Valuing a Business: How to Know if a Business Is Worth Buying

Buying a business is an exciting time for any entrepreneur.
By purchasing an existing business, you can avoid many of the risks that come with starting a venture fresh from the ground up. The company you plan to acquire may already enjoy brand recognition, a solid customer base, or profitability. You can infuse a growing business with new capital and build upon its proven formula for even greater success.
But you must do your due diligence before you commit to purchasing a business or any business assets. One of the most important parts of a business purchase transaction involves establishing the worth and sales price of the business.

The only way to find out how much a business is worth is to evaluate the financial records and daily operations of the company – ideally, with the help of a trained professional and negotiator.

Despite being a business transaction, emotions can skew the perceived worth and value of a company. You may get excited and emotionally invested when you find a business you really love. Plus, the current owner has probably poured their own time and money into the venture. To them, the company may be worth much more than the number on paper.

The more thorough your due diligence, the stronger your position will be at the negotiation table. The last thing you want is to buy a business without an accurate understanding of its prospects and liabilities. You could end up overpaying or even worse – taking on unknown risks or debts that could sink your investment after the ink has dried on the sale.
How Is a Business Typically Valued?The process of valuing a business isn’t always as objective as you might think.
Even with advanced appraisal formulas, the future is impossible to predict. Your evaluations can certainly get more confident with the more evidence you have. But many aspects of appraising a business are subjective or intangible – for example, determining the value of brand recognition or customer goodwill. You and the seller may disagree on how much these are worth.
Even if there is no “perfect price,” you can use different valuation formulas to get to a reasonable price range that both buyer and seller can agree upon. 

• Income and revenue valuation – If you're looking to buy a business as an investment similar to real estate, stocks, or bonds, you need to find out what kind of return (ROI) you can expect to get from your investment. To do this, you’ll want to take a deep dive into the financial records of the business. How much revenue does the business bring in? What are the operational costs of running the business? Does the company have any significant debts? What is its market outlook for the next year or decade?
  
• Asset valuation – What is the current resale value of any assets owned by the company? Assets could be tangible (i.e., real estate or furniture) or intangible (i.e., copyrights or trademarks). You may have to work with appraisal experts or brokers to get an accurate account of how much different assets are worth.
  
• Industry formulas and guides – Some industries actually have commonly used rules of thumb to help appraise their value. For example, a brewing company is valued much differently than a publishing company. These formulas may be based on the company’s earnings average over a certain period or its “book value,” calculated by taking the difference between the company’s total assets and liabilities.
  
• Comparable businesses – You can get a better idea of a company's selling price by looking at how much other similar companies have sold for recently. However, this may not always work because small businesses tend to be unique. You may struggle to find a recently sold business that is actually comparable to the one you’re thinking of buying. Many startups are created with the explicit purpose of disrupting markets and innovative businesses may offer new products or services that have no similar competitors.
  

Even with these formulas, there is no one-size-fits-all approach to valuing a business. Every business is unique and requires a close look to value properly.
You don't want to take any shortcuts when evaluating the worth of a business. You want to make sure you've left no stone unturned so that you don’t encounter any surprises later on.
How Do You Determine the Value of a Business to Buy?When determining the price of a business you want to buy, you can expect to negotiate within a price range with the seller, taking into account the company’s financial health.
The lowest end of the price range would cover the current market value for any of the assets the company still owns, minus its debts. This might be the case if a company is going out of business and liquidating its assets – and you don't plan to continue operating it.
The higher end of the price range would cover any business assets plus expected earnings for the future. If the business you plan to buy has a solid reputation and strong customer base with a high likelihood of increasing revenue and profits, that will affect the purchase price.
But assets and revenue aren’t the only factors to consider in a business purchase transaction.

• What are the terms of payment and will that affect the final purchase price?
  
• What is the market demand for the company’s products or services?
  
• What are your reasons for buying this company?
  
• What is the seller’s intent and do they have any personal needs or goals?
  
• Does either party have time limits they must consider?
  

For example, negotiating with a small business owner who built their labor of love from the ground up but has plans to retire soon will be much different than negotiating with a franchise owner or investment firm. You’ve got to consider these circumstances in your approach.
When you buy a business, you get more than just a company. You could be investing in a personal dream, a lifelong goal, or a new adventure. You want to make sure you get the most of the new venture you’re getting into – and the best way to do that is to have a business lawyer on your side, covering your back and watching out for unexpected curve balls. You want a seasoned negotiator who can get you the best deal possible.
Thinking of buying a business? Get the experts on your side. Call the Philadelphia offices of Holmes Business Law at 215-482-0285 or use our contact form to get started now.