Risk vs. Price
Some buyers look for the “perfect business” (high profits, low risk, great potential, easy to run, and no problems). If such a business is ever found, the price will be high, and the competition from well financed industry professionals and corporate buyers will abound.
Other buyers look for very inexpensive businesses, often failing and preparing to close. These businesses are high risk and usually involve a significant amount of additional capital to make the business profitable. These too, are best left to industry professionals or corporate buyers who can afford the cost and the risk.
Our organization sells most of its businesses in what we like to refer as “The VR Safety Zone”. Businesses in the VR Safety Zone are priced less than the “perfect business”, if it exists, and significantly less risk than those failing or preparing to close. The VR Safety Zone business offers equilibrium between potential and risk. VR searches to locate businesses that are well established, have identifiable opportunities for financial growth, and have a committed and reasonable seller.
Pricing a Business
Price is in most cases related to cash flow and varies with the agreed upon financing terms. Price will also depend on the type of business, the value of the combined assets, general attractiveness of the business, and the future potential. True market value is what a buyer agrees to pay and a seller agrees to accept without undue pressure.
Privately held business owners attempt to minimize their tax consequences to maximize their financial benefits. Given and accepting these circumstances, correlates to the businesses financial statements (books and records) being “Recast” or “Normalized” to reflect the true picture of the businesses income producing capabilities (Discretionary Earnings, or DE). This means working between the lines to add back to profitability all of the legally taken charges to expenses that weren’t necessary or will not be taken by the buyer in the future. Your VR intermediary will explain, educate, and advise you on how this process works in pricing a business. There are many methods of pricing a business. The most commonly used are:
Cash Flow Method
A multiple of the annual cash flow (which we refer to as Discretionary Earnings or “DE”, or Earnings Before Interest and Taxes or “EBIT”). This multiple can vary widely depending on the business, the industry trend, and the economy.
A combination of “Furniture, Fixtures, and Equipment” (FF&E), the inventory and multiple of Discretionary Earnings (DE).
Gross Sales Method
3 – 12 months gross sales; again dependent upon the business, the industry trend, and the economy.
Comparable Sales / Market Method
This method compares sales of similar businesses and also the valuation multiples from these acquisitions. An adequate number of comparable companies are necessary to produce credible results. The VR proprietary BizEx system contains the largest database of comparable sales available in our industry.