Yes, I know
how to spell ‘stupid,’ please don’t e-mail me.
I’m cranky
and sore and upset. I’ve got a cold and
an ear infection.
What makes
me more cranky and upset is when I hear the same poor advice about rules of
thumb for pricing small businesses being passed around again and again and
again.
This week I
tell the story of the old accountant who told me once in a workshop,
‘Businesses sell for 5 times their cash flow.
Those with real estate sell, those without don’t.’
Simplistic
rules of thumb like this one guarantee only one thing… mistakes are being made
and it’s costing someone dearly.
I explain
why those with real estate sell, those
without don’t in this video and the answer will make you sick to your
stomach if you happen to be a business owner who could have fallen victim to
this kind of advice. Watch it here: https://youtu.be/ck_AmnOIzDE
If you own a
business and will want to sell one day, you need to educate yourself about how
this process works and give yourself time to get ready.
Learn what’s
involved in selling your small business.
Take my 3 hour online course at www.HowToGetOutOfMyBusiness.com or buy my Amazon best-selling book; How To Sell My Own Business. Available from Amazon.com or Amazon.ca
Please remember to like and share this article, it’s the
only way the people who run the internet have of knowing if the content is any
good or not. The more you share, the more likely someone who needs this
information will be able to find it.
If you would like to hear from me weekly before anyone else,
you can sign yourself up at www.DavidCBarnett.com
I’m coming to Charlottetown, Prince Edward Island in January
2017. My live events always fill up
fast. Find all my live events here: http://davidbarnett.eventbrite.ca
You see for
a ‘market’ to exist, you need many buyers, sellers and a product or
commodity. For example, there is a
market for 4-door used cars and a market for 3-bedroom homes in each town and
city, but small businesses are very individual.
They’re unique.
Therefore,
they each have their own market!
In the video
I give an example of the process engineer who will never buy the highly
profitable flower shop. I used to see it
all the time when I owned my business brokerage.
As far as
pricing goes, it doesn’t change much over time except if certain industries are
perceived to be more or less risky.
Business are valued on their cash flow and what the buyer is willing to
pay is based on their perception of the risk that the cash will continue to
flow into the future.
There is one
exception though. It’s an old story
about market manipulation.
I’ve seen
first-hand that government programs meant to encourage immigrant investors are
causing price bubbles in certain categories.
Convenience stores, franchise food locations, Laundromats, gas stations.
Anywhere
someone with limited English can run a simple business and quickly learn enough
words to make change and serve customers.
I recently
worked on a case where a newcomer was willing to overpay by 40%... because he
was up against a time-limit and if he didn’t buy a business he would lose a
$75,000 deposit that he had made to get into the country.
Welcome to
Canada, let us into your wallet. I bet
he feels all warm and fuzzy about igloos, beavers and maple syrup.
Just like in
any market where politicians and civil servants decide to meddle, an artificial
urgency has been created and business sellers are taking full advantage of
these victims created by government policy.
If you’d like to learn how to create high returns by making
local private lending and lease deals, check out http://www.LocalInvestingCourse.com
The Local Investing Academy starts in September. For a quick introduction, read Invest
Local. It’s available from Amazon stores
worldwide or as a .pdf here: https://gum.co/quoB
Please remember to like and share this article, it’s the
only way the people who run the internet have of knowing if the content is any
good or not. The more you share, the more likely someone who needs this
information will be able to find it.
If you would like to hear from me weekly before anyone else,
you can sign yourself up at www.DavidCBarnett.com If you need my help with your project, give
me a call at (506) 381-8416.
Do you live in the Maritimes? I’ve got workshops coming up on buying and
selling businesses in the fall. Book now
http://davidbarnett.eventbrite.ca
This week I answer a question about the different ways we can evaluate the price of a small business that is for sale.
For an in-depth demonstration of how to do this yourself, sign up for my online course at www.BusinessBuyerAdvantage.com
Transcript:
Hey there it's
David Barnett once again with another viewer question. This time it's from
Michel, and Michel asked, what are the different ways to evaluate a business
that's for sale? And basically the methods that we use when evaluating a
business fall into one of three camps. Let's take a look. So our methods of
small business fall into three different camps or schools of thought. The first
one being market comparison. So if you wanted to have a business evaluated as a
buyer or a seller, and you went to someone who had the proper training skills
and access to information on how to evaluate a small business. One of the
things they would actually do is actually compare the subject company that you
are looking at with other businesses in the same industry that have already
sold. And what they want to do is compare similar businesses and similar size
businesses. And what they are going to find is what other people have paid as a
percentage of sales and as a factor of discretionary cash flow So the database
might come back and tell me that a given company might sell for; other people
paid about 32% of sales for example, or they paid 2.4 times discretionary cash
flow. So we are actually comparing the subject company with other businesses
that have sold. And what we are doing is that we are actually getting the
feedback of all those previous buyers and more listening to their opinion of
what they thought the risks were in getting into this industry. So that by far
to me is one of the best way to evaluate a business.
The second group is
the capitalization or I put mathematical methodologies. Because basically what
we are doing in this case is we are trying to determine what rate of return is
going to make us happy. What do we want to see happen at the end of the day if
we were to own this business? Are we going to require a 20% return on our
investment? Are we going to require a 40% return on our equity that we put into
the deal? So there are many different ways that you can look at it from a
mathematical point of view. And if we are looking for a certain percentage,
these are often called capitalization rates. Cap rates are used quite often for
example in the real estate evaluation area. The other way to look at it is
multipliers which is the same thing, just from a different point of view. So
you might hear people say that certain businesses sell for three times earnings
for example. That would be an example of a mathematical or capitalization type
method of business evaluation.
The third category
will be simply looking at the assets involved. So I call it asset evaluation or
cost to create, where you are going to look at, what are the tools, equipment,
inventories, receivables, operating capital etc. required to make this business
function. If I were going to take a subject company and recreate the same thing
next door, what would it cost me? Now part of this can be done from the balance
sheet of the company, but to really do it accurately you would actually have to
evaluate and find out what the market value was of certain assets within the
business: hiring appraisers, evaluators, this type of thing. So the one thing
though that this group of methodologies doesn't include or leaves out is
goodwill. So if we have a profitable business that makes money all the time, then
it's conceivable that there would be a goodwill component to any value for that
business. And this would be left out using those methods. Now when I evaluate
businesses, I actually try and employ these three groups and methods. There are
13 specific methodologies that I use when I'm doing an evaluation. And I don't
employ all of them in every case. But I try to have at least one from each of
these three groups.
It can be
informative for example when you are setting up your deal structure that you
might offer an amount of money that included goodwill. So your offer might be
based on a market evaluation or a capitalization method, but perhaps you don't
want your down payment amount to be greater than the asset or cost to create.
So that the amount that you are asking the vendor to finance, the vendor take
back is in fact largely the goodwill component, which makes it safer for you
and makes financing more easy. So I hope that answers your question Michel. If
you want to see in detail how these things get applied, then what I suggest is
that you take my business buyer course, which is available at
businessbuyeradvantage.com where we actually take an example company through
the entire process. We look at the financials, we do a normalization, we then
do an evaluation and I show you the different methodologies and they get
applied. Thanks and we'll talk to you soon. Have a great day.
