Can We Play "Price That Business"?

Hi All. I’m hoping to get some perspective on business valuation. Won’t you please play along?

Two locations selling popular desert item and the like. $486k Combined sales in 2013 and income from operations of $68K (if I can get payroll down 10%) or $55K (if payroll remains as-is) without owner working directly in day-to-day operations.

Question… how much would you pay or encourage your best friend to pay for this business?

I’m a bit limited in what I can divulge so I will apologize in advance. Thanks for reading.

  1. This might sound a bit nit picky, and maybe it is nit picky, but 2013 net income from operations was already $55,000. What I think you mean is that IF you can reduce payroll for 2014 and IF everything else remained equal, 2014 net income would be $68,000. I think it’s important to point that out, because being “sloppy” with your language makes me concerned you’re putting more weight on the past performance than is warranted.

  2. Second, if I all I had to work with is gross receipts and net income from 1 year I’d just walk away and offer $0 without a shred of doubt in my mind that it was the right decision.

You need complete monthly or quarterly financial statements for at least 5 years. Look at and attempt to understand trends. Look at expenses in absolute terms and as a percentage of sales and how they’ve trended in recent history. Think about how you see the business changing in the future (besides your plan to cost reduce payroll) and then do sensitivity analysis to see how your sales and income look depending how far off your expectations are.

Once you’ve done that, purely from the point of view of financials, you might be in a decent position to do a general valuation.

I sell commercial real estate and in the past the occasional business although we try (really we do) to avoid that. With over 25 years in the business I can say with some degree of certainty that (usually) buying a business where you are not intimately familiar with the cost structures and expenses is generally a bad idea and occasionally an extremely bad idea.

Asking the question “What should we pay for this business” is the first clue you should not be in that business. Yes, I’m a dream destroyer, but I have seen too many people get in over their heads and crash and burn over the years. People have extremely romantic notions of retail operations where the truth is that it’s usually an extreme grind, physically demanding and mentally exhausting.

Jumping into a business you are unfamiliar with is not a good idea. It never ceases to amaze me that people will often go five or six figures into debt to effectively buy themselves a job making less and working longer hours than they did simply working for a company.

Fuzzy and astro have some very good advice.

I see a lot of SME’s and their financials in my job, but I don’t deal with retail, much less food retail at all, plus I am based in Australia. So feel free to take this with a grain of salt.

Most businesses will sell on a multiple of EBITDA (Earnings before Interest Tax Depreciation & Amortisation). That multiple can be anything from 2 times to 5 times, and I believe that food retail would tend towards the lower end of that spectrum. Add to that any Plant & Equipment costs to be considered.

If I am reading between the lines, you may be looking at a franchise store? If so, there maybe a premium attached to the ‘Goodwill’, plus you will likely be up for additional costs in getting approved by the franchisor to be allowed to purchase the business, plus training costs that you will have to incur, before you can even start operating the business.

Two more generic tip in terms of the numbers you’re talking, never take into account potential costs savings/profit improvements when negotiating price. I’ve seen that approach taken by some vendors arguing that you ‘could’ cut x out of the costs and try to add that benefit to the purchase price.

Vendors always, and I mean always, overestimate what their business is worth*. This is particularly so if it is family business that has been in the family for years. Go in to any negotiation knowing that their starting price is almost laughable.

  • One exception is if the sale is being brokered through a competent, honest business broker who is forceful enough to set some real price expectations with the vendor.

One and a half times the net profits, plus the assets.

Is that food retail specifically? [Just curious]

Thanks for all the input. Some very good points made.

This particular business is listed at $400K+, which I thought was ridiculous. I was thinking it might be worth $200K but I haven’t broken down assets; I suspect $80K at most due to the type of stores these are. This is not a franchise and there is no real estate ownership involved.

Is it common for brokers to list SBs at 2-3X valuation?