The valuation of small businesses seems to be one of the topics preferred by the regular readers of my weekly column on the Observer. So today I am sharing what are in my opinion the top 5 valuation elements to keep in mind when considering the acquisition of a Small and Medium Enterprise.
Let us first clear the air by saying that these are my personal opinions, and I am in no way advocating following only these 5 rules of thumb for any investment.
Always seek professional advice before making an offer. Having said so, each of the items in the list below could deserve an article on its own. This is just a quick summary.
95 per cent of the world’s small businesses are turning over less than $1million a year. So, looking for valuation criteria certainly differs from case to case. Profit is the best indicator to start with. If the company is not in a loss, then risk is reduced, so it might be worth considering an acquisition and move to the second criteria.
Owning a business might come with assets such as machineries, software or even properties. In this case, the valuation is quite straight forward, as physical assets are relatively easy to valuate by comparison. Just a note of caution, make sure that the assets are entirely owned by the company, not by the owner of the company, so that they stay with the company as you buy it.
Often small businesses are owned and operated by the same person. If that is the case, and you are planning to buy one of such businesses, then the acquisition can be referred to as “Buying a job”. Once you own the company, you will be the one operating it. In this situation, it is very important that you assess the salary that the owner paid to himself or herself. Many small business owners do not compute their own salary from the beginning, and they do not even establish this healthy practice later.
They mix profit with salary, which is not recommended. Having a clear cut between what profit belongs to the company as an entity and the amount of money paid monthly to the owner as salary is essential for clarity when attempting to assign a price tag to a small business.
This could be a double edge sword. When purchasing a business that sells good, one must keep in mind that very few goods in this world appreciate value over time. In most cases, the value will drop soon or later. Consumable products have expiry dates and electronics become obsolete. So before “jumping” at a bulk deal based on the discounted market price, one should consider offering a devaluated stock price.
5) SOCIAL MEDIA
I would have not included this in any business valuation 10 years ago, but it is apparent now that digital followers have become an asset. Let us imagine a business with 10,000 total cumulative social media followers. This could be a great starting point for introducing new products once the business is taken over.
Starting social media from scratch is slow and expensive, so a quick start could be worth paying the price to save time.
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