Tuesday, May 20, 2014
There are a number of standard appraisal methods used to value a business that include, Asset approach, Income approach, Market approach (Comps), Capitalization of Earnings and Discounted Future Earnings. Each one of these methods individually does not always represent the true value of a business. We have seen appraisals where the derived value of these five different approaches varied by 500%. Also used are Rule of Thumb values based on multiples of adjusted profits or percentages of gross sales. The rule of thumb methods only work when there are many similar businesses having the same operating expenses and assets. This doesn’t always happen and when you use the method on more unique businesses it just doesn’t work. Using Comps tends to give the average value of the compared businesses and not the value of the business being appraised. Capitalization of Earnings and Discounted Future Earnings are less often used and tend to end up with values that also tend to give the average value of the type of business. After working with the standard methods for some time and evaluating what creates value in a business we learned that combining the Asset, Income and adding market influences into a single method gave an accurate market value. Having been involved with our own Business Brokerage for over twenty years we were also able to look at the businesses we sold and adjust and refine the combined method to reflect a True Market Value Appraisal. The next step was to find a way to keep the through detailed analysis of the business being appraised and present it in a simplified easy to read manner. By looking at the components of a business that created value and categorizing them into Income, Assets and Market related we were able to create an Excel program to present the appraisal. The program was designed to be flexible so that it can be changed to meet different types of businesses and the many different purposes for business appraisals. This system may look simple but the complexities of doing an appraisal are still applied. There are many things that we still consider that are not listed in every report. When they are needed we add them into the Excel program. Appraisal Requirements For an appraisal system to work it must address the following: 1. the profitability of the business 2. the tangible assets of the business 3. the presence of intangible assets 4. the value derived should represent the market value 5. have flexibility to allow for the terms of a sale. 6. simplicity - Usable and understandable. The first step was to determine what components in a business have value. These are some of them: 1. a functioning business with modest growth 2. skilled employees 3. working equipment 4. adequate usable inventory 5. a quality product or service 6. a profit 7. collectable receivables 8. a broad customer base with no very large customer 9. some new product development capabilities 10. a good reputation (name) in the market place 11. a clean, adequately sized work area 12. a financially sound operation with a good accounting system 13. the business located correctly for its market place 14. a good base of suppliers After building this list it has to be divided to fall into a profit/asset based appraisal system. They are categorized as follows: 1. Profit based items. a. business profit b. a functioning business c. business size - gross sales d. intangible assets 1. skilled employees 2. a quality product or service 3. a broad customer base - customer list 4. new product development capabilities 5. a good reputation - business name 6. good financial management 2. Asset based items: a. inventory b. equipment c. receivables d. contracts e. patents f. trademarks g. real estate By Robert A. Klein, President and owner of Business Appraisals, providing business appraisals on all types of businesses. Former President and owner of Business Search, Irvine, California, a Merger & Acquisition firm specializing in the sale of manufacturing, distribution and related businesses, with programs for both buyers and sellers.
Saturday, January 25, 2014
5 Ways To Raise Extra Money When Buying A Small Business It's common for someone buying a business to discover he or she will need more cash than expected to take over the company. In addition to the down payment, money will be required for working capital. Here are five of the most popular strategies buyers have employed to get the extra funding needed. A surprise that some entrepreneurs encounter when buying a small business is that the amount of money expected to go into the purchase will not cover every expense involved in becoming the new owner. Not only is it necessary to come up with the down payment, but in order for the business to succeed the buyer will need working capital when taking over. Smart strategies for raising that extra money include: 1. Seller Financing: If the deal calls for an all cash purchase, and the buyer is emptying his bank account to p ay off the seller, perhaps the agreement can be modified to include a promissory note to be used by the buyer for part of the price being paid. That will free up some of the cash originally intended for the down payment. The seller may find tax benefits to this arrangement. Besides, making sure the buyer has sufficient working capital is an important way to help her succeed. 2. Inventory On Consignment: The buyer can save the money that would ordinarily go for purchase of the inventory at close of escrow, by paying the seller the wholesale costs for inventory items only as they are sold to customers of the business. Rather than the buyer's several hundreds or thousands of dollars tied up with parts or products, it can be used for other expenses and the seller will be paid for each item of inventory as the buyer sells it. 3. Earn-Out Agreement: Another way for buyer and seller to work together to make sure th e business won't run into trouble for lack of working funds, is their agreement to establish a lower selling price than was originally planned. That can call for a lower down payment than the amount stated in the sales agreement. The seller will be compensated later, under the earn-out provision of the sales contract. It would specify that the price is linked, by an agreed-on formula, to a specific low performance level for the business. As the business outperforms this initial projection, the price would rise according to that formula. That means the seller sacrifices at first, with lower payments for the balance of the price than he wanted. But as the price of the business goes up, so will the amount owed to the seller, as expressed in larger payments. 4. Borrow From Financial Institution: The buyer may be able to get extra money from a bank or other financial institution. If there is seller financing involved in the deal, another lender i s more likely to agree to approve an application for a loan to help fund working capital. And it's a good idea for the buyer to start shopping among financial institutions before he or she finds a business to buy. That way the buyer will know which company is likely to offer the needed cash. 5. Assume Seller's Debt: If the seller will need cash at close of escrow to pay off business creditors and deliver the business free and clear of debt, the buyer may be able to assume that debt instead. That will require the cooperation of the vendors to the business. Some or all are likely to go along with the plan as it will insure their continued relationship with the business. A shortage of cash to take over a business need not stop a buyer from proceeding if he or she can use one or more of these methods to raise additional funds before taking over the business. About The Author: Peter Siegel, MBA is the Founder & President of BizBen.com (businesses for sale, businesses wanted to buy, resources, & articles) and the BizBenNetwork Online Community. He advises and consults with business buyers, business sellers/owners, brokers, agents, investors, & advisors on a daily basis. Reach him direct at 866-270-6278 to discuss strategies regarding buying, selling, (or financing a puchase of) small to mid-sized businesses.