Post: #1

I'm exploring options of buying into a privately owned business, probably around 15-20%. I have asked around about different ways to value a business and have had different answers. hoping I can get a few opinions from you all.

the business itself turns over about $1M net per year and is increasing at approx 3% annually. the building that it is located in is valued at around $500K.

the owner is offering to sell a share of 20% for $1M. meaning the business is valued to him at $5M.

any thoughts?

Post: #2

(06-30-2014 11:05 PM)Puddles Wrote:  I'm exploring options of buying into a privately owned business, probably around 15-20%. I have asked around about different ways to value a business and have had different answers. hoping I can get a few opinions from you all.

the business itself turns over about $1M net per year and is increasing at approx 3% annually. the building that it is located in is valued at around $500K.

the owner is offering to sell a share of 20% for $1M. meaning the business is valued to him at $5M.

any thoughts?

Get a professional, especially if you're buying a minority share that you can't easily sell to someone else.

Also, this should be in lifestyle.

WIA

Post: #3

(06-30-2014 11:12 PM)WestIndianArchie Wrote:  

(06-30-2014 11:05 PM)Puddles Wrote:  I'm exploring options of buying into a privately owned business, probably around 15-20%. I have asked around about different ways to value a business and have had different answers. hoping I can get a few opinions from you all.

the business itself turns over about $1M net per year and is increasing at approx 3% annually. the building that it is located in is valued at around $500K.

the owner is offering to sell a share of 20% for $1M. meaning the business is valued to him at $5M.

any thoughts?

We don't know anything about the business and you want us to give our unlicensed expert opinion.

I suggest you get professional consultancy because there are more important things than % of share you get in the company and % of growth per year. Because 3% growth in the last year, doesn't mean in the future. It might be 3% but maybe -20%?

If you want us to give our opinion tell us what kind of business, what they are doing, tell us about the competitors, tell us about their debt, their anual income, company assets and liabilities, etc.

Post: #4

How did you get to a point where you can spend $1M to buy a business, without learning how to do this? Not being sarcastic, it's a serious question.

I'm not an expert on valuation of businesses....not yet, at least.

I would look at the balance sheet, cash flow, and P&L. Using the balance sheet you can determine what they value the things they own, line by line. Scrutinize for things that look over/under valued. Using the cash flow statement and P&L, you can get a sense of where the company is going.

Then, try to value the intangibles for yourself. Brand/identity may play a factor, and the culture among the employees and management is important too -- especially if it's a startup where an innovative culture may be the difference between creative employees and people who just show up to earn a salary and leave.

The owner is offering a 20% share at $1M because he wants $1M for it, not because the company is worth $5M. If you were to bid $800k and close the deal, that doesn't mean the company just dropped value by $1M...

To be blunt this is probably not the place to get advice on such a topic, especially without details. Of course, I and others will try to share our thoughts if we have something to contribute.

Post: #5

So the buyer wants a 5 multiple for a business that is growing at basically the inflation rate (i.e. flat). You would end up being a minority shareholder in a private company. You would own more than 5% so that helps a little with shareholder rights but not enough to be comfortable.

How are you expecting to make a profit from this investment? Do you have an agreement from the majority shareholder(s) to disperse the entire $1M every year based on % ownership? What if they want to reinvest the profits to expand? Do you get a say in that decision? Based on how the company is structured you could end up paying taxes on those yearly earnings. Do you have an agreement to buy back your shares at a later date for the same 5 multiple? Why is the company/owner taking chips off the table now?

As the others have said before investing $1M in a small closely held illiquid company, there is quite a bit of homework you should be doing.

Post: #6

Read up on the stock market, basically all the ways to value things there, is how you can value this.

An investment of $1m, to get a payout of 200k/yr that's growing? That's is a screaming buy. Price to Earnings of 5, or a return on investment of 20%. As others have mentioned, what's done with your 200k? paid out? reinvested? While not really different from an investment standpoint, from a personal cashflow standpoint, yes.

The other thing is what are their sales and margins? 1 million net on how much sales? Is there a lot of competition? the 3% growth, is it from expanding business, more margins, what?

The other way to value a business is book value. Whats the value of all the 'stuff'? a 500k building, and anything else? If he's generating a $1m profit on 500k invested, that indicates a screaming deal too.

Second, why is he trying to sell you a share of the business? If he's generating that kind of net, he doesn't sound like he's hurting for cash.

Again as others had said the devil is in the details, and this isn't the place to get advice to make that sort of decision. If I'm going to invest a million bucks, I'd want to have a better blessing than a bunch of folks on the net.

Post: #7

I caution you to be careful. Several years ago I almost bought an existing buisness. I ended up working there for a few months, just enought time to discover the owner was bat shit insane and his manager had been stealing from the company for years. You can hide a lot on a balance sheet or P/L sheet.

Post: #8

Being a minority owner in any business is a huge risk unless you'll be working there full time.

Post: #9

Check Shark Tank episodes. It might be a popcorn version of real investments. But it´s a good start.

The rule is net profit * 5= Value of the company.

Be sure to check any hidden costs. By hidden costs I mean costs which are not on the books. Normally Construction companies, etc pay they employees cash.

Also think about creating an escrow with a lawyer/bank with specific terms. Your money will be blocked for three months and only released if no problem arises from the company. Imagine the company just got a huge fine of thousands of dollar. But the fine itself is only on the starting process. So you cannot know if it exists.

Post: #10

Is this your life savings? What % of your net worth is this? If $1m is chump change to you, then you can afford to learn a very expensive lesson.
If $1m is your entire liquid net worth, I'd say don't do it. There are a number of factors to consider. Valuation is one thing, but values change in different environments. Seeing that you're in Australia, you have to consider the fact that your country's economy piggybacks off of China. I suspect that within a 3-5 year time frame there will be a big decline in the Chinese economy when their current, overextended credit cycle unwinds. You will see valuations fall tremendously. If you invest now, and your small business goes bust, you could lose everything. How did the business do in the previous recession in 2008/2009? Have you seen the financial statements and tax returns for the past 6 years? A very basic screen is to simply see if the income statement is income reported on the tax return. If they don't correspond, then he's a liar. If he's willing to lie to the government, you can be sure he's willing to lie to you.

As a general principle, the seller of a business is more savvy than the buyer of a business, unless you're in the industry. If you have zero experience in the business, then imagine yourself as the patsy in a card game.

Post: #11

(07-01-2014 07:13 PM)Pepini Wrote:  The rule is net profit * 5= Value of the company.

Where did this rule come from? This seems obscenely generous, and just about every company on the markets that isn't about to fall off a cliff has a multiplier of 15+. Some up and coming growing companies like netflix can be in the hundreds.

Post: #12

(07-02-2014 09:32 AM)Seadog Wrote:  

(07-01-2014 07:13 PM)Pepini Wrote:  The rule is net profit * 5= Value of the company.

Where did this rule come from? This seems obscenely generous, and just about every company on the markets that isn't about to fall off a cliff has a multiplier of 15+. Some up and coming growing companies like netflix can be in the hundreds.

Small, private companies tend to have lower valuations. High risk, small enterprises may go for as low as 1.5 times cash flow. A further discount may be needed for minority interests.
Anyone can take a quick look at http://www.businessesforsale.com/ to see prices of businesses offered.

Post: #13

(07-01-2014 07:13 PM)Pepini Wrote:  The rule is net profit * 5= Value of the company.

I would avoid using rules of thumb for seven figure investments. There are quite a few ways to value a company. For example, book value and discounted cash flow can be used. Basically you use the prior years profit and growth of profit to try to look into the future. But given that the future is risky you discount the future years profits more heavily the farther out you go. You then add in the assets of the company depreciated over time.

At the end of the day, the true value of a company is the price a buyer and seller agree to. You'd be surprised and how often private companies sell for values wildly different from any logical valuation.

Post: #14

I agree with Seadog that it sounds like an obvious buy assuming no other problems. But that's exactly why I'd be cautious. $1m for a $200k annual income stream in perpetuity is such a no-brainer investment (especially in today's market) that it makes me think the owner is not fully confident about the future prospects of the business and is trying to cash out now. I would take a close look not only at the books and financial statements, but the operations and current/future competition the business is facing. Look for any red flags that would make you think the owner was trying to reduce his exposure to what he thinks is a business about to entire a decline for one reason or another. If after doing your homework you don't find any flaws of this type then I think you should give the investment serious thought. A five year payback period is quite good, and if the business has long-term potential a deal like this could make you a lot of money.