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.