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Sale price of business directly relates to profit?

Discussion in 'Small Business' started by Jamestangjjj, 19th Aug, 2015.

  1. Jamestangjjj

    Jamestangjjj Member

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    iam trying to figure out whether many business for sale based their sales price against the 2x to 3x of the profit per annual?

    Examples below

    1. sale price $100K - profit 30K PA

    2. sale price $300K - profit 100K PA

    3. sale price $500K - profit 312K PA

    The sales price disregard the revenue per year or rent or expenses.

    Anyone can share some insight as to how business sales prices comes along?
     
  2. D.T.

    D.T. Adelaide Property Manager Business Member

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    Its quite common for business price to be a multiple of its profit. Exactly what multiple depends on the industry, the type of business, the health of the business, current state of economy, current business confidence, and a host of other variables.
     
  3. Simon Hampel

    Simon Hampel Founder Staff Member

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    There are as many different ways to value a business as they are types of business it seems!

    I've seen some businesses with fairly well defined cashflow valued on some multiple of annual revenue, other valued on a multiple of profit, some valued purely on goodwill (ie loyalty of customers), and others valued based on the value of stock held.

    It very much depends on the industry, the nature of the revenue, the type of customers, plus many other factors.

    Either way - you need really good advice before you consider buying a business - someone independent (ie not emotionally involved in the transaction) to seriously look at all of the income vs expenditure to work out whether you are going to be able to justify paying a particular price.
     
  4. Propertunity

    Propertunity Exclusive Real Estate Buyers Agent Business Member

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    The sales price needs to disregard the revenue per year or rent or expenses as the profit calculation is revenue less expenses.
    So you could have a business that brings in $500K in revenue with $450K of expenses making $50K profit and being valued at $150K (multiple of 3).
    Or same business revenue of $500K with expenses of only $100K being valued at $1.2M (3 x $400K profit).
     
  5. Jamestangjjj

    Jamestangjjj Member

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    Are you saying the sales price is depended a upon the profit? approx 2 to 3x ?
     
  6. Simon Hampel

    Simon Hampel Founder Staff Member

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    No - you can't apply that approach to every business in every industry - it very much depends on the nature of the business.

    In some cases, yes, 2-3x profit is a reasonable valuation, but not in every case. In many cases it is 1x or less.
     
  7. Ace in the Hole

    Ace in the Hole Well-Known Member Premium Member

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    The way some franchises and other small operations out there are going, you should actually get paid to take them over based on the figures.
     
  8. Jamestangjjj

    Jamestangjjj Member

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    thanks guys.

    Iam looking into buying a food business and they the vendor happy to provide a 2 weeks trials. As with many businesses they deal with cash and not many of them put the full statement to the ATO.

    Any hints as to what i should look out for during my 2 weeks trials?

    For me iam specifically looking for:

    1. Confirming sales per week
    2. Cost of goods
    3. Wages
    4. other expenses????
    5. daily/ weekly net profit

    any others?
     
  9. Ace in the Hole

    Ace in the Hole Well-Known Member Premium Member

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    I would research:
    Historical cost of goods for the past few years.
    Historical expenses for the past few years.
    Historical net profits for the past few years.
    Lease conditions and history of lease.

    See if anything stands out or spiked anytime.
     
  10. Propertunity

    Propertunity Exclusive Real Estate Buyers Agent Business Member

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    Yes, don't just rely on what might be 2 x good weeks. The vendors may craft those 2 weeks to be the biggest on record for sales and the lowest on record for costs.

    Seek advice too from an accountant who deals in small business sales / purchases.
     
  11. barfly

    barfly New Member

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    Agree with Ace & Prop ... remembering a near relative's past experience (he eventually had to sell his family home) ... it was not one thing but a misfortunate combo of things that did go wrong within the first year ... food distrib bus ... in addition to understated cost of goods s.. over discounted customer sales prices ... a number of equip failures incl major del truck repair items, coolroom failures leading to destoryed food (lack of or lapsed warranties) ... From day one (after the trial) things started to go wrong ... he just rang out of fight. So your risk mitigation must include due diligence across all assets and equip - notbjust the figs.
     
  12. Simon Hampel

    Simon Hampel Founder Staff Member

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    Some small business owners don't effectively account for their own wages in the cost of running the business - so you'll often find "profit" claims don't include any allowance for actually paying yourself!

    Also take a look at staff turnover rates and how time consuming it is to train new staff. If you are relying on staff to keep the business operating, they will be both your biggest expense and your biggest risk (but also potentially, your biggest asset).

    Make sure you understand the cost of the capital equipment used in the business - storage and cooking appliances and so on. If they will require significant capital outlay to replace, make sure you understand the age of them and that your cashflow can afford to pay for repairs / replacement when they do die. If it's not part of the weekly cashflow, these costs may well be hidden elsewhere in the books.

    Either way - I once again strongly urge you to get some good independent advice before committing to anything.
     
  13. Lizzie

    Lizzie Well-Known Member

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    ... and remember that nowadays "goodwill" is worthless.

    For our holiday accommodation business we paid a nominal pittance for the business for the above reason - with the actual value being in the real estate.

    I personally would be very reluctant to pay for "virtual" income ... and definitely nothing for goodwill as BV has found out ... I prefer owning the actual the bricks and mortar housing the business as well. At the very least - pay no more than the value of the equipment in it's current state plus a reduced percentage of the income ...
     
    Last edited: 20th Aug, 2015
  14. Ace in the Hole

    Ace in the Hole Well-Known Member Premium Member

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    Remember too, it's an easy entry, but difficult exit.
    Don't rush into something only to regret it later, all due to lack of research and evaluation prior.
     
  15. Greyghost

    Greyghost Well-Known Member

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    Sale price will also depend on other factors too, such as; are there any client contracts in place, time remaining on contracts, scalability of the business, current competitors in the industry, government policies..

    A plumbers business might be worth day 600k pa, but with a council contract to provide x service for x years it may be worth 6m.

    There are basic rules of thimb for certain industries though. Do your research on that industry. Also get the financials of the potential business purchase but through a thorough due diligence by an accountant and solicitor who specialise in that field, not just average joe accountant who does your BAS return for you.. Measure twice, cut once!
     
  16. THX

    THX Well-Known Member

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    In addition to the numbers I'd ask why are they selling? Is the current owner integral to the business? can you fill their shoes?
     
  17. Ace in the Hole

    Ace in the Hole Well-Known Member Premium Member

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    In addition to all the advice given already, I'd look to the future also.
    Industries can go bad due to unforeseen circumstances.
    I'd scope out any potential threats from either possible future competition or, even potential issues with future suppliers, of which there could be many.

    Weird stuff like the power going out for a whole day causing a total loss of stock and takings for the day, happened here in Cronulla last week.
    Is there a back up generator?
    Got to watch out for sabotage with customers calling food poisoning on you, posting all sorts of stuff on social media and review sites.
    This kind of stuff can destroy your reputation and crush you.

    So many things to consider....
    Is the risk worth the reward?
     
  18. Scott No Mates

    Scott No Mates Well-Known Member

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    Was chatting to a chef today, he has recently purchased his current business. Enjoying more than his previous 7 day per week business. Still, looking at an exit plan 5-7 years away. This is something to consider, how long do you want to do it, do you need to be hands on, hands off or need to know how to measure it.
     
  19. Truly Exotic

    Truly Exotic Well-Known Member

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    Agree to everything mentioned here except one.

    there are so many factors in buying a business that I think its so daunting and why most would bother. especially for a newbie

    however, if you can get a business for stock or real estate value alone then id say its very lucky or the industry/business is in dire stratights

    as for good will, I think it still has a place, if I was making offers based on assets/real estate/equiment value only, i reckon id get laughed at

    if I was buying a well established restaruant or retail shop, provided there is nothing that I can forsee to drastically change it, eg econmy, competitor etc. etc. I d be happy ot pay good will.

    i certainly wouldnt be offering $300k for a 1.5m maccas saying there is no value in good will

    anyhoo, I always start at , why are they selling the business

    every broker will say due to family reasons/health. but if its such a good business, then why sell it???? obviously genuine reasons range from health, retirement, divorce, or its simply a dud
     
  20. Lizzie

    Lizzie Well-Known Member

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    Very fair answer ... but what you are factoring in is "branding" rather than goodwill. I'd pay for branding.