Q: We have a successful business that we started 25 years ago and now we would now like to sell the business to one of our employees. The business will gross approximately $500,000.00 this year, we have very few liabilities, and do not want to finance the sale. Can you help us? Thank you.
Donna G, Santa Fe NM
A: When it comes to selling a business, there are basically three questions to consider:
- What does the business own? A business that has invested a lot of money over the years in assets is obviously more valuable than a business that has not. Assets can take many forms. Of course they cover things like trucks and equipment, but also consider valuable contracts, intellectual property rights, and “goodwill” or the reputation that the business has in the community.
- How much does the business earn? Again, the same principle applies – a business like yours that earns $500,000 a year is much more valuable than one that earns $100,000.
- Are there any intangibles to consider? What makes the business unique and profitable? Do you have a great location? Do you have a favorable lease. Do you have great employees? These are the last things to consider.
Once considered, these three items can then be taken into account and used to determine the value of your business. There are two ways to go about doing so. The first is called price building. The second is called return on investment.
Price building is a valuation method that looks at the hard facts – assets, goodwill, leases, real estate holdings, etc. Essentially what you do here is list every asset and giving it a reasonable dollar value. For example, yours might look like this:
- Real estate: $150,000
- Equipment: $125,000
- Inventory: $50,000
- Trucks: $75,000
- Total: $400,000
You would then add in the intangible assets, such as trade names and the like to come up with a value. As a very rough rule, one year net earnings may be about all you can expect to get using this method. In your case, that would mean that the intangibles are worth about $100,000, which sounds about right. The fact is few people would be willing to basically work for free for more than a year after purchasing a business.
Return on investment looks at income statements, capital equipment schedules, debts, expenses, taxes, and the like. These will be used to calculate a net business profit, per year, to help the buyer see what the return on his investment will likely be. For example:
- Net profit: $100,000
- Business sale price: $500,000
- Return on investment ($100,000/$500,000): 20%
Using this method and these numbers, the buyer would be getting a 20% return on his investment. Thus, a higher amount for the business might be in order.
There are two more things you can do to ease the way and maximize the profit of your sale. First, contact a business broker (look in the Yellow Pages under “business brokers”) and speak to a few. Though you will pay one a decent commission, it may be worth it to ensure that you are well taken care of. Second, pick up the book How to Sell Your Business by C.D. Peterson, and good luck!
Put it in writing. No matter what agreement you make with someone, it always is smart business to put it down on paper.
The advantages are 1) everyone is clear as to the nature of the commitment, 2) even if memories fade, the document will not, and 3) if you ever do have to sue, it won’t just be your word against theirs.