August 12, 2019

Written by: Hunter Leonard, Silver & Wise

This resource is about buying a business, and it will incorporate some elements of understanding what type of business suits you, also how to value a business and some of the pitfalls that you might come across in purchasing someone else's business. Before you even start thinking about a specific business, it's useful to, first of all, think about the type of business that might be suitable for you, and this will be a mix of a number of different factors.

The first one is, what skills do you have already? What skills are you willing to get in regards to running a business? For example, if you bought a café and you didn't know how to make coffee and you were going to be the person making the coffee, then, obviously, you'd want to do some kind of course to learn how to make a good quality cup of coffee because the quality of a coffee in a café is going to be something that's going to attract or detract from your potential success in regards to your business.

You want to know a little bit about the skills that are required for that business and the skills that you have now and the skills that you need to get.

The second part is, do you have a passion for that type of business

Passion, purpose, or being inspired by a particular type of business is pretty important, particularly in the long-term and particularly at times when you run into challenges or tough days. If you have a passion or a purpose for that particular business or you're inspired by the type of customers that you deal with or the products or services that you're providing to those people, then you're likely to be able to get over the humps, the tough days, the challenges, the difficulties because you're driven by something that will take you over those challenges and difficulties.

If you don't have a passion for the business and if you're really just running it for the money, then when you run into something that's challenging or that's tough, then you're likely to start to really not enjoy running that business, so you might be fine when times are good, but when times are bad, you need that extra special something, which we'll call purpose or passion or inspiration for the purposes of this, and in a spark that's going to drive you to continue against the odds in order to make that business successful.

Now, let's get onto the subject of, how do you value a business? One of the smartest things I ever heard somebody say about how much a business is worth was that they basically said that a business is worth what someone will pay for it.

Now, this has two sides. Of course, that means that you could potentially sell a business for more than it might be worth because someone really wants that business and it makes sense or inspires them.

Of course, you could also pay more for a business than it's worth, as well. Valuing your business is an incredibly complex thing, and every single business is different. Of course, in some industries, there are some conventions as to what a business might be worth. Take insurance broking, for example.

There are industry standards about what someone will pay for a book of insurance customers. It might be one and a half times the value of the book. It might be two times the value of the book. In many industries, a standard business might get one and a half to three times the profit of that business. In other words, somebody will pay up to three times or three years worth of profit to buy that business. Having said that, there are other businesses that could be worth many, many times more than that, depending on the type of business. 

You may heard in the news certain businesses that really are yet to make money being valued at billions of dollars. There's a sense that that seems a little untrue or unlikely, but some of these types of businesses have the potential to scale and the potential to make lots of money in the future, and, therefore, that future value is [inaudible 00:04:27] more people will want to pay for those businesses. This often is linked to technology businesses that have a specific channel or a type of product or a type of service that is delivered through technology, and they can be worth quite a lot, but your average everyday business won't be like that. It won't be worth many, many multiples of its profit. It will be worth a certain number of multiples of its profit, and that will be dependent on the industry that you're operating in.

It's a little hard to show an article to, say, categorically, that a business is worth X because it is a fairly complex area. It's well worth doing your research and asking some experts in your industry what the standard value of businesses in your industry that you're looking is. Of course, franchises have a certain value in most industries. A cleaning franchise might cost you $15,000. A well known franchise might cost you $25,000. A café might cost you half a million dollars. A McDonald's might cost you a couple of million dollars. Those businesses are the value or the price is set by the franchisor, and that has its own industry average, as well.

Apart from coming down on a specific number about what a business might be worth or how to calculate that, definitely check with the experts in your industry, talk to business brokers, talk to accountants, talk to people who have expertise in that sort of industry, somebody who can advocate for you as a buyer.

Let's just take a little look at some of the things that contribute to the value of a business and how you might decide whether a business is good or bad in relation to looking at that business as a potential one to buy for you.

One of the first things that you need to look for is, does the business have a track record, a track record which will be evident in what are called the books or the profit and loss statement and the balance sheet.

Of course, all the story is not in the profit and loss and the balance sheet, and both of these can be made to look better than maybe they are, so there's some other things that you need to look at in a business, and the things that I would look at are these.

The first is, has the existing business owner got a strategic plan and a marketing plan for the business? If they don't have a written down strategic plan and they don't have a marketing plan, that says to me that a business hasn't necessarily been operated well, that the business owner hasn't necessarily been planning for the future, and if you were to buy that business, you may fall victim of the fact that that business owner has not planned for the future and doesn't have a workable strategy and a workable marketing model.

Let's talk about workable marketing models. A business will definitely be worth more to you if the existing business owner has already proven what marketing works for them to attract new customers and also to keep existing customers, to keep customers loyal. If a business can show you that they spent money on a certain marketing activity and that generated a certain amount of new customers and could show you that that's a profitable method that they've found that works for their business, then this will add value to your business, the business that you're purchasing.

Whether or not the existing owner has added to the price or asked a premium for that workable marketing model is up to you to find out, but, certainly, if they are able to show you that they have a workable marketing model that can attract customers that they've been growing, then these things can give you good comfort.  

Of course, it's also important to see if the business has loyal customers or customers that continue to purchase time and time again and over the long haul. Some businesses are transactional, so if they're running a café or you're purchasing a café, you may not be able to see the loyalty of those customers. However, if it's a business that has a database and you can see that a good percentage of the best customers are buying on a regular basis and you can see that the business isn't losing customers and having to replace them all of the time, this, again, will add value to the business.

If you look broadly in the business, other things that you want to be looking for is, do they have good systems and methodologies for all of the things they do in the business? Do they have quality control procedures? Do they have job descriptions and performance reviews for all of the staff that you might be taking on as part of purchasing the business? Is the premises clean? Is there any backlogging collecting money? Do they have a record of lots of customers paying late?

Effectively, what you're looking for in buying a business is a business that is being run well, that has demonstrated to run well, and that has all of the major markers of one of a well-run business. In other words, loyal customers, making profit, growing, a proven workable marketing model, clean premises, lack of backlogs, happy customers, happy staff, good location. All of these things all contribute to having a business that will be worth more than another business of the same type that doesn't have those things in place.

Of course, as a purchaser, you may choose to buy the cheaper or less well-run business knowing that you can actually improve it and get more value out of having purchased that business, but you want to be really confident that you can actually improve it, that you could make your customers more loyal and that the business hasn't damaged its reputation so much that it's impossible for you to rescue it and there's nothing left on the table for you by the existing purchaser. In other words, they're asking more for the business than it's true future value.

The only reason you would pay money for any business is that there is future value of the business. In other words, the opportunity for you to recoup your investment on top of being able to make enough out of the business for your own income, taking into account that you're going to be paying back the amount that you paid of right business in the first place.    

A good example of this might be an insurance broking book where you buy a book of insurance. An insurance broking firm that has kept 98% of their customers for the last 10 years is going to be more valuable than an insurance firm that's losing 20 or 30% of its customers every year and having to replace them.

The reason for this is that attracting new customers costs more in terms of marketing. It's easier to keep existing customers.

Just one last final word on loyalty of customers. You really want to make sure that those customers aren't loyal to the existing owner. In other words, if they only do business with that business because of the existing owner, then you are in danger of losing them as soon as you take over, and this is very, very important. You need to know that the business isn't linked to the existing owner through their personality or the way they do their business, and this will require some due diligence in order to asking the existing customers if they would stay with you if you purchased the business. This might be difficult to get, but you really want to be looking for this sort of information      

That's it for some information on how do you value a business when you're thinking of buying a business

Of course, this is general advice, and you really should get some specific advice from experts in their field, business brokers, buyers, advocates, accountants, and perhaps even your lawyer whenever you look at the purchase of a business. There's a lot of pitfalls in purchasing a business. I've heard people purchase businesses that the existing owner then went and sold all the stock, so they ended up selling the stock twice.

They sold it to the purchaser and then they resold all their stock to their customers, so the new owner came in expecting to have a shop full of merchandise ready to start business and the shop was basically empty.

That and many, many other pitfalls in buying a business, you want to be making sure there is a future value in the business, that you can recoup your investment from purchasing the business. You're not just buying yourself a job, that you're buying yourself something that has value for you in the future.