Business Value


From original questioner:

I'm in talks with my employer of the past 4 years to buy his shop as he is ready to retire. We're trying to come up with a number. The owner and I do all the office work, drafting, operate the CNC, and also do a lot of work in the shop and installing. There is 1 full time employee who is quite good and has been with the company a very long time, he does all of the finishing.

As for the financials, there is about $100k in cash and receivables. I'm not sure how to put a number on the fixed assets because they are all fully depreciated, old, and wouldn't fetch much at auction, but my best guess is somewhere between $40k and $50k. As for profit, there basically is none. Total sales have averaged about $400k the past 4 years.

What's a ballpark number to value this business at, with the assumption that I inherit the cash and AR?

From contributor Pa

There isn't much here beyond the cash and AR. Even the auction value of the machinery seems high. And don't let him snow you with "goodwill." Hate to say it, but if your employer wanted to cash out of this business he should have run it differently. Is there another buyer in the picture? If not, you really don't have to offer him anything.

Just my opinion though. You should have an accountant of your own to review this with, preferably someone who has been involved with the sale of small businesses. That person should be able to help you.

Good luck!

Paul Downs

From contributor Al

You need to back the "expenses" and "bonuses" to the owner back into the profit to get an accurate cash value.

If he puts 22k in a IRA or buys a new truck and expenses it or lots of other places that there could be cash going to the owner that reduce profit for tax purposes would need to be built back into a cash flow statement. then if the business produced x dollars of income a year the investment would be based on goodwill + assets plus the value of the income. This assumes you can do everything he does. The name and location have some value, the cash and a/r have value, but if you get the cash and a/r you generally get the liabilities and warranties.

You need to consult an accountant to help you get a true value and then you need to determine if its worth that to you


From contributor Gr

Thanks for the reply Paul.

No, there is no "goodwill" involved since there are no profits to pay any "goodwill" from.

It's hard for me to wrap my head around the fixed assets, however. If I were to set up a new shop just like the one I'm working in now, it would cost me north of $50k. But if the owner were to cash out now, he would likely get $20k or less. So there seems to be a "window" of value there that is hard to put a number on.

I don't know of any accountant who would have any idea of the cost to set up a slider, and edgebander, a CNC machine and the software to run it, compressed air lines, and a host of other machines that required specialized knowledge.

From contributor Ak

Ok so if I am reading this correctly....

1. You say there is no profit, and likely hasn't been. To me this is a red flag. Either lack of sales, and or pricing that is too low. I hate to tell it as it is, but this would be a big concern. This could be fixed but indicates a problem as is.

Given that, I am going to give you an important question to think about.

2. Does the business have existing clients. Sales, and contracts in the pipeline, etc? Is there a sales staff with active leads? This is important because.

If the business does not have existing clients, sales & contracts, active leads regardless of what you would like to call it you are essentially buying assets, perhaps taking over a lease. You would be in effect starting your own business, as you are primarily purchasing assets.

I would be making sure that there is indeed a business to purchase. Otherwise my offer would be based on the value of tangible assets (real property, equipment, machinery ,etc...) If you have to do all the hard work of developing sales, and marketing, you might as well start your own business, and perhaps agree to hire some of the former companies employees.

From contributor Ak

Furthermore another factor to consider.

How much business is from existing clients? Like I said in my past post, if most of the sales are coming from new customers, you are going to have to go out and generate these leads, or hire someone to do so.

Hypothetically if you are looking at purchasing a business and they have 100k in sales for example. There is a big difference if that 100k in sales is

1. mostly from new clients that will not purchase from you a gain, and

2 100k in sales to wholesale accounts for example that make consistent purchases.

In regards to example 2 there is "business to purchase"

Example 1 would be more of a situation where you are buying inventory, assets, branding, etc and essentially starting your own business.

From contributor B.

You need to consider spending $1000 to $1500 for a proper business appraisal. This will show you what they could sell the business for in the open market.

A general guideline is that a business with $50,000 to $100,000 in profit will be worth somewhere around 1.5 to 3 times max. the annual profit. The higher the profit the stronger the ratio.

Profit includes any money taken out of the business by the owner.....whether as salary or or not. So if your owner was taking home $75,000 a year the business is likely worth in the neighborhood of $110,000 to $225,000. This is a very rough estimate/guess but gives you a peak at how an appraiser will look at the business.

Unfortunately machinery generally does not come into play in the value. If the business is worth $200,000 it doesn't matter whether that profit is being made with $10,000 worth of machinery or $100,000 worth of machinery. Weird and sad........but pretty much the way the appraiser is going to view the business.

Inventory on the other hand is taken into consideration. That is as long as it is viable material and not items that have been sitting around for years because there is no use for them.

Hope this helps to begin to give you an idea on how this all works.

BH Davis

From contributor Gr

In response to Alan and Ake,
I'm privy to the books for the past 4 years, and there are no "hidden" bennies going to the owner. OTOH, there is still no profit or bonuses at year end. I don't consider it a red flag, it's just something to consider in regards to assigning a value to the business.

There is no sales or marketing structure. It's all word of mouth and existing clients, some of which date back decades. Again, not a red flag since neither of us expect to assign goodwill value. There is roughly $400k/year in sales to wholesale customers that I fully expect to continue going forward.

I can, and have been, doing everything the owner does, so I'm ready for him to exit the picture without affecting operations.

From contributor An

A few things to think about and balance in your projections

1) How much does the current owner take out in total for salary/draws/benefits/auto etc? If he was out of the picture, that is the gross profit for this business.

2) Assuming the owner spends time in the business actively working, how much will you have to pay another person to pick up some of your duties and some of his? Unless the current owner is mostly absent from operating the business and from performing actual work in the business, there is no way you can long term do both your job and his when he exits. The cost of the extra help needed eats into the gross profit you'd earn from the owner exiting. You may find the sum of those two numbers is negative.

3) What happens if your biggest commercial wholesale client leaves? What if more than one client leaves? You need to have a plan to replace that lost business if you want to maintain what is happening now. And you need to be prepared to shrink if necessary.

4) You will probably need to add more clients if you want to grow the business. Where will they come from and what is your plan to bring in their business?

I could keep going. That's probably enough for you to think about in this round.

From contributor Ri

In a small business, the business can basically be the owner. He has all the history, contacts, and customer loyalty. What will happen when he is not there? Do you think you can maintain customer loyalty? How do you propose paying for the business when it presently doesn't turn a profit with old outdated machinery that you will be buying? How will you get financing when the bank sees the profit/loss statement? I would only pay scrap value for the machinery. That is what he would get at auction.

From contributor de

just a point. Profit does NOT include any money taken out by the owner- whether salary or not.
What's left over after all expenses are paid, and the owner takes a reasonable salary for the efforts he puts into the business- that's profit.

From contributor B.

Dean C,

Technically I would agree with you. But from an appraisal perspective what the owner takes from the business is considered the profit/income that determines the value of the business.

If the owner hires someone to do what he has been doing his/her cut becomes less, and the appraised value of the business becomes less.

Every situation is different of course and the final value of a business will be solely determined by what someone is willing to pay.

BH Davis

From contributor Gr

Dean, there is no profit in this business. The owner salary is roughly $80k.

Would you sell your business for the scrap value of your machinery? Wouldn't you just have an auction instead?

There is value to be paid for the customer base, it's just a matter of figuring out how much.

From contributor Ri

You ever been to an auction with old 3 phase commercial machines? Around here, they bring close to scrap prices. I would also argue that the customer base will automatically transfer. It takes years of hard work to build customer loyalty. With a new owner, this relationship will have to be rebuilt.

From contributor La

I pretty much agree with Rich about the value of older equipment. Individuals don't buy it because of the 3 phase, Production oriented businesses don't because it's old and likely to have high maintenance costs, lost production time etc. In a business this size almost all the value leaves with the owner. If you have established a good working relationship with the repeat customers, that has some value. If he has been actually taking $80K out for salary, that in some sense is "profit." Profit in a micro business is difficult to measure. What if he had been taking $20 or $200K? The picture would look a lot different. So would the value of the business.
Seems like a lot depends on where you wan to go with the business. Continue as is? Ramp up production, hire more. Strange as it sounds, increasing production, costs, quite a lot actually. Do you have access to $ other than a bank loan?

From contributor Fr

A business has value to the extent it can generate profits and the value of it's assets. The profit is probably the difference between the owners salary and what you could pay someone to do his job.
It sounds more like you are buying a job.

From contributor Al

On the same lines as what Frank just said it looks like the current owner may be buying a job for a long time.

If the leads and sales that exist have expectations of low prices, why pay to continue that cycle, it needs to be changed to get in more profitable customer base that is in the niche of where you want to be.

You can always structure the deal that the sales price is based on asset base plus a percentage of actual profits for existing customers and leads. ie if what you say is true, you get paid, if it isn't you don't


From contributor Gr

I think what you proposed makes the most sense: assets + percent of sales. So I would essentially be paying the current owner a sales commission every year. That protects me if those sales falter. And it protects the owner if I can't figure out how to make a decent salary based on those sales.

The question then is, what is a reasonable sales commission to pay for that existing client base? And for how long?