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How To Establish The True Value Of Your Business

It took blood, sweat and tears to build the business you’ve created, but how much is it worth to someone else – for instance, a prospective buyer?

As a seller you need to determine what your business is worth and which valuation method makes sense for your situation. Exodus Business Solutions understands the differences and how to apply them to your specific industrial sector.

Asset valuation method

Add the value of your assets and subtract your liabilities to calculate how much your business would be worth if it were to be sold today. This method does not take into account any future earnings potential or any intangible value, such as the goodwill of the business. Goodwill may or may not be transferred along with new business ownership. Goodwill might include the business location or the owner’s personal reputation, or a special relationship with customers. An underperforming business may not have goodwill, so net asset valuation might accurately reflect its value.

Capitalization of earnings or cash flow

The capitalization rate represents the rate of return a buyer would require on an investment when compared to the market rate for other investments that have comparable risks. A buyer would need to determine the annual earnings trend.

Gross income multipliers

When business expenditures are predictable or in a situation where the buyer intends to drastically cut expenses after a business sale, it can be reasonable to base the business value on a gross revenues multiplier. However, this method, along with using a capitalization rate, doesn’t take into account that businesses within the same industry may have differing profit margins, based on expenses.

Assets and Earnings Valuation

The IRS recommends this method, which bases a company’s value on both assets and historical earnings. After calculating the expected returns from your business assets, then compare this total with your historical earnings. If your annual earnings are higher than the return from your assets, the difference is your excess earnings, which can be divided by a capitalization rate.

Attracting the Right Buyer

There are generally four types of buyers in the marketplace and it’s important to consider their motivations for acquiring your business.

Strategic buyers usually are interested in investing in larger businesses, often with revenues over $20 million, and are often attracted to entering new markets that offer new technologies, proprietary processes or products. Most small businesses don’t meet the criteria to attract these types of buyers who are focused on future earnings and market share.

Industry buyers often lack strategic or synergistic motivations for purchasing a business. Their goals are to locate and secure raw materials or products and negotiate the best possible price to benefit their company or organization.

Financial buyers often are interested in cash flow. They have money to invest, and are looking for a variety of different businesses within varying industries. If they don’t have the experience, they may need significant training and assistance from existing management after the sale, which should be reflected in the purchase price.

Corporate, or sophisticated, buyers are an attractive buyer for most businesses. They often take into account future earnings when assessing a company’s value. This financial information should be well-documented with credible and supportable assumptions to attract these types of buyers.

To receive a fair and accurate market value for your business, enlist the support of an expert in the field, like Exodus Business Solutions By hiring a professional to create a detailed valuation report, it demonstrates to potential buyers that you understand the market and your company’s true worth.

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How To Sell A Business

If you are a business owner considering your options, you may be in the stage of determining how to sell a business. Being one of the areas leading firms in the industry, we are well equipped to help you with your questions. Your business information will be handled by experts and conducted in a confidential manner. Below is an outline of some of the issues you should expect when selling your business.

The Many Aspects of Preparing to Sell

Even if you think you’re many years away from selling out, you should consider what your heirs or successors would have to do if you died unexpectedly. If you don’t have a workable exit strategy in place, you (or your heirs) may have no choice but to liquidate the business and sell off the assets piecemeal, getting nothing for the goodwill you’ve built up over the course of the years.

Initial issues in selling out – how should you time your decision and choose experts to help, and what legal/ethical pitfalls do you need to avoid?

Valuations of small businesses – how does the market put a price on a small business, and what can you do to maximize your own business’s value?

Finding a buyer – what do you need to know about working with a business broker, creating a selling memorandum, and other marketing concerns? If you work with us, we already have pre-qualified buyers, and one of the first steps in selling your business is to see if we have potential buyer matches in our database.

Tips during the listing process:

•Have up to date financial information available
•Prepare a current list of fixtures, equipment and inventory (if any)
•Maintain normal business hours
•Dress up the business premises
•Be prepared to negotiate
•Gather all of the information a buyer might like to review (see below)

Structuring the deal – what are your options as to terms, paying particular attention to the tax implications of various alternatives? For a brief recap, the following will need be reviewed by potential buyers:

•Financial information (including tax and liabilities)
•Premises and assets (condition, value, etc)
•Intellectual property (trademarks, copyrights, etc)
•Employees (roles, key members, etc)
•Management (effectiveness, etc)
•Products and services
•Customers (relations, reliability, etc)
•Suppliers (relations, cost, etc)
•Licenses and contracts (staff, leases, customers, etc)
•Sales and Marketing (methods, costs, success, etc)
•The industry itself (history, present and the future)
•You

Financing the deal – what should you know about seller financing, and third-party financing through leveraged buyouts?

Completing the deal – from the Letter of Intent through due diligence to the closing, what are the typical steps you can expect to go through in the sales process? When you sell the business, there are expenses in the selling process and you will not receive the exact amount that you sold it for. Below is a summary of what you can expect to receive (cash) from the sale. This is for guidance only as it will be different for everybody depending on what approach was employed to sell your business.

SELLING PRICE

(Less)
Cost of Solicitor
Cost of Accountant
Cost of Business Broker (can be high as 10% of the final sale price)
Any accounts payable
Payment of any outstanding loans, leases, contracts, etc
Cost of bringing the business up to speed (repairs, refurbishments, etc)

(Plus)
Prepaid rents, insurance, etc

(Equals) SELLERS EXPECTED PROCEEDS

After the sale – have a plan in place for what you plan to do with your life!

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How To Buy A Business

Sometimes entrepreneurs ask us how to buy a business. We tell them the best way is to enlist the help of a professional service to help you with the transaction. Below are some of the checklist items we discuss with our clients.

Review their financial documents. Determine how much cash flow you can expect in the near term after giving yourself a modest salary. Divide the cash flow by your cash investment to get your return on investment. Is the ROI acceptable for your perceived risk? If it is, make an offer. Rely on the process work and you’ll find the business that’s right for you.

Get expert advice – It’s always a good idea to speak to an accountant and a lawyer, before you buy a business. For instance, you may want to make sure the seller cannot open another similar business just around the corner. Don’t forget, mistakes made now may come back to haunt you in the future. Get advice about issues such as:
•  The expected return on invested capital.
•  Valuation of stock and work in progress.
•  Inspection of the seller’s accounts, tax returns, wages books, and any statements that must be given under the law, etc.
•  Find out why is the business being sold – Sellers will offer any number of apparently legitimate reasons to explain the sale of their business. But it is worth asking anyway, and attempting to judge how comfortable the seller is in releasing information. Sometimes the seller wants to sell the business for a reason that should discourage you from buying (eg it’s not making money!). Make sure an accountant looks at the business’ accounts.

• Determine what is a fair price – Usually a business that is a going concern is sold with a certain payment for “goodwill”. This is the price the buyer pays for the business’s “good name” that has been earned over the period of operation. An accountant can help you establish an appropriate figure for goodwill by examining the business’s financial accounts.

What are the sales prospects? Among other things, you should know:
• The sales figures for each month of the year.
• The profiles of buyers (eg their age, spending patterns).
• Who the suppliers are and what their relationship with the business is.
• What the stock figures are, including average costs and turnover.
• If the stock is realistically valued.
• Profits and expenses

Make sure the profit figures offered by the seller are analyzed by your accountant. For instance, it is important to know whether the business will generate enough profits to cover your financial needs and support your lifestyle. Make sure the seller’s figures presented as expenses are realistic and are also looked at by an accountant. For instance:

• Are the expenses listed in full?
• Are there hidden costs?
• What are the depreciation costs?
• Are there any cost increases likely in the future?
• What are the terms of the lease of premises?
• What is the cost of borrowings for the business?
• What is the business’s credit rating?
• What are the total costs of employees?
• What are the liabilities that will carry over with the sale?
• Are there likely to be any rental or leasing increases?
• Are there any outstanding maintenance costs that must be met?
• The assets – Make sure you understand what assets are included in the sale price. For instance:
• Are they priced at a fair value?
• What are the depreciation costs?
• What are the leasing costs?
• What is the cash flow?

Legal help – A lawyer can help with the following issues:
• Whether the business structure is suitable for your needs.
• Agreements with the seller to ensure they don’t compete in the same geographical area or the same market.
• The terms of the purchase agreement.
• Whether the purchase agreement should be subject to finance.
• Whether there should be a trial period built into the purchase agreement.
• Looking at existing leasing agreements.
• Whether the purchase agreement says what you think it does.
• Searching the council and other agency records to ensure there are no plans or council orders that could disrupt the business or lead to a drop in sales.
• Checking the zoning regulations.
• Drafting any restraint of trade requirements of the seller, including dealing with prior customers and conducting a similar business.
• Transfer of business names, trademarks, etc.
• Information to be supplied by the seller (eg a list of current customers and suppliers).
• Any agreement for the seller to work in the business for any length of time.
• Any specific requirements of legislation

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Buying A Business: What Price Should You Pay for It?

If you’re interested in purchasing an existing business, it can be difficult to determine how much the business is really worth. The process is part-art and part-science, and there are several methods which may be used to arrive at a company’s purchase price.

Asset-based Valuation
One of the most common methods to determine a businesses value is to add up its assets, and subtract its liabilities using the fair market value standard. Assets would include any intellectual property items, key customers’ contracts, and any strategic partnership agreements. Don’t overlook any unrecorded liabilities, which may include any pending legal issues, environmental compliance costs and property and income taxes.

This method does not take into account any future earnings potential or any intangible value, such as the goodwill of the business … another common asset-based method is capitalized excess earnings, which accounts for both tangible and intangible assets.

Market-based Valuation
Market based valuation methods rely on pricing multiples, which calculate a company’s financial performance, including its revenues and profits, and its potential selling price. This method is commonly employed by buyers and their advisors to calculate a company’s worth. Comparison data – “comparables”, based on sales of businesses similar to the business you are interested in buying, is also analyzed. This requires that the data is carefully selected and scrutinized and offers consistent data reporting standards.

Income-based Valuation
The bottom line for most buyers is how much income this business could generate for them. An income valuation approach factors in the risk and rate of return on the investment, based on capitalization and discounting. The capitalization rate represents the anticipated long-term growth rate subtracted from the discount rate. If a company’s earnings vary significantly from year to year, using the discount rate is often the better way to find the business valuation. The discount rate represents the rate of return necessary each year to make this business venture worth the investment. The business purchase price is compared against the annual return of other safer investments.

There are other factors to consider when attempting to determine a businesses’ value, and having a valuation prepared by an expert will lend credibility to your offer.

Determining the value of a business is just the beginning … let the professionals at Exodus Business Solutions help guide you through the process to make your dream of business ownership a reality!

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Business Valuation Formulas

EB Valuations can help you determine a fair and accurate valuation for your business.

The best results are produced by an in-depth analysis of many factors. EB Valuations is very experienced at assembling an accurate picture and executive summary. However, from time to time we are asked: “Isn’t there some kind of rule of thumb short formula for businesses?” The answer is that, yes there are short formulas, but these are generally inaccurate.

Even though that is the case we are sharing with you what some people think are various rule of thumb valuation methods for specific types of businesses.