We’re about to show you the technique used by every business broker and savvy business investor to roughly value a business, or immediately recognise if a business is over-priced.
Learn how to value a business by clicking here!
Business valuations are generally based on Return On Investment (ROI), because when you put money into a business it’s just like investing in shares or property – you want to see a return on that money. It is generally accepted that an investment into a business should get at least a 30% return. For example, if a business costs $300,000, it should make at least $100,000 in net profit back each year.
When a broker does a valuation, they will work this equation the other way around and use a “Profit Multiplier”. So a good small business that has a net profit of $100,000 should sell from 1-3 times that figure, anywhere between $100,000 and $300,000.
If a business is priced higher than 3 times the net profit, then you need to start asking why. Most times, it is simply due to the seller being over-optimistic about the value of their business because they don’t understand that a buyer needs a return on their investment.
You can cross these businesses off your list for the moment because you don’t want to be wasting time and energy trying to convince a seller that their business isn’t worth what they thought it was. If it is something you really want to pursue, wait a few months before contacting them to give them time for reality to sink in (either from having no offers or interest, or being offered low amounts).
Value a Business – 3 insider tips…
Go through your list of businesses and write down the “Profit Multiplier” for each business. Just divide the asking price by the net profit and check that it is less than 3.
Asking Price / Net Profit = Profit Multiplier
Please Note: There are of course exceptions to this rule, which is obvious when you see internet businesses like facebook.com that generate no profit and are sold for many millions of dollars. In these cases the return on investment is not monetary, but strategic. It is based on future potential and access to a huge client database. For this system however, we do not recommend buying this kind of business because the risk is much too high. In this system, you only ever pay for what IS, not what COULD BE.
Another exception is large multi-million dollar businesses with net profits of over $1Million. The profit multiplier for valuing these businesses can be 3 to 5 times, because bigger businesses usually have stronger Pillars of Value, especially in SYSTEMS, BRAND/INTELLECTUAL PROPERTY. This is the exciting potential of business – if you can grow or put together a business with this level of turnover, you can sell for higher and higher multiples, and make higher and higher profits – up to 25 times the profit if you list on the stock exchange!
Learn how to value a business by clicking here!