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How to Buy a Business – Determining The Purchase Price

You may consider it odd that I have left discussion of this factor until last, but there is a very good reason for this.

Most of the above questions can be resolved through your own research and diligence. But determining the value of the business is the stage of the purchase that requires Professional help, and therefore begins to involve you in Serious Costs. Unless you are happy with all of the above issues, it would seem pointless to advance to this stage.

There are many books available on how to value a business. Most of them have masses of theoretical information, with formulae and graphs and reams of calculations. Most have not got the point that a Barber Shop has no value to a Plumber, but may have a lot of value to another barber, who wants to increase his own business.

Basically, the purchase price should be such that the business can allow you to repay your investment in a reasonable time, having regard to the risks and effort involved. This might vary from 4-5 years in the case of, say, a Post Office Agency, down to less than 1 year, in the case of a pizza parlour or video hire shop. Manufacturing, service and wholesale businesses would generally fall somewhere in between, once again depending on the security, and level of assets involved.

In general, it would seem wiser to pay a little more for a sound business, than less for a "bargain" that could send you broke. The total cost of acquiring a business should be taken into account, and can be divided into a number of components, covering both tangible and intangible assets.

Tangible Assets

  • Freehold Property (if applicable). This can be valued by comparison with other similar property in the area. Take care that the business is paying rent, or allowing sufficient return to cover imputed rent.

  • Plant and Equipment. The book (depreciated) value may vary from the auction value, which may vary again from its "going concern", or current market value. This may occur if it has been subjected to accelerated depreciation, or expensed rather than capitalized. There is also the factor of installation, commissioning and tooling costs. Basically, plant and equipment in a profitable business is worth what you are confident it can earn for you, otherwise it is only worth resale value.

  • Stock. You should ensure that you only purchase good and salable stock, at the Vendor's landed cost. The amount of stockholding should be at a level commensurate with the demonstrated stock-turn of the business, and historical logistics considerations. Excess or obsolescent stock should only be purchased if the terms are favourable.

Intangible Assets

  • Intellectual Property. This is the value of licenses, leases, agreements, patents, processes, tooling and know-how, which are necessary to the successful operation of the business. Generally they would have cost time and money to accumulate, and would certainly cost time and money to duplicate. It is generally lumped in with "goodwill".

  • Goodwill. This is the difference between the value of the business on a "return-on-investment" basis, and the net value of the tangible and intellectual property assets. A business acquires an element of goodwill if it can demonstrate to your satisfaction a reasonable expectation of future super profits in excess of the value of the other assets, so that the return on the total investment in the business is financially viable.

  • Working Capital. The amount of money needed to operate and grow the business with reasonable confidence.

Click here to read How to Buy a Business – Negotiating the Purchase.

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Article written by Rudy Weber. Published with permission from Rudy Weber, Lloyds Business Brokers.