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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