Valuing a business...how does THAT work? I've seen many interesting valuations here in Guanacaste Costa Rica, and back in the U.S. - but the basics are the same, yet, having said that, it can be a very complicated topic. There is a good deal of "art" that goes into business valuations, as well as some very basic "science". It really depends on the business type, condition, books, age, competition, etc.
It should be noted that businesses can be valued by Market Value - similar to a home or other real estate...that is,what is a buyer is willing to pay for it based on other sales of similar businesses (I would argue that even based on other sales, a valuation should be done based on the numbers, assets and potential return as a back-up of course...), or based on buyer and seller simply coming together in agreement under normal circumstances. This tends to be a rare form of valuation, here in Guanacaste especially, since we do not have a huge database of recent sales to compare to. Other methods that are more appropriate here are: Asset Valuation, and Income Approach, or a combination of the two.
But, let's cut to the heart of the matter for small to medium businesses, and go over the basic items sellers, and buyers, should be taking into account regarding business valuations.
Starting with the "science" (or math, really) portion of a basic valuation we generally see small to medium sized business valuation based on the following:
1. Profit or Owner's Benefit (basically, profit plus owner pay and fringe benefits)
2. FF&E (Furniture, Fixtures and Equipment - or the business' hard assets)
Businesses valued using the Income Approach are valued at a multiple of earnings, or in the case of small business, Owner's Benefit:
Example: A business that produces $50,000 per year in net profit (after Owner pay and other Owner benefits), plus pays the owner a salary of $25,000 on top and has an expense account used by the owner of another $10,000 (all of which would have gone to profit if not used) has an Owner's Benefit of $85,000. Based on the income alone, the business is worth a multiple of that amount. What is that multiple? This is where the "Art" comes in...more on that below.
Additionally, if the business has positive cash-flow and good assets (FF&E) these assets should be included in the valuation at fair market liquidation value (in small business the argument can be made to include assets at the value of equivalent replacement - not new, but equivalent condition used - more on this reasoning at the end.)
So for most of the typical small - medium businesses here (i.e. restaurants / bars, tour operations, stores, etc.) a valuation of a multiple of Owner's Benefit plus some asset value is appropriate.
The art of determining multiples and asset values is where things can get tricky. Does the business have good history? Is it in good standing in the marketplace? Does it have good presence / location / low competition. Does it have accurate and organized books? These and more factors make up the art of the multiple. We'll find most multiples of between 1 and 3 times profit or Owner's Benefit. Honestly, here, 3 is not the norm. We will normally see buyers looking for 2 to 2.5 times net earnings / benefits.
I think the easiest way to summarize the art portion of valuating a business, and the mix of earnings and assets that go into the pricing is the "bar to entry." Can someone else come into the marketplace and duplicate your business easily, or have you cornered the market? Is the entry very complicated and expensive based on permitting factors and other governmental or community conditions? Is your business one of many in the crowd, or THE one everyone talks about? These factors not only steer valuation, but are the very things buyers look at (or should look at) in determining what a fair value is to pay.
One last comment. What if the business makes little to no money, or even loses some money annually? In this case the business valuation will be dependent on asset value and "goodwill" (name brand / community standing,etc.), presence, location and the other factors making up its "bar to entry" - in many cases their is still some solid value in a company that is struggling to break through a profit barrier. Many times buyers want to enter a market and take over a struggling business to make their start-up less complicated.
Questions? Confused? That's ok - reach out to us and we'll chat about your specific situation. If you are buying, we'll help you determine what you should be looking for, and help with the all important "Art Factors" on any specific business you are considering.
Tony is the owner of Coastal Commercial Group LLC, Limitada, in Flamingo Costa Rica. Coastal Commercial Group specializes in Commercial Real Estate and Business Brokerage - helping businesses position and sell, and helping buyers buy businesses and investment properties, navigating through proper valuation, permitting and legal issues. Should you wish to have a chat about the commercial real estate / investment / business market in Guanacaste Costa Rica, reach out and contact Tony here. You can also find out more information at www.CommercialCR.com or CRBusinesses.com