Tag Archives: building businesses

Business Valuation

For a number of reasons I’ve had to discuss / review business values.   Based on that, I thought I’d discuss business valuation in more detail.  Let’s start with the most common valuation method which is the earnings valuation method.

The Basic Calculation

The basic calculation was calculated as follows – net assets multiplied by the earnings multiplier. Or written out:

(Assets – Liabilities) + (Profit  x Earnings Multiplier) = Business Value

Things however get complicated for a number of reasons.

Assets

Assets for most e-commerce businesses include the stock, furniture, website and the accounts receivable amounts.

Note, however that things can get complicated if the company has decided to purchase assets like furniture outright or has already applied depreciation.  In addition, you’ve got t o assess the value of a website which can be tricky.

Goodwill theoretically should be there. but Goodwill is often disregarded in cases like this.

Liabilities

Liabilities are generally easier to do.  You have Loans and Accounts Payable to worry about, but not much else..  Shareholder loans can be tricky as you need to assess what the loan requirements are – many companies have a substantial shareholder loan but no documentation attached to it.

Profits

Profits at first seem pretty simple – just take the Net Profit right? However, it’s more complicated than that.  When selling, you want to include things like the Owner’s draw and discretionary expenses (Add Backs) that might have been taken out of the Net Profit that are not necessary to the running of the business.

Often, especially with smaller companies; a number of discretionary expenses are added to lower the tax burden.  These costs shouldn’t be part of the actual profit and thus, the sale price.

Profit Multiplier

How about the profit multiplier? Well, this is tricky.  The multiplier can be as low as 1 and as high as 10 depending on the industry and the growth (expected or historical) of the company.  This is a harder number to find though business brokers or business sites like BizBuySell, etc can be a good place to start.  Generally, multipliers of 2 to 3 are quite common for profitable businesses.

Other Factors

Are there other factors to take into account? Yes, a ton.

  • Growth potential of the company can drive up the profit multiplier
  • A history of profitable earnings can increase you general profit, not to mention your profit multiplier (if it’s shown to continually increase as well)
  • Documentation and processes – a well documented business with policies & procedures that make it turnkey can significantly increase the value of a company
  • Seller financing (i.e. you being willing to be paid out from the profits) can increase the value of the company
  • Market share / ease of entrance into marketplace.  If you are in an industry that is hard to enter and/or have a substantial market share (i.e. market leader); you can often command a higher premium for the company

Other Valuation Methods

Lastly, let’s talk other valuation methods:

  • Book value (what’s it worth on paper?)
  • Liquidation value (great if the company is liquidated and/or not an on-going concern)
  • Debt-paying ability / Free cash flow (how much free cash does the company provide, thus allowing the business to be bought for that value)
  • Capitilzation of earnings (basically, figuring out the return the buyer can expect)
  • Revenue multiple (for high growth companies, this could be viable if they are not making any profits).

At the end of the day, there are a ton of methods of valuing a company.  It’s worth noting why a company is being sold too – if you approach a company ‘blind’; unless the owner was intending to sell the company; you are likely to pay a premium compared to one that is actively looking for a buyer.

Choosing the right product

Now that I’ve been in this business for a while, I’m realising more and more how important it is to choose the type and kind of product you sell carefully.  There are a few reasons for that, but here are the major factors that will affect your performance:

Market Size – how many people demand the product

Fragmentation of market – how easy is it to get hold of these people? A market may be huge, but if your market is highly fragmented, it’ll be much harder to market to and devleop

Average Order Value (Product Value) – all things being equal, a higher value / priced product will generate more revenue than a lower priced / value product.  Go too high though and you’ll see conversion rates drop, but within the $100 – 200 range seems to be pretty good from hearsay.  Our experience has shown that if your products average around $40 – 50; you’ll almost double your average cart value compared to products in the $25 – 50 range.

Competition – not much required to discuss here

Uniqueness – if you have a product that others can’t find / locate / buy anywhere else, you have a much higher conversion rate than others.  This is great when you can manufacture or otherwise sole-source a product which has high demand and often the reason for breakout successes fir small companies.