Am I Paying Too Much for a Business

With the economy growing at rates we have not seen since the mid-2000s, many aspiring entrepreneurs are considering purchasing a business. Buying an existing business can be a good strategy for someone who is able to obtain the funding because if it is the right business, it allows you to start making money right out of the gate. It is certainly preferable to bypass the startup phase and the seemingly endless 60+ hour workweeks with very little pay and go straight to profitability. A business intermediary can assist with these hard decisions.

Owning an established business is great, but some buyers get caught up in the excitement of acquiring a particular business, which can cause them to pay more than they should. How much to pay for a business is a decision that should be made based on facts rather than emotion!

Business Valuation Methods: There are three general ways to value a business you are going to purchase, these are:

Earnings-Based Valuations: One of the most popular valuation approaches is to use a net earnings multiplier. Here is an example; a business that is earning $150,000 in net profit per year may use a multiplier of 3 ($150,000 X 3) to arrive at a value of $450,000. This means that as long as profits remain the same or similar to their prior years’ averages, the buyer should see a 33% annual return on their investment and a full return on investment after three years.

There is a variation of this method known as “discounted future earnings.” This means that instead of valuing the business based on an average of the past few years of net earnings, the valuation is done based on current earning trends. This might be necessary with riskier businesses that have highly volatile earnings that fluctuate from year to year.

Asset-Based Valuations: An asset-based approach simply means that the value of the business is determined by total value of its assets minus liabilities. This could be the current value of all assets minus liabilities, or the net amount that could be raised if all assets were liquidated and all liabilities were paid off.

Market-Based Valuations: The market-based approach examines the sale price of comparable businesses that have recently sold in the same area. This approach is similar to what is typically done in the residential real estate market, but it is only effective if there are a sufficient number of comparable sales in the area.

Which Valuation Method Should I be Using: The method used in each individual case depends largely on the industry the business is in and other specific factors. In many cases, a combination of the three factors is used to properly value a business for sale. The best way to know for sure which valuation method to use is to speak with a qualified professional. For buyers, working with a business broker can be invaluable. Established business intermediaries are highly trained and have several years of experience with these types of transactions. They can work closely with you to examine all the factors and help get you into the business that best fits your passion, skills, and budget.

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