Proper Benchmarks To Consider When Buying A Business For Sale

August 21, 2010

Buying a business for sale is a multi-step process and each step is important. You should never think about proceeding to the next position until the preceding step is complete and whatever you do, don’t be tempted to short-cut ever. You can view any time spent in preparation and in the revelation of facts and figures about the business to be well spent and as such you will be ensuring that no horror stories come back to haunt you when you take over.

A lot of information can be revealed before you even talk to a prospective seller. One of the most important questions you must ask yourself before you go forward is what kind of enthusiasm you possess for the type of business you have your eye on. Do you really want to be involved in that industry and does it represent an area that you truly want to be engrossed in? Be advised, that unless you want to be a completely “absentee” owner and are considering the many additional steps that you need to take if this is the case, you should be enthusiastic about the business that you are getting involved in.

A process of due diligence requires you to inspect all kinds of documentation:

* Financials: these documents will include balance sheets, payroll records, tax reports, reconciliation documents and profit and loss statements. If the seller claims a considerable amount of “cash sales” but cannot point to these within tax declarations, then they cannot be counted and you must ignore them.

* Employee records: including information on individual behavior, attendance, length of service and pay scales.

* Licenses: including federal, state, city, county as appropriate, plus any certification licenses you must possess to operate the business. It would be in your best interests to look at records independently, certainly if you believe there may have been any problems in the past or possible discrepancies.

* Equipment records: including age, depreciation, maintenance, replacement cost, and any required inspections.

* Inventory records: re-saleability, turnover and overall condition.

* Supplier contracts: are they transferable, do you have alternatives and is there goodwill?

* Property records: are any rental agreements transferable to you without any problem, as this can be particularly important.

If you find that all records, licenses, contracts and agreements are in order and are workable for you going forward, you may be wondering how to arrive at a good value when you buy business assets. A number of different ways to look at this exist. Some of the methods used to calculate include:

* Asset-based multipliers, where assets are totalled and value is determined.

* Rule of thumb, where industry benchmarks are used to establish the value (not recommended).

* Revenue-based multipliers – a percentage is applied to monthly or annual revenues (not recommended).

* Cash flow multiplier, is where a business owner’s profit level is added to his or her salary and any other perks and certain expenses are deducted. This method is most commonly used to determine the value of a business.

While there are many documents and figures that can be proven to backup an owner’s claim, or not as the case may be, you need to take into account significant facts. What is the age and reputation of the business, the level of competition expected, its physical location in many cases, the legal structure of the business, the quality of the premises and/or the difficulty in obtaining a new lease. When looking at a business for sale, take everything into account as you determine whether you should buy a business like this.

Richard Parker is the author of the How to Buy a Good Business at a Great Price series. As President and founder of Diomo Corporation – The Business Buyer Resource Center, his materials, seminars and consulting have helped thousands of business buyers realize their dream to buy a business.

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