My Uncle is thinking of buying a bar. The guy who owns it wants $200,000. I’m curious how the worth of a small business like this is calculated. If it were me doing the buying, how would I know if this is a reasonable price or not? The space is leased with 8 years left on the lease.
I’m not asking for specifcs, I’m just curious about the principals involved.
What your uncle needs to do is to go over the books of the existing business (or hire an accountant to do it for him, if he’s not comfortable with accounting procedures) to see what the profit/loss of the business has been for the past few years. This will give him an idea both of the worth of the business from a profitability standpoint, and also an idea of the kinds of major expenses he may be looking at.
not quite sure if it still applies, but the standard PE ratio for a stock type investment would be somewhere between 10-20, probably about 15…
so if the bar is making more than $14,000 a year, that’s a pretty good deal… that’s $14,000 after all wages, stock, leases, ect.
You would make a comparison between the investment amount and the future cashflows, adjusting in some way for the timing of the flows and their probability.
Every business type and situation could have a different “discount rate” to come up with the net present value of those future, uncertain cashflows. If the net present value is greater than the present cost, then the price is less than value.
In real life, it’s usually just a WAG.
I think there are some rules of thumb involving adding up physical assets (building, equipment, inventory, etc.), expected profits for X number of years, and “goodwill” (significant intangibles) that are used to appraise the market value of a business. I’m sure these guidelines vary some with different types of businesses. I believe this is the type of thing that daffyduck is looking for.
Here are some good resources:
http://www.businesstown.com/valuing/index.asp
http://www.mergers-acquisitions.com/valu.html
http://www.businessbookpress.com/articles/article109.htm
http://www.qwest.sbresources.com/SBR_template.cfm?document=steve.cfm&article=2004Mar29
When the business is a bar, the matter is a little more complicated. The primary asset is usually the liquor license. If that can’t be transferred (or can’t be transferred to the buyer) the deal won’t work. So you need to look at that too.
I saw a book entitled something like “How to Sell Your Small Business” in the library the other day. I’d suggest finding a similar book and looking at it from that perspective. This will give you an idea of what the guy who is selling the bar ought to have considered. This will include some of the things mentioned here. I’d also take into account as much as you can of other information like:
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Location: how stable is the area? Will there be any changes to the area in the foreseeable future? For example, a new stadium opening next door would be a gold mine. A new dump next door could put you out of business. You get the idea.
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Customer base: how stable is the customer base? Will the old owner open a new bar across the street and take all of his old customers with him? Or is your uncle currently a “regular” there? This could be bad since all of the old gang will expect free drinks and bitch about him if he ever needs to increase prices.
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Assets: What, exactly, is included in the sale? Is the property owned or leased?
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Intangibles: How hard is it to get a liquor licence in the area? If the barriers to entry into the market are high it can really increase the potential value. Is your uncle shrewd at business and have ideas for drastically increasing cash flow? Are there other, undisclosed issues which could increase/decrease the value. Are there nightly police problems?
An important consideration: does your uncle have any history or signs of problems with alcohol? If so he should run away from this as fast as his feet can carry him.
Some general issues - Valuing a Business for Sale and Other Issues
Business Valuation Methods and Formula(s)
Some version of discounted cash flows (DCF -see above) is what most professionals use, but as a caveat it’s often difficult to get verifiable “real” numbers in selling food and liquor establishments, as a lot of business is often under-reported on paper. DO NOT ever believe what someone tells you about sales without external verification. Many user to user bar/restuarant sales are “proved out” by the potential purchaser working with the selling owner for a week or two and seeing the actual cash flows and expenses. If there are personality conflicts this can be difficult.
In my experience “appraisal values” of the transactional worth of small, entreprenurial businesses are most often worth paper they’re printed on. Most real property appraisers have very little real world notion of how to properly apply a real world value to a business. You’d be better off talking to a professional accountant with experience in valuing businesses.