How to determine the value of a business before making an offer

How to buy a business

If you’re on the hunt for a business, price will likely be one of your top considerations. Whatever the level of your budget, it’s important to determine the true value of your prospective business so you’ll know if the asking price is fair – or missing the mark by a mile.

Due diligence is your friend at this point – you’ll need to examine the financial, legal and commercial details with the help of a good accountant, solicitor and financial adviser so you don’t miss any important points. The aim is simply to know exactly what you’re buying, what needs work and how much it’s worth.

1. The bottom line

A good place to start is the company’s audited accounts. Ask to see the balance sheets, income and cash flow statements, as well as three to five years’ worth of tax returns. Your objective is to check that payments are being received and bills settled in an orderly fashion to maintain a profit margin and cash flow. You’re also looking for any liabilities that are inheritable.

It’s a good idea to look at monthly sales records; a close analysis will give you an insight into the business’s sales cycles and will help you to map buying patterns. Although sales history is an important indicator of performance, you’d be wise to look for evidence of future business – contracts with customers, for instance. While valuations are often based on multiples of earnings to date, you’ll be more concerned with how the business is likely to perform in the future.

2. Understand what you’re buying

It sounds obvious, but it’s important to understand exactly what you’re buying – a brand, a building, equipment, a website? If you’re buying fixtures and fittings, you’ll need a list of all items and an evaluation of the condition and market value of each. It stands to reason that a business with a nearly-new inventory will require less investment – and therefore be worth more – than one with equipment that’s ready for renewal.

You’ll also want to analyse the business’s location, reputation and the strength of its competition. Take a view on the industry and economic outlook in general to determine whether sales are likely to grow, decline or stagnate. Do you think you’ll be able to cut costs or raise prices in order to increase your return on investment (ROI)?

3. Structuring the deal

Check copies of all contracts and legal documents including leases, purchase agreements, distribution agreements, business employee agreements, and any other legal documents relating to the business. If you’re taking on a lease, find out whether it’s transferable and if permission is required to assign the lease. You’ll also need all the relevant information regarding employees’ contracts and responsibilities to ensure a trouble-free transition. Anything that could cost you time and money further down the line will affect the value of the business.

How you structure the deal could affect the price you pay. If you’re looking to part with cash, you can expect to get the best price. If you’ll be relying on seller finance or staggered payment terms, expect to pay more for the privilege.

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