How is a business valued?

First, you should know that there is no one way to value a business. That’s because “value” means different things to different people. In addition, there are lots of variables that affect the value. These include the circumstances around the sale, the economy, the market/industry served, and more. In the end, the value will be the price that the buyer and seller both agree on to complete the transaction.

When learning how to buy a business and how to value a business, as a buyer, you will want to be sure to ask: “What valuation method was used to value this business?” Three common methods of valuing a business include asset approach, income approach, and market approach. Let’s briefly look at each.

Asset Approach

Every business has assets and liabilities. The assets are things that are owned like equipment, vehicles, real estate, computers, furniture, etc. Liabilities are debts or obligations that are owed by the business to some else. These include things like leases, mortgages, taxes, and more. The value of the business then could be defined by assets minus liabilities, or more commonly defined as net worth.

This approach sounds simple in principle. The reality is usually more difficult. For instance, a patent may be an asset. But how much is the patent worth? It depends on the marketability of products that are developed from the patent.

To value a business using the asset approach, each asset and liabilities must be discovered, reviewed, valued and compiled in a summary. An experienced business intermediary can help with this valuation.

Income Approach

The income approach to valuing a business is focused on the business as an income generator. If a buyer invests money in the business, they are expecting a return. The amount of the potential return will determine whether the buyer wants to make the investment or not. So, the valuation must present the business to the buyer in terms of the potential return on investment (ROI).

The income approach usually uses one of two methods: Capitalization and Discounting. The capitalization method divides the expected earnings of the business by the capitalization rate (CR). The CR is equal to a discount rate (DR) minus the expected growth rate (K). Thus CR = DR – K. For example, with a discount rate of 25% and profits growing steadily at 5%/year, the CR is 20%. A business with a CR of 20% would be worth 5 times its earnings.

The second method: Discounting Cash Flow method, values the business based on its earning power weighed against risk. The first step is to estimate cash flows for the next five years. Next, you apply the DR to your five-year model. The DR, in short, is an interest rate factor that reflects the opportunity cost of the capital that you are about to invest in this business. In other words, you will need to know if it is more worthwhile to invest in the business or put your capital elsewhere in a more profitable option. The DR can be calculated by a qualified business intermediary.

Market Approach

Finally, the third approach to valuing is the market approach. This method relies on the value and worth of other similar businesses in the same market. It is somewhat comparable to the concept of comparing your house to other houses that have sold in your neighborhood to determine your selling price. A qualified business advisor will be able to help you determine what similar businesses have sold for in your area.

Five Skills Needed to Run a Business?

There are several fundamental skills that a person needs to own and run a business. Listed here are some of the essential ones:

Leadership

If you are going to be an employer, it is important to be a leader. A leader has a vision for where the business needs to go. The leader then organizes a team of employees around that vision and motivates them in each of their roles on accomplishing the vision. It’s more about listening and encouraging than about issuing orders and dictating. Your success will depend on your ability to lead and motivate your team.

The business owner does not have to be an expert bookkeeper. But it is important for the business owner to understand their costs. While you can hire good people to maintain your books, there is no way around understanding profit margins, return on investments, and balance sheets. Your ability to understand the financing aspects of your business will be the difference between surviving in both the short term and the long term.

Sales

Sales are something that we all do. Everyone in the company, from the receptionist to manufacturing, service, parts, and the call center is “selling” the company. It’s about convincing others of the value of doing business with you. Getting, delivering, and keeping the business is everyone’s role. There is no one in the company that cares more about that aspect than the person at the top. If that’s you, then you will need to keep everyone in the company “sales-minded.”

Project Management

Whether you are launching a new product line or a new website, it’s all about projects. Running a business means knowing how to “get things done.” Projects require the coordination of people and resources on a timely basis. A business is nothing more than a lot of projects, all bundled together. Some are ongoing; some are short term. The business owner is the grand orchestrator of lots of projects. The ability to manage projects and regularly get things done is critical.

Delegation

An important lesson to learn early on is: “you can do it all yourself.” A successful business is a team effort. The larger the business, the larger the team needs to be. If you cannot delegate responsibilities, your business will not grow. The opposite is also true. The faster you can let go of your need to control everything, the faster your business will grow. All of this assumes that you look for and hire good qualified people.

Five Reasons to Use an Attorney

There are lots of good reasons why you need to hire an attorney, especially when buying a business. Here are a few ways that an attorney can help you purchase and run your business more effectively.

Structure

When purchasing a business, the buyer will need to determine the best way to structure the business. There are lots of options. Each option will have its own implications for the owner. An attorney will advise on the best way to structure the business after the acquisition.

Contracts

Attorneys are experienced at reviewing and writing contracts. They are familiar with all of the essential elements that need to be included in a contract. When you are buying a business, the attorney will review the buying agreement. They will also review any outstanding liabilities and agreements held by the business you are purchasing. An attorney review of the buying agreement ahead of time can prevent headaches and legal problems after the purchase.

Advice on People Issues

Running a business involves people who have some type of relationship with the company. The owner makes decisions regularly that affect the people that work for the business. The people can be employees, independent contractors, customers, and others. Businesses are required to follow laws and regulations related to the people involved, and often those regulations are so complex that an attorney is needed to advise the business owner on the best way to comply.

Government Complaints

From time to time, governments (local, state, federal) will not like something that the business is doing. When that happens, they come knocking in the form of lawsuits, complaints, zoning, licensing, taxation, and more. The regulatory environment has become so complex for businesses that, most of the time, only an attorney can figure out how to comply with the government regulations. Unfortunately, everyone pays for this through higher prices. Nevertheless, this is the environment we live in. That means today’s business owner can’t get by without legal counsel from an attorney.

Negotiating Experience

When purchasing a business, you will want someone by your side with experience. A good attorney will have experience in negotiating the buying and selling of a business. Their experience could save you thousands if not hundreds of thousands of dollars. They will know the questions to ask, which will reveal the true nature of the current situation of the business; that kind of experience is invaluable and worth paying for. Don’t underestimate it.

How Does A Business Advisor Help When Buying A Business?

Many buyers want to know whether they should hire a business advisor to help them buy a business. The answer is “yes, but…” We say “but” because you should plan to use an advisor, but not necessarily hire them to help. Let us explain.
A business advisor plays an important role in the purchase of a business. It is important to understand that role. In the vast majority of sales, the advisor is representing the seller. The seller generally pays the broker a commission to help sell the business. That means, when the advisor is helping the buyer, he/she still has a fiduciary responsibility to the seller. So, why should you use an advisor?

Source of Listings

Keep in mind that a business advisor does not “share” business listings with other advisors. That means each advisor has their own listings. As a buyer, you will want to let various advisors know that you are interested in a purchase. They will then show you their listings. Those listings are a big reason to seek out professional business advisors.

Paperwork

The amount of paperwork and documentation in the purchase of a business can be overwhelming. An experienced advisor will keep the sale on track by making sure all the appropriate paperwork is completed.

Intermediary

The business advisor will act as an intermediary between you and the seller. Many times you will want this. The negotiation process can be delicate. For many, it is an emotional process. When you work with an intermediary who is not emotional about the process, it is easier to sometimes deliver terms and details to the other party.

Here are several questions you may want to ask when choosing a business advisor:

• What is your experience?
• How many transactions have you been involved with?
• What is your business experience?
• Do you have references?
• How many clients are you presently working with?
• Do you share your listings with other offices?
• Do you specialize in any particular type of business?
• How Can The Buyer Help The Advisor?

Once you are comfortable in selecting a business broker, there are several ways that you can help them. After your relationship with the advisor is established, it is important for you to let them know that you are serious as a buyer. Here are a few ways you can do that:

• Prepare a thorough and complete list of the kinds of businesses you would consider.
• Give them a copy of your personal/corporate financial statement.
• Tell them exactly how much you have to invest in a business.
• Ask them for suggestions on how to improve your search for the perfect business.
• Keep in touch with them on a regular basis.
• If you locate businesses on your own that are of interest, ask them to check them out. Note how long it takes for them to follow up. (It should be quick, like within a day or two.)

When a buyer of a business takes over, one of their concerns is whether important employees will leave. There are a few things to think about here. First, the new owner needs to remember that most employees typically “need” their job. They are not eager to leave. Second, the employees are probably just as nervous about a new owner taking over and “firing” them as the new owner is about the employees leaving. And finally, remember that the employees are people just like you. As the new owner, are you capable of treating them the way that you would want to be treated? If so, you have nothing to worry about. It is a matter of mutual respect for one another. If, on the other hand, you are a type A personality that can’t get along with anyone, you may have to make provisions to put a manager in place that can work with your employees better than you!