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How Much to Pay For a Business

So, you want to buy a business. You’ve done your research and have found an opportunity that fits all of your criteria. But how much should you pay for it? This is one of the most difficult questions to answer in a M&A transaction negotiation due to many variables involved.

This article will break down a few of those variables so you can get a general idea as to whether or not this company is priced fairly to sell.

I also want to mention that I’m going to be using Family Business Sales as my main case study throughout this article. They’re an actual company that buys and sells family-owned businesses across the United States, which has been around since 1974. In addition, they boast an A+ rating from the Better Business Bureau (BBB).

The numbers that I use in this article are made up and the valuation ranges given to me by Family Business Sales do not reflect their actual opinions but rather a general estimate of what they see in most transactions. This is just to give you an example as to how much information I am working with for this case study. Okay, so let’s get started!

When calculating the value of a privately-held company, there are several things worth taking into consideration:

1) Comparing apples to apples: if it’s your first time pricing and selling a business, you’ll want to stay away from companies in the same industry or related industries. Doing this can result in any deal being potentially overpriced or underpriced. If it’s not your first time selling a business, you’ll still want to stay away from companies in the same industry as reselling can become expensive if you make an error.

2) The age of the company: according to Investopedia, there are five stages of growth for businesses; start-up, early development, rapid growth, maturity and decline.

Some businesses may be worth more due to their early stage of development where they have the most room for growth. Other considerations include how long has this particular company been operating? Is it healthy or barely getting by month-to-month? These are all things that will help formulate what type of valuation range you should be looking at.

3) The industry the company is in: this should be standard knowledge but not all industries operate in the same way. Likewise, not all companies within that industry are built the same. There are several factors to consider when doing this such as how old is the business? Is it a niche market or does it have national coverage? How many competitors are there in the market place? All of these will affect not only what you can pay for a company but also what type of return on investment (ROI) you can expect after purchasing said business.

4) Gross Profits vs Net income: like I mentioned before, not all businesses are created equal. You’ll find some companies make less money than others do while paying out that money to the owners and other companies may be making large sums of money but paying very little out in order to keep as much cash on hand as possible. Like I mentioned earlier, Family Business Sales uses an A+ rating from the BBB. If you’re looking at a business with less than perfect credit, it might make sense for them to do this in order to keep themselves afloat. The downside however is that these businesses generally have less room for growth and require more capital for things like advertising and staffing compared to one with better credit scores and several years under their belt (more on that later).

5) What type of assistance is available: if this company has been around long enough, there’s several options available when it comes time to write a check and close the deal. Some companies will offer financing in order to look more attractive to potential buyers and reduce the initial payout needed today. Other options include installment agreements (also known as seller financing) and lines of credit (LOCs).

6) The financial records: this goes without saying; you’ll need accurate figures if you want an accurate valuation range. You’ll want three years’ worth of personal and business tax returns, monthly profit & loss statements (P&L), balance sheets (B/S) and cash flow reports (C/F).

Family Business Sales uses an A+ rating from the BBB. If you’re looking at a business with less than perfect credit, it might make sense for them to do this in order to keep themselves afloat. The downside however is that these businesses generally have less room for growth and require more capital for things like advertising and staffing compared to one with better credit scores and several years under their belt (more on that later).

Similar to the point above, there are also intangible assets you’ll need access to. These can include everything from clientele lists, intellectual property rights, patents, trademarks, trade secrets/confidential information about products or services they offer or anything else of value that isn’t readily apparent at first glance. What you will want to avoid is legal liabilities that could come back around on you if something were to happen after purchasing a company.

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