builds up so slowly in the beginning of long-term loans However, it s mostly to do with the fact that they want the business or home and also just want to know they can pay for it Loans bearing heavy mortgage payments can be tolerated short term when the business can stand the freight and when equity buildups amount to signi cant dollars during the period In our real case, the buyer elected to proceed with his purchase because with the added seller nancing, the business would largely pay for itself out of cash ow And at the end of the fth year would be a substantial relief from debt payments and the accumulation of an outstanding equity position Bear in mind that this might not always be the fair market indicator for estimating value
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Business Is Fairly Priced If:
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1 Asking price is not greater than 150% of net worth (except where reconstructed pro ts are 40% of asking price) a Net worth $568,943 times 150% equals $853,415 b Reconstructed pro ts $204,639 divided by asking price $1,000,000 equals 205% 2 At least 10% sales growth per year is being realized a Growth is under 10% per year but steady 1998 to 1999 was 3%; 1999 to 2000 was 116%; and 2000 to 2001 was 83% 3 Down payment is approximately the amount of one year s reconstructed pro ts a $250,000 minus $204,639 or $45,361 (222%) more 4 Terms of payment of balance of purchase price (including interest) should not exceed 40% of annual reconstructed pro t a Debt service $147,119 divided by $204,639 equals 719%
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