Mr PoP’s Thoughts on Small Business Valuations – Part 1

Even though Mrs. PoP and I are reasonably happy with our current jobs in sales and writing code, every now and then we like to wonder about buying a local small business. This has been going on for a while, I came close to buying two different car repair shops a few years ago, and different parts of my family have owned pieces of restaurants and resorts for decades. Buying one isn’t part of our game plan for the near term, but we’re not ruling it out as a possibility in the future.

As it turns out, buying a small business ins’t all that much more difficult than buying a house. Much like real estate agents list homes for sale on behalf of current owners, and there are business brokers who specialize in businesses with revenue under a million or two per year.  One of the brokers I peruse is this one over in Miami, but there are similar ones in any reasonably sized metro area. This is what a typical listing can look like.

BusBrokListing

In general, prices for businesses listed by these brokers range from $25K (like the bakery above) all the way up to a few million dollars. But what you’ll also notice after looking at a few of these is that the listing doesn’t give you too much information on the business. Sometimes if you know the area well, you might be able to decipher which business it is, but in general, the listings intended to be anonymous. The main items you get to see the price, and some basic financial information like gross revenue, total business assets, and “earnings”.

 

Mrs PoP’s Sidebar on The Numbers – WYSIWYG?

Take these numbers with a grain of salt. Eventually if you get serious about making an offer, you should be able to see all the financials for the business. For now, consider them more of a ballpark.

  • Gross Revenues – total money exchanged for goods or services (generally WYSIWYG)
  • Total Assets – might include inventory, real estate, fixtures, goodwill (not always WYSIWYG)
  • Earnings – some listings use the phraseology “owner benefit”; includes actual cash income to the owner, but very fudge-able (not always WYSIWYG)

 

What Makes For An Attractive Purchase?

Mrs. PoP and I aren’t fools – we want a business that has the best chance of providing an ever increasing cash flow through the years. Unfortunately, there is a ton of problems with just evaluating a business based on price, the gross revenues, and the earnings.

1.) Are you buying a business, or are you buying a job? Especially in the financiapolcalypse a few years back people would loot their savings accounts and buy a business that was little more than a single person operation with a phone number, some rented offices space, and a client list. Not for us. Listings with words like “absentee owner” are more like what we’d be looking for.

2.) How the hell do you define Earnings? The seller wants to get the best price possible, and has every reason to inflate the earnings number. This can happen a number of ways-by claiming income that is off the books, or by using creative accounting methods, or even pro-forma earnings (sometimes called EEBS – Earnings Excluding Bad Stuff). I once inquired about a car rental place with incredible “owner benefit” and found out that they had counted the depreciation of the cars as a benefit to the owner! This may be GAAP correct, but you can’t eat depreciation for dinner…

3.) Does this business have a moat? Assuming that the thing you are buying is more than just a contact sheet, and that it has a current income stream that will support the actual benefit the new owner will receive, how do you know that the business will continue to be successful in the future? Warren Buffett would say you have to find a business that is easy to understand, and has a significant moat around it so that other business can’t come in and steal your sales. Moats can come in many forms; they can be a superior brand and reputation, fantastic geographical locations, favorable governmental licensing. A little while ago I saw a jet-ski rental with great earnings and a very strong valuation; the reason was that the local government issued a very small number of licenses for those types of business.

But There Are So Many!

One last issue is that there are hundreds of possibilities for sale at one time on these sites, Mrs. PoP and I need a way to sort through the listings quickly and eliminate the ones that are duds, and leave the business that are worth further consideration. Tune in next week and we’ll show you how we’re going to give it a try…

 

Have you ever considered buying a small business? Do you peruse the local business broker listings for fun like me?

28 comments to Mr PoP’s Thoughts on Small Business Valuations – Part 1

Leave a Reply

You can use these HTML tags

<a href="" title="" rel=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

  

  

  

CommentLuv badge