| There are no rules cast in concrete when you | | | | what is actually bought when a business is sold as |
| wish to determine the correct selling price of a | | | | a going concern. It is further necessary for the |
| business. It is thus necessary to make use of | | | | parties to the transaction to be in full agreement |
| factual assumptions rather than using undefined or | | | | of this. |
| emotional price decisions. | | | | Although the business, as a going concern, is sold |
| Sellers might fail in being realistic as to what the | | | | as a unit or "package", this package could be |
| financial status of the business can offer to a | | | | broken down to a few saleable assets.o Goodwill |
| purchaser. In some instances, sellers price their | | | | often represents a large part of the purchase |
| business to high in an emotional last attempt to | | | | price. Sellers always place a high value on goodwill, |
| profit from their hard work during their period of | | | | purchasers does not want to pay goodwill and |
| ownership. These businesses stay on the market | | | | financial institutions will seldom if ever view |
| for lengthy periods and, in time, earn a reputation | | | | goodwill as surety for borrowed capital. Goodwill is |
| as non sellers. When, at some stage, the prices | | | | often overvalued by sellers and misunderstood by |
| are corrected these businesses are still hard to | | | | purchasers. |
| sell because of previous over exposure at | | | | Goodwill can be viewed as the clientele of the |
| non-realistic prices. | | | | business. Other factors that add to goodwill may |
| Sellers should actually be able to make a complete | | | | be the location in relation to its markets, the trade |
| mind shift and try to think like a purchaser when | | | | period (time established), an actual prime premise, |
| determining the price of their businesses. This will | | | | a favourable lease agreement, the history of |
| result into factual arguments when negotiations | | | | profitability, Special skills of the staff and trained |
| take place. | | | | staff, trade contracts, registered brand names |
| Purchasers tend to over bargain when negotiating | | | | and more. |
| a deal with a seller. Purchasers often upset sellers | | | | Although the value of goodwill is a grey area to |
| in placing emphasis on the weaknesses of the | | | | calculate, it is a definite asset that adds value to |
| business as a bargaining attempt. This may result | | | | the business. A business without goodwill still has |
| into emotional arguing which has no benefit to | | | | to become a business.o Inventory of trade assets |
| concluding the transaction. | | | | like shop fitting, signage, equipment, etc, are |
| In an attempt to help them make a decision, | | | | easier to value, because it represents tangible |
| purchasers often seek advice from friends or | | | | items. The question is what the correct criteria to |
| other non-experts in the field. Many a purchaser | | | | determine its value are. |
| has decided not to buy a good business, or has | | | | The replacement value might be used if all the |
| burnt his fingers by listening to the so called "good | | | | assets are fairly new. If the book value is used, it |
| advice" from an inexperienced friend. | | | | might be under valued because of tax write offs |
| As a starting point in bargaining, a purchaser | | | | in the past. Although the most difficult to |
| should ask a seller a question that he must qualify | | | | determine, it may be the best to value the |
| like one of the following;o Tell me how you got to | | | | inventory at an approximate auction value. |
| the price for your business.o Can you tell me why | | | | Refinancing of trade assets like late model |
| you think my offer is not realistic?o I base my | | | | vehicles, could form part of the payment for the |
| offer on the following. ............... .............. I am of the | | | | business. The down payments thereof should then |
| opinion that it is a very good offer. On what | | | | however been noted as an expense against the |
| grounds do you differ from me? | | | | profits of the business when the PE value of the |
| In making statements like these and by asking | | | | business is calculated from such profits.o Stock is |
| the right questions, the negotiations are forced | | | | normally included in the sale, but paid separately |
| away from emotions and rather focus on facts. | | | | for, because of the fluctuations in its levels. |
| The experienced business agent / broker will | | | | Businesses like rental companies differ from |
| always direct negotiations to facts. He should be | | | | retailers in the sense that stock levels are more |
| able to avoid emotional traps. When the parties, | | | | stable. In such businesses the stock price could be |
| to the negotiations, fall into these emotional traps, | | | | integrated in the selling price.o It is best to exclude |
| the agent / broker must be able to guide them | | | | creditors from the sale, which means that the |
| back to facts with as little as possible emotional | | | | seller will be liable to settle his debt with all |
| scars to the negotiation process. | | | | creditors.o Debtors, like stock, might be included in |
| Let's look at the cost of money and time. | | | | the sale, but excluded from the purchase price. |
| The transaction involves money that changes | | | | Payment of the debtors' book to the seller might |
| hand. The purchaser expects maximum profits | | | | be postponed until monies have been collected. |
| from his investment, but often fails to make a | | | | The sum of the debtors book might also |
| proper analysis as to what the expected | | | | completely be excluded from the sale. It could |
| price-earnings ratio of his newly acquired business | | | | then be collected by the seller, or it could be |
| is. He might have been better off by investing his | | | | collected by the purchaser on behalf of the seller |
| money elsewhere and stay at home, rather than | | | | at a percentage fee. |
| to sell his personal time to the business the | | | | Putting it all into practice. |
| moment he took ownership of it. | | | | Net profit, after VAT has been paid, before |
| The first factor that needs to be evaluated is the | | | | income tax has been calculated, is a fairly uniform |
| cost of money (capital) employed.o Borrowed | | | | criterion to use in determining the selling price for |
| money always cost you money because it is | | | | a business. Such net profit may include the |
| incurring interest, say for instance @ 15%o A | | | | business profits plus the owners' earnings and |
| purchaser's own money, invested in a business, | | | | benefits. |
| always cost him the interest that he could have | | | | Gross profit or turnover is not that uniform. Take |
| earned when the money was invested elsewhere. | | | | away businesses has a far lower turnover and a |
| -Passive investments in blue chip shares on the | | | | far higher gross than wholesalers and general |
| JSE returned 30% + p.a. during the past 10 years. | | | | retailers. |
| -Investments in real estate averaged more than | | | | Everything comes back to PE or return on |
| 20% during the past 5 years. | | | | investment as being the only basis for calculating |
| -Passive investments in financing large property | | | | the correct price. |
| development companies offer 22%, some with | | | | Although stock is calculated separate from the |
| guarantees, though some with more risk than | | | | purchase price, it is a necessity for the purchaser |
| others. Bear in mind that investing in any business, | | | | to have. He has to pay for it and he might have |
| even your own, has a risk factor attached to it.o | | | | to provide operating funds for additional stock or |
| Whether money is thus borrowed or owned, it | | | | debtors. If it is a franchised business, a listing fee |
| has an interest cost value when employed into | | | | to the franchisor might be applicable. It is essential |
| any investment, like for instance your own | | | | to include everything that the purchaser has to |
| business. | | | | pay for, when calculating the PE. |
| The second factor that needs to be valued when | | | | The following example can be used in calculating |
| buying a business is the purchasers own time | | | | the value of a business: |
| involved.o If a purchaser takes up 100% | | | | Per Month Per Annum |
| employment in his newly acquired business, the | | | | Net profit after VAT, before income tax: = R 33 |
| business will have to be able to pay 100% of his | | | | 000 R 396 000 |
| salary. | | | | Capital outlay of the purchaser: |
| The two factors mentioned above, could be | | | | Franchise Listing:= R 50 000 |
| illustrated as follows when investing the total | | | | Stock: = R 80 000 |
| amount of R800 000.00 in acquiring a business. | | | | Business as a going concern, |
| The cost of capital employed (Interest on R800 | | | | Including Goodwill & Inventory = R616 400 |
| 000.00 @ 15%) = R120 000.00 | | | | Agents commission @ 8 % = R 53 600 |
| The salary of the purchaser @ R23 000.00 per | | | | (Commission is payable by the sellerfrom the |
| month (X 12) = R276 000.00 | | | | funds generated by the sale) |
| To cover the above, the business needs to | | | | Total outlay: = R800 000 |
| return p.a. = R396 000.00 | | | | This example results in a price earnings ratio of |
| This example results in a price earnings ratio of | | | | 2.02. |
| 2.02, (which is still good). | | | | (Price Earnings Ratio or PE = Capital employed |
| (Price Earnings Ratio or PE = Capital employed | | | | divided by the yearly profit earned) |
| divided by the yearly profit earned) | | | | The earnings could also be expressed as a return |
| The earnings could also be expressed as a return | | | | of 49.5% on investment. |
| of 49.5% on investment. | | | | (Return on Investment or ROI = 396 000 divided |
| (Return on Investment or ROI = 396 000 divided | | | | by 800 000 X 100 = 49.5%) |
| by 800 000 X 100 = 49.5%) | | | | Although not cast in concrete, the table below |
| Remember, in the example above, the business | | | | may serve as part of a more factual approach in |
| has only covered the basic costs for its owner. | | | | deciding what the total capital outlay should be in |
| No provision has been made for capital | | | | relation to the profit when a business is sold. |
| repayments and year end surpluses (profits) will | | | | Outtlay Profit p.a. PE Ratio R.O.I. Risk Factor |
| be non existent. | | | | 1188000 396000 3 33.33% To High. Not a |
| Businesses transactions at a PE of higher than 2.5 | | | | consideration for a purchaser |
| (ROI of less than 40%) and which are dependant | | | | 990000 396000 2.5 40.00% Viable Limit |
| on full time owner involvement, could be viewed | | | | 880000 396000 2.222222 45.00% Good |
| as getting risky. | | | | 800000 396000 2. 020202 49.50% Good |
| What is sold and what is bought | | | | 792000 396000 2 50.00% Low |
| It is important to know what is actually sold and | | | | 594000 396000 1.5 66.67% To Low. |