11 November 2008

Buying and selling a business.

I SPECIALIZE IN THE NORTHERN AREA’S OF JOBURG.

· Fourways
· Sunninghill
· Paulshof
· KyasandS
· Honeydew
· Laser Park
· Strydom Park
· Kyalami
· Midrand.

Professional advice is only a click away!

If you need to sell your business, or want to buy a business, in the above area’s, and want the Aldes specialists to facilitate your mandate….please contact;

Kevin Foot - Cell: 082 553 0884.
Email: kevin@aldesactive.co.za


How Different Valuation Methods Affect The Price Of Two Businesses

Let’s look at how valuation methods introduced affect the price of two businesses. One is a garden service business, the other a gift shop.
Both have been established for two years and have profits of R6,000 monthly.
The garden service runs from the owners garage has assets of approximately R60,000 including an old bakkie and various lawn mowers and hedge cutters. It has 50 monthly contracts of which a large part have been going more than a year. It operates a five day week. Its clientele is derived from advertising in local pamphlets. The gift shop has assets of R140,000, comprising stock at cost of approximately R120,000 and fixtures and fittings of R20,000. It has a good position in a busy centre and is open five and a half days a week with its sales coming from passing trade.
Payback period
As a guide, an older, more established business with a high asset base, say 50%, would need 18 to 24 months to recoup the investment. A younger business with a low asset base and particularly businesses perceived to be higher risk because they are easier to start from scratch, would need 12 to 15 months. The gift shop would be calculated at 18 months, times the net profit of R6,000 ( R108,000 ) and the garden service at 12 months times net profit ( R72,000 ).
Why the difference
With the garden service, being home based, it could be easier to start from scratch and have less valuable goodwill. Also the contracts can be cancelled on a months notice and the customers may not take too kindly to a change of ownership. With the gift shop the business stems from its good position in the centre, which is not easy to duplicate and most landlords will not allow businesses selling the same merchandise in their centres. As long as the same stock mix is maintained it won’t matter who is behind the counter.
Return on investment
Assess an acceptable percentage return before tax and how much one would pay a manager to run the business. The norm is 35% before tax for small to medium sized businesses with a managers salary of say R3,000 a month, particularly as both ventures do not require highly skilled people to run them. One could accept that the gift shop has a lower business risk and the expected return would then be 30% and the garden service with a high risk 40%.

The sum would be as follows:
Annual net profit, less salary, times by the return. In both cases R72,000 – R36,000 = R36,000. The difference would now be: Garden service R36,000, divided by 40% = R90,000. The gift shop R36,000 divided by 30% = R120,000.

As can be seen, both the above methods look purely at the net profit of the business and don't take assets into account. The gift shop is therefore valued below its asset value.
Super Profits Method Of Business Valuing

The last method of valuing a business is the extra earning potential, or super profits method. To do this, calculate the income that would be earned from investing an amount equivalent to the asset worth of the company, its fixtures, fittings, machinery and stock, in the bank. Add to it an annual salary for managing the business, then deduct it from the net profit of the business over 12 months. This is called the extra earning / super profit of the business. Multiply by the same factor used in "payback period" method, to determine the goodwill and add the result to the asset value and you get a value for the business.

Example:
Extra Earning potential / Super Profits
Garden Service
With assets of R60 000, the equivalent percentage amount on fixed deposit at 11% would earn R6,600 a year. Add a R36,000 annual salary = R42,600. Deduct R42,600 from the annual net profit of R72,000 to give an extra earning potential of R29,400 a year. Using the one year period of the payback method detailed previously gives a goodwill value of R29,400 ( R29,400 x 1 ). Add this to the R60,000 asset value to give a price valuation for the garden service business of R89,400.

Gift Shop
Asset value = R140,000. Earning 11% pa = R15,400 return + salary of R36,000 pa = R51,400. Deduct R51,400 from the annual net profit of R72,000 to give an extra earning potential of R20,600 a year. Multiplied by 1,5 years = R30,900 plus assets of R140,000 = a price of valuation of R170,900. This method puts a higher price on a business with a higher asset base. This may not always be justified.

Market Value
To balance out anomalies, take an average of results of the three methods I have detailed.
For the garden service, that works out at R72,000 + R90,000 + R89,400 for an average of R83,800
For the gift shop, R108,000 + R120,000 + R170,900 = R132,966 average.
The R49,166 variation between two businesses with the same net profit is justified by the differences in risk profile and asset base.

Although the price of the gift shop is only its stock value, remember assets are only as good as the profits they generate and also each business with similar profits is in competition for the same buyers.

But why should you pay a premium of R49,000 plus to achieve a very similar profit level? Simple. Not everyone wants a garden service business some and would rather pay the extra for a venture with less risk, fewer labour problems, a bigger asset base and maybe most importantly one they can empathise with.
Price and Value Compared


It is one thing to have practical methods for putting a market related value on a business you want to buy, but will theoretical prices be realised in the market place?

We have looked at three methods of assessing the value of two businesses with the same net profit but different asset bases. Both had net profits of R6 000 a month, but the garden service business achieved it with assets of R60 000, while the gift shop got by with assets worth R140 000.

We put an average price tag on the garden business of R80 466 and on the gift shop one of R138 366. There often is a difference between value and price. It can be based solely on horse trading between parties.

But there are many other factors influencing price, a violent robbery, for example. Unfortunately, over the past few years this had been a real concern with buyers. A seller whose wife passes away may want to get out of the business at virtually any price. He is not overly interested in the value of his business. Partners who are at each others throats and are keen to sell tend to accept any reasonable offer, even less than the valuation. A seller with cash flow problems will be forced to accept a lot less than the value.

A seller who is not prepared to provide any financial information about the business will receive low offers. But there are things which help the seller to get value. Offering good terms to a buyer is one way. Having sound records and provable profits creates buyer confidence, resulting in a better price.

Buyers often find they lose golden opportunities by adhering religiously to third party advice on not paying more than a certain amount. Then they spend months trying to find a similar operation, eating up their capital and berating themselves for not offering a little more the first time.

If the business will pay you a salary and give you a reasonable return on your money and the balance of the price is being financed out of the cashflow of the business, it really doesn’t matter what you pay.

The point is you are buying more than plant and equipment, more than a lease to some premises, more than just a profit, you are buying a way of life.
Let's Sum It All Up Again

That’s it, then. If you can’t yet buy or sell your business, you haven’t been reading carefully enough for the
last 21 articles. To end off, here is a summary.

Mr / Mrs Buyer; are you ready to invest sweat equity? Buying a going concern means not having to spend 18 months getting to a profit situation with a new business.

Identify acquisition prospects with a broker or by scanning "business for sale" ads or advertising in "businesses wanted". Get advice from the right people.

Mr / Mrs Seller; making it widely known that your business is for sale sends the wrong message to suppliers and your bank. Tart up the firm to improve price prospects by being liberal with information to a qualified buyer.

Buyer, shortlist good buys and check these aspects:
· Lease on the premises.
· Turnover.
· Gross profit.
· Net profit, bearing in mind these include all owners perks.
· Stock check.
· Staffing and
· List of fixtures, fittings, plant and equipment.
A myth in setting a price for a business is that profit is the major determinant. You can’t put the same price on two businesses with identical profits if they are otherwise quite different.

The methods I recommended involve the payback period, return on investment and extra earning capital.

Remember, 80% of businesses are purchased on emotion, not logic.
So be careful and do your homework.

Tips On Selling A Business


Selling For Top Value
· The secret in achieving the highest possible price is simple.
· Without information there can be no value
Do you want value?
· Listen to the experts
· Overpriced businesses do not attract serious buyers
· Your business is in competition with all others in your profit range
· It takes hard facts to satisfy a buyer
· The average business is on the market for 3 months before the seller becomes realistic about his demands, lowers his price and considers terms
· Very often the first offer is the best offer
· If your business is on the market for a long time, buyers become suspicious and think there is problem with the business
Confidentiality
· The confidentiality of your business is extremely important but once the buyer has been qualified you must supply the information
Price Achieved
· Fabulous businesses receive a fraction of their asking price and other ordinary ones achieve high prices.
· Why? The attitude of the seller
· Buyers are not fools - never treat them as such
· You as the buyer? What would you expect? What would you wish to see? What price would you pay? Would you be interested if the seller was not prepared to divulge the figures etc?
· Remember! No matter how good you think your business is, it will take hard facts to satisfy a buyer
To make A Decision The Buyer Needs
· Monthly turnover figures for the last 12 months
· Breakdown of monthly expenses
· List of assets with valuations
· Copy of the lease of the premises
· List of staff - plus salaries / service / contracts etc.
· Write up on the business
· Management accounts up to date
· Balance sheet/ Income statement for the last 2 years
· Delays in details turn serious buyers away

ALDES BUSINESS BROKERS ©