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Offering Price Less: Down Payment Less: Financing Uncovered Debt Cash Flow (commonly used last completed year, assuming that conditions of the business warrant such) Less: Principal/Interest Cash Flow Free of Debt At 7 times earnings value At 9 times earnings value $1,220,000 300,000 920,000 0
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$ 221,935 116,370 $ 105,565 $ 738,955 $ 950,085
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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 $1,051,465 times 150% equals $1,577,198 b Reconstructed pro ts $221,935 divided by asking price $1,220,000 equals 182% 2 At least 10% sales growth per year being realized a No growth
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3 Down payment is approximately the amount of one year s reconstructed pro ts a $300,000 minus $221,935 or $78,065 (352%) more 4 Terms of payment of balance of purchase price (including interest) should not exceed 40% of annual reconstructed pro t a Debt service $116,370 divided by $221,935 equals 524% What does all this mean for estimated value It means that the price in the deal through the eyes of buyers, if they have read a multitude of publications whence this information was gleaned, could be viewed as a bit much to pay Thus, we might conclude that $1,220,000 would be the maximum estimated value Perhaps a most-likely selling price might be in the range of $900,000 to $950,000 Quite honestly, that is the reason that I split my sale of business and real property; because, as with many sellers, I too wanted my price That s what is so good about small business owners and purchasers can be exible as to nal deals
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Well-established small retail companies with strong evidence of good operating performances have been known to change hands in the range of 4 to as high as 6 times reconstructed earnings Thus for this case, estimated value ranges from a low of $887,740 to a high of $1,331,610 could be expected in any given market The $1,220,000 price tag in our example translates into 55 times earnings Another rule suggests 75 to 15 times net plus equipment and inventory Bear in mind that the projected sale included receivables, payables, sales promotion samples, and customer advances that need to be reconciled and included when using this rule If we were to average the low and high at 112, $640,127 would be forecast as value not including real estate When using rule-of-thumb estimating, these ratios rarely, if ever, take the value of real estate into consideration Real estate cannot be arbitrarily added to the rule-of-thumb value, and purchase of facilities must meet the test of cash ow
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Book Value Method Adjusted Book Value Method Hybrid (capitalization) Method Excess Earnings Method Forget the Scientist Method Rule-of-Thumb Estimate $ 575,015 765,460 1,127,344 1,220,000 $738,955 to 950,085 $887,740 to 1,331,610
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As mentioned elsewhere, I traditionally calculate the book and adjusted book value scenarios, although I know that good operations will rarely change hands at these prices Data from these, however, are an important consideration to the hybrid and excess earnings formulas; and because some businesses have not produced cash ows strong enough to support values beyond these hard-asset values Thus overall business values may not be greater than the values they hold in these hard assets We guessed from initial review of the balance and income statements that this retail operation had an added overall intangible value that was greater than the value in its assets What we didn t know at that time was how much more could be justi ed For added avor, the new business owner leased the facilities for $14,400 per year This plus the $75,750 rental income came to $90,150 triple net real estate income The business was sold for $550,000 and real estate later at $700,000 Together, these sales derived $1,250,000 The wholesale portion was another source of pro t Needless to say, I m pleased to report that seller nancing kept my kids in shoes for quite a while The Japanese have a philosophy about life that we Americans might well be advised to adopt: kaizen (continuous improvement) Business valuation processors cannot possibly know it all, but they can always bene t through continuous improvement I, for one, have no other choice; I do it to survive
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