What Price is the Right Price to buy a Small Business
You shouldn’t confuse the asking price with the value of the business….to you. There are many ways to compute the value of a small business. The results can be wildly different and all correct. The issue isn’t “what is a business worth?” as much as “what is it worth to you?”.
In this post we will discuss the elements that create value in a small business. As Business Brokers we have these discussions with buyers but more importantly we have the same discussions with business sellers.
Here are key elements that drive the value of a business up or down:
- Stability of Earnings. A business with consistent earnings is worth more than a business that has wild swings in it’s profits year to year. The reason is a business can never pay it’s bills with next year’s profits (unless you add debt or spend prior year profits). If you buy a business with consistent profits you will be able to borrow more to finance the purchase and therefore you can pay more.
- Customer Concentration – A customer with 100 customers all doing 15 of the revenue is worth more than a business with one customer doing 70% and 3 others doing 10%. If the 70% customer leaves the business is in the tank.
- Business has a high barrier to entry – Not many businesses have this but it it does it’s worth a lot. Barrier to entry could be patents, highly recognized brands, special equipment not easily duplicated, exceptional location, etc. But beware, if the business has one of these it will be reflected in the business by delivering higher profit margins.
- Management/Employee responsibilities – The less the owner of the business is involved the more the business is worth. In his book Built to Sell author John Warrilow describes how this characteristic creates value. Also, Michael Gerber has written a great book E-Myth that talks about applying these principals to small business. If you are serious about buying a business I would highly encourage you to get both of these books and read them before you begin your business search.