April 18, 2009
Matthew S
 
I have had two small businesses since May of 2000. One of them a roofing company I started by accident (trying to answer the need of a friend by coordinating roofing estimates for him). In the past I only subcontracted my roofs out to other contractors. Therefore I haven’t really needed anything more than insurance and a basic knowledge of roofing. Here’s my question: I am at the present time proposing to buy an actual roofing company out. This company does mostly commercial jobs (I have only done residential). This will be the first business buying venture I have taken on. In trying to “do it right the first time,” what should I be asking? I have asked for, the previous five years financial statements, I have asked for a detailed list of what is to be included in the sale. At this point, I guess that’s really all I have asked for. We are in the proposal stage of things. This business has been in existence since 1974. The owner is 68 years young and wants to travel (he wants out). The business is actually two, but the owner doesn’t separate them in accounting. One is roofing and the other is blown in insulation in a couple of different forms. HELP! I want to do it right the first time around.

Hello Matthew,

This is a complicated question that an accountant will charge you a couple thousand dollars to answer. But… I’ll give it my BEST shot! Now just remember I’m no accountant and I’m no attorney but I HAVE started, built, ran and sold a couple of my own businesses. So let’s break this down into easy to analyze chunks.

Here's a business valuation I put together!

First, I’m going to assume you’re going to buy the assets of the business as opposed to buying the actual legal entity itself. So with that in mind all you have to do is look at assets and determine what they’re worth to YOU!  So your asset list will probably look something like this…

1. Equipment (tools, trucks, machines, etc.) - This one is easy. Since you’re already in the roofing business, you ought to know about the condition of the equipment that the business owner is trying to sell you. Let’s say one of the pieces of equipment is a 37′ Scissors Lift. It shouldn’t be too hard to look at the used scissors lift market to figure out what the value is. Just make sure you don’t pay a penny more than what you could turn around and sell it for tomorrow.

2. Supplies - This one is even easier. All the supplies you will buy from the business will be brand new and un-opened. Just go look at how much these sell for.

3. Building - If there is a building involved in the sale you’ll want to hire a good commercial real estate attorney IF you go through with the purchase. As far as determining the actual value of the building, well that could prove to be a little more complicated. You could ask a friend of yours in the commercial real estate business to help you out or you could look up the history of commercial real estate building sales in your county. Again, don’t pay a premium for the building. Look at it from a completely un-emotional perspective. If something happened on the day AFTER you closed on this business sale, you’d have to SELL that building. So be sure to think of it from that perspective.

4. Forecast Net Profit - Okay this is a simple one but it’s easy to screw up. Here’s why. The REAL net profit of a small business is the profit the business makes AFTER the owner is paid a “market” salary to run the business. If the business ONLY makes enough money to pay the owner a modest salary, well then the business itself isn’t really making ANY money. So let’s say you could hire a good employee to run all the operations of the roofing company for $75,000 per year. Well, the actual net profit of the business would be what’s left over. So NOW you look at this potential annual profit as a cash generating asset and determine what THAT would be worth to you. Considering the amount of risk involved in almost ANY small business, I think a multiple between 2.5 and 4.0 is a reasonable amount to pay for a small business profit stream. So if the business was CLEARING $100,000 per year, the value of this would be between $250,000 and $400,000.
NOTE! You also must relate the value of the equipment you’re going to be purchasing to the amount of profit the business generates. If you need to buy $4,000,000 of equipment and buildings to clear $50,000… you might want to look for a different business!

5. Customer List (Goodwill) - This will be a little trickier. A customer list has value because it takes time and money to build or create one. So the true value of a customer list can only be determined when you factor in a whole bunch of things. Here are some questions to ask the buyer and yourself. 1.) How profitable are these customers? 2.) How much time and energy would it take for you to build your own customer list? 3.) How deep is the customer list? —> if more than 35% of the business volume comes from ONE customer, well that is NOT a good thing! So in the example spreadsheet below, you’ll see that my example “Acme Roofing Company” earns a net profit of $50,000 per year. So what is the “goodwill” value of a customer list that generates $50,000 of profit? I’d say it’s worth $10,000. (I’m confident that with $10,000 I could put together a local marketing campaign that would EVENTUALLY generate $50,000!)

6. Misc. Goodwill Factors - This is just a place to add or subtract value based on any sort of misc. factor. For example, if you were buying the business from someone you’ve known for 50 years and you trust and like them, well you might want to add some money in here to make the offer look a little nicer. The reason you call it goodwill is because THAT’S WHAT IS. Don’t fall into the trap of padding assets that are easy to determine. If you want to offer a little more money than the business is REALLY worth, that’s fine… just be sure to call it what it is… generosity or goodwill!

Hope this helps.

Tim Schmidt

Hello Tim- How does one determine a fair selling price for a business? A partner and I (who are well matched) are looking to purchase a service type business. The business has been profitable since it started from scratch about 10 years ago. The several large industrial type clients are only on a month to month contract but are very loyal. The owner, after taxes, takes home about $50K a year. We have a plan to grow the business but we can’t afford to carry a large business mortgage. There are actual assets of about $30,000. It is important we stay friends with the owner (who is retiring due to urgent issues). The owner is also emotionally attached to the business. After a long chat with a banker we trust we have an offer price in mind but, realistically, the offer amount is going to be a lot less then what the currant owner is expecting for their “baby”. Thanks for your input.

Hello XXXXX (Anonymous Per Request),
Ah yes… private business valuation can be a very complex animal. It’s actually kind of funny. It can be extremely complex but at the same time the value of a private business is ONLY what a buyer will offer. Does that make sense? Back in 2000, I hired an engineer who wanted to buy 25% of the stock of Schmidt Engineering. Well, he was a very valuable employee and I thought this would be a great idea. So, we hired an accounting firm to go through a complicated business valuation analysis whereby they used three different “standard” business valuation formulas to determine what the TRUE business value would be. Well, when the accounting firm got done and submitted their final report, I was surprised to read in the final footnote something like this, “The business valuation figures presented are only estimates and the true value of the business can only be determined by the availability of willing buyers.” Yep, we just paid $2500 for someone to tell us what we already knew!” Oh well.

So here is how I’d determine the value of a service business. First, I’ll lay out all the assumptions. I assume that YOU will have to work in this business to make it work. Second, I’m going to assume that the $50,000 you mention is the overall NET profit of the operation.  So what do we have here? We have an asset that produces $50,000 of non-passive income. If this is the actual scenario, then this business does NOT have much resale value. I’d say the business has a value of $30,000 (assets you mention) + $10,000 (goodwill for customer list) + $10,000 (goodwill for business name & longevity) = $50,000 total! Why is this so low? Well, a business only has REAL VALUE to an owner if the owner can walk away, hire a good operations manager and STILL make a profit. In this case the business itself isn’t really making a profit because if you were to hire someone to make it work, you’d probably have to pay them the $50,000 profit. Thus the business itself is a break-even business and thus all valuation multiples end up going to zero! Heck, even $50,000 is generous!

Take care,

Tim Schmidt

P.S. - If, in fact, the business DOES have an actual profit of $50,000 AFTER all employees are paid, then the business is probably worth 2.5 to 3.0 times that profit or $125,000 to $150,000.

Monique (April 5, 2009 - 8:57:08 PM)

What is the best way to market a small salon in a small city?

Dennis (April 5, 2009 - 12:30:32 PM)

Hi Tim, I’m 51 and recently laid-off from the last employer I ever want to work for. I’ve started my own business (again), training people to get their concealed carry permit for the state of Florida. I have several certifications and am obtaining more and setting up safety classes for new teen-age drivers as well. My budget is super-small, so I must make my advertising really pay-off. I’m on several internet search engines but I need to reach more of my local area. Where’s the best bang for the buck when it comes to local advertising?

Hello Monique & Dennis,

Believe it or not but I’m going to answer BOTH of your questions at the same time. Yep, I am NOT kidding. Your best value in small-town or local advertising is either Val-Pak coupons or Yellow Pages advertising. BUT… and this is a HUGE, you have to do it right. Now the good news is that most businesses do Val-Pak coupons and Yellow Pages advertising all wrong. But that’s OK, they’re just making it a lot easier to compete with them. Here’s what you do, you make your Val-Pak coupon or Yellow Pages ad look EXACTLY like a miniature direct-response mail piece. First you must lead with an attention-grabbing headline. DON’T put your company name and logo up at the top. Don’t do it. The only people that care about your company name and logo are YOU and your Mom. Your headline ought to be a benefit-driven headline that answers the question, “What’s in it for me?” Next, you need a short list of immediate BENEFITS that your prospect will receive if they DO what they’re supposed to do. Now you’re probably thinking, “Well Tim, what are they supposed to do?” Good question. That brings us to the second to the last thing in your ad, a call to action. Yep, tell them what to do. Dennis, here’s a call to action for you. (Examples) Call 123-456-7891 to schedule your FREE Concealed Carry expert consultation. Monique, here’s a call to action for you. Call 987-654-3210 to book your appointment and get a FREE highlight procedure (or whatever you call that stuff). So you grab their attention with the headline, give them a short list of benefits, and then tell them exactly what to do. Give them something of tremendous value and they will come back for more.  Oh yeah… and the LAST thing to put in your ad? In small type at the bottom, you can put your name and logo… just to soothe your ego and make your Mom happy!

Good example! FREE offer, then tells them what to do. Business name is at the bottom, secondary to offer. Give value=build trust=loyal customers!

Take care,

Tim Schmidt