The true value of a small business is found beyond its finances
When trying to determine the value of small businesses, one of the most commonly asked questions that buyers have is:
- If I purchase this business, how much money can I make?
However, it is equally important to look beyond financial data when you are determining the worth of small businesses. Often, these financial data can be inaccurate or inadequate because they exist mainly in order to minimize taxes and not to measure how financially successful the business is.
Beyond financial data, there are some basic factors that affect value and must be taken into account when you buy a small business:
- The business has provided stable income for several years
A business in operation for at least 3-5 years is worth being recognized for its success, however great or small it may be. This means that the income has been enough that the owner can make some kind of life and, at the same time, can cover professional expenses, rent, sellers and employee payroll.
This means also that gross sales provided enough cash flow to maintain smooth business operations. Sales affect value to a great degree. This is due to the fact that the real bottom line of profit (Seller’s Discretionary Earnings or SDE) is drawn from the first line of profit (gross sales).
For a small business that has been in operation for at least three years and is earning less than a million euros in gross sales, a general rule is that the profit of the owner (SDE) should be somewhere between 10 and 20 percent of gross sales. As soon as a business starts making more than a million in gross sales, the profit of the owner (SDE) should be reduced to 10 percent or less.
- Does the business have room for growth and expansion?
A business is more valuable if it has the ability to grow after being sold. When evaluating a business, 30% of your attention should be focused on what the owner has already done and the other 70% should be concentrated on what you could do yourself with the business after purchasing it.
For example, if an entire business is based on the current owner because it depends to a large degree on one person, then it would be very difficult to expand. In order to expand this business, it may be necessary to do a lot of work in the beginning in order to create processes and systems that will ensure the smooth operation of the business in your absence.
Other important factors include:
- A strong commercial brand – A business with a good reputation on the market is more valuable than one which has been deeply affected by a crisis or by delivering bad services. A strong commercial brand within an industry will be much easier to expand.
- Place on the market – A business which is better situated than its competitors has more of a chance of gaining a better place on the market. Those companies offer products and services that stand out on the market.
- Quality of employees – A strong business has trustworthy and skilled employees. Those who remain with the company long term are likely to affect the quality and success of the business.
- Continuous business operation – A business that operates year-round can offer a steadier stream of sales compared to similar seasonal businesses.
- Strong and loyal customer base – A reliable customer base is equally important since it is quite likely to remain even after the sale of the business.
- Running the business matches your lifestyle
Buying a business is just as much an emotional as it is a financial decision. If you do not like the industry in which the business is involved, or it does not match your lifestyle, then it will never be a suitable business for you, regardless of how successful it is.
Questions to ask yourself include:
- Do I have the necessary skills to run this business successfully?
- Is its location convenient for me?
- How often will I need to be physically present at the business?
- How often will I need to travel in order to meet with buyers and suppliers?
- Do I prefer a wholesale or retail business?
- Is it the size I want? (e.g., managing a large number of employees)
Dedicate some time to understanding the factors that affect the value of small businesses
Buying a small business will change your life in unexpected ways, both in terms of your income as well as your daily life. For this reason, you need to be certain about what you are looking for before you make a purchase. As soon as you evaluate the basic factors and choose a potential business, you will inevitably need to visit it for further investigation. The next business you will visit might just be the right one for you.
If you have any questions, or need help and guidance, you can contact our skilled staff at Business Interval.
