Hi Brad, I’m ready to become a business owner but how do I know what’s the best price to pay for a existing small business?
What I want to see first is really the sales and marketing side of the business. You know, a lot of people look at their business and think it is worth a lot of money, but the reality is, if you’re a carpenter, oftentimes you’ve got to sell your business to another carpenter, because you’re not selling a business, you’re selling a job. Therefore you won’t ever get very much for the business.
Next, you’ve got to look at the business assets on very much a written down value: what are they worth in a fire sale auction? If you want to make real money, you can’t pay full price for a business.
Now when you go in to do the valuations, you’ve really got to be fairly careful that you don’t in any way, shape, or form, value it at what replacement cost would be. Its value is what you could sell it for in a fire sale at an auction.
Also, keep in mind that the average person overrates goodwill massively, when it comes to the business you are looking to buy. You see goodwill, in 99.9% of cases is worth zero, and the reason I say that is because most of the time, the clients that are coming there now won’t stay there if a) the staff, or b) the owner leave, especially if you don’t do something drastic to keep them there.
Too often, people seem to say ‘Well, you know, they’ve already got good turnover and they’ve already got good profits,’ but in most cases you’re going to lose a fair bit of that when you first take on the business, and you’re going to need to rebuild a lot of that. But the flipside of that, probably 80% of businesses that are for sale out there in the marketplace are actually running at a loss at present, and that’s a very important thing to remember.
Sure, the sellers may show you how it’s really making a profit but if you took a normal wage out for you doing your own job in the business, after that it’s not making much profit. So you’ve got to balance it up. Before you buy a business, think about it. If I took a wage out and paid someone else to do the job that I’ll be doing, would it still be making a profit and would I still get a good return on investment?
All the best,
Date: January 2, 2014