Determining the value of a business you are considering purchasing is a tricky subject. Most owners think their businesses are worth far more than they are. And in the end the true value of anything is determined by what a willing seller is willing to sell it for and a willing buyer is willing to buy it for.
Step one would be to acquire the use of West’s Business Brokerage Handbook and skim through the rules of thumb sections. If you are looking at a dry cleaning business Tom West, the author, describes the nationwide average values of dry cleaning businesses using either the gross sales percentage method—usually from .75 to 1.5 times the annual gross sales; or the cash flow method, which is usually 2.5 times the net income plus discretionary spending the owner benefits from. Value of real estate included is added to this figure. As you can see there can be a wide variance.
Of course, nothing really beats a true business valuation, or third party independent appraisal of the value of the business. A business broker who is also a certified business intermediary can probably arrange for a valuation from one of the companies the SBA recognizes. These valuations for a small business can range in price from $800 to $1,500 with a reputable company. But beware! There are several companies charging from $5,000 to $10,000 for worthless “valuations” that are simply overpriced opinions. If considering a valuation, first check the price and make sure it is in the lower range. Then ask the representative if it is accepted by the SBA and if he can prove it. Your banker, if he is experienced in business purchase loans can probably recommend a company.
Another recommendation in determining the value is observation. Remember that many small business owners have underreported income and over reported expenses on their taxes, with the goal of paying as small a tax burden as possible. If you can spend a few days in the business observing, with a notebook and calculator, you’ll get a good idea of what the average customer spends and therefore what the gross sales should be averaging.
After determining the cash value of the company, the most important thing to determine is, what is the value of the company to you? You may have found an under priced bargain when you think of the freedom to determine your own destiny provided by business ownership.