Buying an existing business, Officinado Business Help Directory

Buying an existing business

How to value a business

Valuing a business is often the most worrying part of buying an existing business.

To get a general idea of how healthy the business is, look at:

• the history of the business
• its current performance - sales, turnover, profit
  
  
• its financial situation - cashflow, debts, expenses, assets
• why the business is being sold
  
  

As part of your investigations, talk to the vendor and the business' existing customers and suppliers. They may be able to give you information which affects your valuation. For example, if the vendor is being forced to sell due to decreasing profits your valuation will be lower. They may also be able to give you general market information about conditions affecting the business.

The most difficult part is valuing the "intangible assets" These are usually difficult to measure and could include the company's reputation and relationship with suppliers, the value of "goodwill" or licences, patents or intellectual property. You should consider how the value of these assets could be affected if you decide to buy the business.

The list below details other factors that will affect the value:

• stock
• assets
• products
• debtors
• creditors
• suppliers
• employees
• premises
• competition

Once you have considered all these factors you can then decide how much you want to offer, or if you want to buy it at all.

Common methods of valuing a business

There's a range of ways to value a business. Valuations based on multiples of future earnings and the capitalisation of future cashflows are the most common.

1. Businesses with a record of sustainable profits are often valued at a multiple of earnings. Profits are adjusted for any unusual, one-off items to arrive at an estimate of "normalised" earnings. Smaller businesses are usually valued at a lower multiple than similar, larger companies - typically at somewhere between five and ten times their annual post-tax profit.

2. Mature, cash-generating businesses can be valued in a similar way but based on cashflow. Future cashflows are estimated and discounted - with cashflow far in the future worth less than cashflow soon.

3. An asset valuation might be appropriate for stable businesses with significant tangible assets - property or manufacturing businesses, for example. Your starting point is the value of assets stated in the accounts - known as the "net book value". These figures are then refined to reflect factors such as changes in the value of assets or bad debts.

4. The cost of creating a business similar to yours can be used as a basis for valuation. Costs could include buying equipment, employing staff, developing products, attracting customers, and so on. It may be possible to estimate this "entry cost" as a benchmark of your business' value. Of course, if the cost of entry is low there's little likelihood of your achieving a successful sale.

5. In some industries, there are established rules of thumb for valuing businesses. For example, the number of branches an estate agency has.

A potential buyer may use more than one method to get a range of values for your business. In the end, however, any price will be a matter for negotiation.

Your accountant can also help you value the business.

If you do decide to make an offer, the research you do now will be verified in detail once you've agreed a purchase price with the vendor.

Make sure a business is worth buying: due diligence

Having done your research, it is important to verify the information you have. A period of time is allowed for you to access the business' books and records to verify that all of the information that you have been told up to now is accurate. This is known as due diligence. It should give you a realistic picture of how the business is performing now and how it is likely to perform in the future.

When to begin due diligence

Don't start due diligence until you've agreed a price and terms with the seller. For a down payment they may agree to take the business off the market during your investigation.

The investigation period is negotiable - but most small businesses need at least three to four weeks.

Where to get help

Ideally you should get accountants and solicitors to help you identify risk areas but you can also get detailed information about companies direct from the official UK Government Companies House website.

Due diligence is about much more than the finances of a business. You need to come out of this period knowing exactly what you are getting into, what needs to be fixed, what it will cost to fix them and if you are the right person to take on this business.

Key areas to cover are:

• employment terms and conditions
• outstanding litigation
• major contracts and orders
• IT systems and other technology
• environmental issues


• commercial management including customer service, research and development, and marketing

Information sources

Dig as deeply as you can and use whatever documents are available. For instance, if you're looking at employee records, you could check out:

• payroll records
• staff files
• copies of pension and profit sharing plans plus financial statements, if relevant


• employment contracts 
• the staff manual 
• union contracts, if relevant 

You may also need information from external sources such as the landlord, tax office or bank.

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