SELF EMPLOYMENT SAVVY: Katherine Arno

What's a business worth?

Copyright © 2005 Blethen Maine Newspapers Inc.

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More Information "Preparing the Business for Sale" is prepared by BizHelp24, a business and finance information, news, help and services for small businesses Small Business Development Center< Handbook of Business Valuation by Thomas L. West and Jeffrey D. Jones (IBSN 0-471-53755-1) The 2005Business Reference Guide by Thomas L. West Strategies for Successfully Buying or Selling a Business by Russell Brown To top of story

Changes at National Semiconductor left John Littlefield, a managing engineer there for 25 years, without a job. Unable to find a similar position in Maine, Littlefield decided to launch a new career as a Maine business owner. In addition to finding the right business to buy, Littlefield also had to figure out how much to pay for a business — in other words, "What's a business worth?"

After six months, Littlefield found the Thompson Lake Marina in Casco, offering boat slips, rentals, a wide array of services and general supplies at a picturesque waterfront setting. The business broker who showed him the property said that, while it was common for many businesses to sell at a price equal to two to three times its annual gross receipts, marinas sold at a price some where between nine and 15 times the annual gross receipts. "Is that a reasonable asking price?" wondered Littlefield.

"Figuring out the value of a business is not an easy thing," says Brian Burwell, a Maine Small Business Development Center certified business counselor who helped Littlefield evaluate the marina's price and potential.

According to Burwell, the business broker was using a "rule of thumb" valuation, which should be considered a general starting point. "Rules of thumb are very subjective," Burwell says. In this case, the value of a business is derived by multiplying a figure (or percentage) and a key operating factor of the business. For example, the broker talked to Littlefield about the marina selling at nine to 15 times (a figure) of the annual gross receipts (a key operating factor).

"You also need to look at the value of the business' assets," says Burwell. In this case, a figure is established by adding together the value of all fixed assets including buildings, land, and equipment; some leasehold improvements, inventory, and intangible assets such as trademarks and patents.

"Sometimes, in effect, clients are buying an income," says Burwell of their decision to purchase a business. In this case, an "owner benefit valuation" is most important. For the buyer, it may be as simple as checking to see that the business can generate the desired. For the seller, the sale price is derived by adding together not only the owner's salary, but also profits and nonessential expenses and then either doubling or tripling that number. This value represents the business' ability to generate cash-flow and profits.

A more difficult practice is to price out similar businesses in the area, using the actual selling price versus the original asking price. "This is often hard to do," says Burwell, "because people don't want to disclose that information." He notes, however, that rule of thumb figures come from "comparables" that are obtained and studied on a national level.

Burwell helped Littlefield look primarily at business assets, strength in the marketplace, cash flow and profits based not only on the marina's current services but also on the expanded services Littlefield planned to offer. Littlefield had access to four years of financial records from the current owner, which gave him an excellent starting point. However, because the price of lakefront property had recently appreciated so much, Littlefield's expenses — including a mortgage - were going to look much different than the original owner's.

Once he knew what he needed in order to cover the cost of financing the purchase and to make a reasonable living, Littlefield knew what the business would need to generate. That would be the "benefit" in the cost/benefit computations he would do based on the asking price. Eventually, during a walk around the property, the current owner cited a price at which he would be willing to let the property go "today." Littlefield moved quickly and his offer was accepted.

How risky the business is and whether it is part of a growing sector are examples of other considerations that affect price. For some experts, starting with the operating environment versus the numbers is important. Important elements of the operating environment include information on industry trends, customers, suppliers, local economy, barriers to entry, markets, competition, key employees and products.

In terms of business environment, as the only marina on Thompson Lake grandfathered as a nonconforming use, Littlefield's prospect seemed to have the market cornered. Customers were loyal and the seller, who agreed to stay on to help Littlefield learn the business, "knew everyone on the lake as well as what their dog's favorite food was; he is a real people person."

Still, with increased waterfront property costs, Littlefield would need to add revenues to the existing business to yield an adequate return on his time and investment. He saw an opportunity to add food, not offered by the current owner and available no place else on the lake. This potential, coupled with the current owner's availability to help, were also factors that affected the price Littlefield was willing to pay.

Computing the value of a business becomes especially important to sellers, buyers, and business owners seeking equity financing or bringing on partners. "Ultimately it comes down to what someone is willing to pay," says Burwell, who works at the Maine SBDC center at the University of Southern Maine in Portland. "Even a business that is losing money might be attractive to a buyer," he says, "if that market is one the buyer wants to get into."

Katherine Arno is the Director of Training and Communications for the Maine Small Business Development Centers (www.mainesbdc.org) in its Portland center at the University of Southern Maine. Kate owned her own small business in Maine for eight years. Today, aside from working with small business issues at Maine SBDC, she helps her husband with the small business that he has owned in Freeport for 12 years. She can be reached at Karno@maine.edu.