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How to determine the value of a business ?

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Nimo
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How to determine the value of a business ?

Postby Nimo » Mon, 19 Sep 2005 3:19 pm

Hi, I intend to sell my small IT business, does anyone know how I can determine the value of my business, is there a formula to calculate ? Thanks

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Strong Eagle
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Postby Strong Eagle » Mon, 19 Sep 2005 3:57 pm

This is a very difficult question to answer, especially for a small business.

First of all, it may be worth nothing if you are the owner who knows all the stuff and does all the work. Business customers are loyal to the owner and not the business. So there is not much to sell if you leave.

Businesses are sometimes priced on gross revenues. In this case, the buyer is looking at what the business takes in, and figures he/she can cut costs to improve profits to make money.

In other cases, the price might be based upon net profits, or profits before interest, taxes, and depreciation. In this case, the return on investment is compared to what the investment might return in other businesses, or in stocks, or in real estate.

Inventory counts for something but not for much. Inventory is always depreciated by its age. A six month old computer in inventory isn't worth much.

There are lots of special cases. You may have a few really good clients that pay very well. This might be worth money to someone who wants to establish a business relationship with the clients, or figure out how to expand into the client companies. This will make you worth more for the opportunity the business provides.

You may have a specialized product or service, or a patent that nobody else does very well. Or you could have a monopoly, maybe government granted. These will cause the value of the business to increase.

Other factors that come into play include barriers to entry and the number of players already in the field. If anybody can get into the business with very little money, then why pay you? And if competition is very strong, then there will be strong downward price pressure on your business. If you are in a low growth business line your business will be unattractive because of limited opportunities for growth.

You don't say what kind of IT business. If you are in retail, what differentiates you from the rest of the shops that infest Sim Lim and Funan? Do you have a lot of repeat business that guarantees a revenue stream? Do you have strong brand recognition? If not, why should anyone walk into your store, except by chance, just as they would walk into my store next to you if I set one up instead of buying yours. Do you have attractive manufacturer discounts or other supply side incentives that would be difficult for a new business to get?

My belief that retail IT is fully commoditized. People buy on price and have little or no brand loyalty to the store they buy from. People shop on price and margins are very thin. So, unless you have something that sets you aside from the pack, it makes little sense to pay you a profit in selling your business when I can set up the equivalent myself, for less money.

If you are talking about an IT consulting or programming business, then the valuation will be based on your revenues, your future revenue projections, the number and quality of your clients, and the assets you have in the people that do the work. If you have multi nationals for clients and you have a strong staff that has been with you for years you will be much more valuable than if you cater to "mom and pop" stores and use contractors. In the former you have something a buyer can build on, in the latter, you have nothing that anybody else can't do.

So, there is no easy answer. But you might think about it as a buyer. Suppose you had the money to invest. What return would you expect? How much of a premium over cash flows and assets would you pay for the potential future opportunity that the business provides. What would you like to see the competition look like?

And, I add one thing. The only thing that really matters in a business evaluation is cash flow. Sure, it's worth looking at the P&L, and checking out the balance sheet, but it is cash that matters.

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Re: How to determine the value of a business ?

Postby Oriental » Tue, 20 Sep 2005 3:30 am

Nimo wrote:Hi, I intend to sell my small IT business, does anyone know how I can determine the value of my business, is there a formula to calculate ? Thanks


To keep it simple I suggest you figure out what amount you would pay if it were you who were to take over the business in question.

Calculate the expected earnings based on previous performance and determine how much you would expect to receive in salary. When you have an estimate of the profits you may be able to convince a potential buyer that your business as a going concern is worth 1, 2 or 3 times the estimated yearly profits.

You may offer your services as a teacher for a period of say 1-3 months so the potential buyer may learn from you the basics of running the business.

Remember that if your business ceases as a going concern the value will be equal to the amount you can get for its assets if sold at a public auction. For most small businesses that amount would be close to zero.

Why would you want to sell your business? I’m just curious.
Impossible is nothing!

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Postby Nimo » Thu, 22 Sep 2005 1:22 am

Thks guys for the advise.
I m doing IT services mainly maintenance contracts for corporate client, turn over is about 500K. Do have a few big names that others might be interested to establish business relationship. I know this will add some value to my firm if I got the right buyer, but first of all, I got to know an estimate value of my business before I can proceed to find a buyer. Is there any company that provide cheap valuation services for business or acquisition of small firm ? I m selling my business because of health problem.

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Postby Strong Eagle » Thu, 22 Sep 2005 8:01 am

Nimo wrote:Thks guys for the advise.
I m doing IT services mainly maintenance contracts for corporate client, turn over is about 500K. Do have a few big names that others might be interested to establish business relationship. I know this will add some value to my firm if I got the right buyer, but first of all, I got to know an estimate value of my business before I can proceed to find a buyer. Is there any company that provide cheap valuation services for business or acquisition of small firm ? I m selling my business because of health problem.


Not really... at least nothing that would be cheap.

Here are a couple of questions for you.

a) Are you doing all the work yourself? If yes, then I'm afraid you don't have much to sell. If you are doing the maintenance and then you leave, what is there to buy?

b) If you have personnel, how many and what is the term of the contracts you have with your clients? What are your gross margins? I hate to be the bearer of bad news but IT maintenance is extremely competitive. The largest maintenance firms are averaging 3 to 7 percent margins.

What this means is that there is little return on investment. Consider: You have $500K revenues. With a 10 percent margin, you have $50K. How much would your pay for a $50K revenue stream? I would need to invest $1 million at 5 percent to get a $50K revenue stream.

But, you will never get that for multiple reasons. First, your revenue streams are not guaranteed. They are in fact, high risk since the loss of one or two clients effectively ends the stream. Thus, your price must be discounted for risk, and the risk is very high.

Second, investing is a passive activity. Running a business is an active undertaking. Your price would have to be discounted again.

A rule of thumb is that a business would be worth 2 to 3 times earnings, so using my 10 percent margin number, you would be able to sell for $100K to $150K. But, I don't think you can get that. First, unless you have guarantted long term contracts, your revenue stream is at risk, and it is very risky if the majority of your revenue comes from one client.

Second, the costs of entry into your business are extremely low. Why should I pay you anything when I can hire 10 computer maintenance technicians this afternoon? It would come down to the quality and duration of your contracts.

And there is the final rub. If you were running a shop with a couple of million in revenue, and you had a significant track record of profitability, tehn you might be worth buying as a going concern with multiple customers, process and procedures and a large enough staff to manage your loss. But at $500K, any change in circumstance is material to your company.

I don't value companies. However, I am in IT, in the project management arena. I would not buy your company, or any company in your line of business. The margins are not there to support the investment. And the long term outlook is not good. Dell, HP, and IBM continue to take a larger and larger share of the market, and their focus is on service. They can't make money on hardware so they focus on service. Even the large independent shops are being sorely squeezed. It does not bode well for the small guy.

Sorry to be negative but in my opinion, you would be better off keeping the company you have, scale back your part in the operations and keep taking profits from it.

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Postby Strong Eagle » Thu, 22 Sep 2005 1:13 pm

I did think of one possibility. You might see if your competitors are interested in your business. It is one way they could grow.

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Postby Nimo » Fri, 23 Sep 2005 1:04 am

Thanks Strong Eagle, do agreed with what you said. Look like the only way out is to look for my competitors, thanks again.

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Postby Strong Eagle » Fri, 23 Sep 2005 7:19 am

I think Oriental gave good advice. Put your self in your competitor's shoes. If you were objectively looking at your business, what would you pay? What would you value the existing contracts at? What would you value the leads and relationships at? OR, if you were to buy a competitor what would matter to you and how would you value them?

Good luck.

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Postby alanyeap » Mon, 26 Sep 2005 1:30 pm

It's good to get out of IT business. The margin today is around 3%. The most are 5%. So it's very hard to survive.

After minus the rental, staff, utilities and some hidden cost, the net profit migt be around 1% to 3%.

$100k of business only gets you net profit of 1k to 3k. That is very low. Might as well park the money in bank or investment.

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Postby benjamin » Thu, 06 Oct 2005 2:13 am

Nimo wrote:Thanks Strong Eagle, do agreed with what you said. Look like the only way out is to look for my competitors, thanks again.


One quick question, do you have a product?
This should be able to increase your business' value.

No product, with your experience are you able to clobber one out before you sell?

Otherwise, I think you can market to IT freelancer or fresh IT grads looking out to start their own business. Sell your experience to them regarding maintenance of your customer's software. :)


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