When you want to buy or sell a business, you want to know what the price is going to be. But how do you determine that price of the business? Surely that is trickier than many a website or mathematical model suggests.
Therefore, here are some tips to consider when determining "value.
1. Cash flows are very important
Higher fixed cash flows increase the value. The cash flows the business generates each year are important. A buyer wants to know when he has recouped his investment. A seller knows how much money he can normally get out of the business and wants to get at least that amount when he sells. Moreover, cash flow feels more objective than operating income because it is not determined by your records.
2. Risk profile of company
The higher a company's risk profile, the lower the value. A business that depends on ever-short-term projects with different clients (such as an M&A firm) has a higher risk profile than a business with a fixed income stream (such as insurance products), where clients stay for 10 years or more. A firm's risk profile is determined by many different "factors.
- The market/sector/region
- The size of the business
- Track-record: results and years
- Financial markets and general economic developments
- The earnings model
- The customers: agreements, types of customers, dependencies
- The suppliers: agreements, types of suppliers, dependencies
- Entrance barriers
3. What are unique assets?
Unique assets are value drivers. They ensure that a business can either generate better cash flows than competitors and/or have a lower risk profile. Take brokerage in Amsterdam versus brokerage in northeastern Friesland. There is a significant chance that the former is worth more than the latter because of these two locations; Amsterdam is a growth region and NO-Friesland is a shrinking region.
4. What is the revenue model?
Sometimes the revenue model of the business determines the value of the business. As an example, a company that sells software licenses. The value of the company is determined based on the earning model and on benchmarking. The earning model here includes margin per customer, acquisition cost per customer, churn, etc. The company's score on these elements and the industry benchmark determine the company's valuation.
5. What stage is the business in?
The value of a start-up is determined very differently than the value of an existing business with a long-term track record. The value of a start-up is primarily determined by market trends in the industry, recent known deals, how eager an investor is to get in, and how desperate an entrepreneur is for money.
Based on the above tips, you can begin to form your own impression about the value of the business and what to look for. Don't make it too complicated for yourself and make sure it remains logical and realistic.
Price
The price ultimately paid for a business depends on a lot of factors. After all, how good is your negotiator? How many hijackers are on the coast? What is the cost of financing? How much of a rush is there? How keen are the parties? What factors other than the purchase price play a role?
We recommend establishing (or having established) a bandwidth of a price. That bandwidth is determined by your own circumstances. For the seller, it will be about what is needed for the new plans (time and money) and lost income. For the buyer, it will be about within what period the purchase must be recouped, possibly depending on financing. Within the overlap of that range, the final price will come about and you will stay within your limits.
