By: Max Newnham
There are a number of times when the value of a business becomes important for owners. The first is if they are looking at going into business and buying something that has been established for a number of years. The second is when business owners are looking at retiring and they want to sell their business for a realistic price.
Q. I have recently been made redundant and job prospects are not good. I received approximately $40,000 as a lump sum redundancy and termination payout, I have a house with no mortgage and I am thinking of buying a business or a franchise. How do I work out what is a reasonable price to pay?
A. One of the major determinants of the value of a business is something called its sustainable net profit. This profit is not the stated profit on a business’ most recent financial statements. It is instead the average profit over the last three years adjusted for non-business expenses, and after allowing for a market salary for the working owners.
Non-business expenses are those linked to the owners rather than the business. These include interest on borrowings, car costs not directly related to the business, and extra superannuation contributions made on behalf of the owners.
The adjustment for a salary that should be paid to the working owners is often overlooked when evaluating a business. When evaluating a business the current owners should be asked whether the figures include wages paid to them for the work they do, and how much work they do in the business.
This means a business making a profit of $70,000, where the two owners work for 45 hours a week each for the whole year and haven’t been paid a wage, translates to the working owners only getting $15 an hour for their work. In this case the business does not really have any value, and someone buying the business should know that they are really purchasing a wage.
Once a sustainable net profit of a business is calculated the value of the business is a multiple of the sustainable net profit. A business that faces high risk, such as increasing competition and a declining market due to technological developments, the multiple is a lot lower. In general terms multiples for businesses tend to be between 3 to 5 times sustainable net earnings.
When the business is purchased to produce an income, because there are limited to no employment opportunities, the methodology is still the same. You still need to work out what level of income will be produced by the business and how much work will be required to produce that income.
Before committing to purchase a franchise you should check with other franchisees to see what they think of the franchisor. It can also help to do a Google search to see if the franchisor has come to the attention of any of the regulators for unfair business practices.
Source: The Sydney Morning Herald
