Valuing a business (as a buyer)

A question about : Valuing a business (as a buyer)

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 Ј200,000 with a deposit of around Ј60,000.

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 Ј100-120,000. The P+L shows EBITDA around 11-12k per year on a turnover of Ј180k, plus director salaries (one active part-time, one passive) of around Ј20k. 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 Ј20k 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 Ј195,000 (reduced from Ј225,000).

Any advice or opinions gratefully received.

Best answers:

• If you can only hope to get a pre tax profit of Ј40k 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 Ј12k after management/owners wages, then that would suggest a goodwill element of Ј12-Ј36k which is so low you wouldn't really factor it in.
• Look at it this wa (just one of many)
  You've bought a freehold for Ј100k, so you've paid Ј95K for an investment which pays cЈ11K or just over 11.5% although I would bring depreciation into the calculation.
• 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
• 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
• 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.