Buying a Small Business

Capitalization Rates

There are various valuation methods that can be used as a basis for negotiation when it comes to selling a business and/or issuing new shares to be made available to someone buying into a small business. Capitalized income is one method valuation experts use to value businesses. Arriving at a capitalization rate represents one difficulty with this method of valuation for private companies. A capitalization rate effectively places a multiple on cash flow to calculate value. This is similar to price earnings ratios for publicly traded. The difference is that information for latter can be found in the financial publications and media.

Cash Flow

Buying into a small business that is privately held requires devising not only a capitalization rate but also discounts for marketability (liquidity) and lack of control (minority). For example, regarding the former, shares in public companies can be sold in 3 days making them more attractive to investors so investors will offer a premium for that liquidity. For privately held businesses, a market multiple of cash flow is also used when available in valuation databases. Once all these factors are determined, a cash flow metric such as EBITDA (earnings before interest, tax, depreciation and amortization) needs to be estimated for a company in say Atlanta, GA or Sandy Springs, GA.

Assets

Another method of value - although not used as often - when buying into a small business in Atlanta or any where else is the Asset Based valuation method. This is most appropriate for businesses that have a significant amount of tangible assets like property, equipment, real estate, etc. Manufacturing is a good example. The drawback of this method is it does take into account future earnings or intangible assets not found on the balance sheet. Its focus is on the market values of tangible assets less the market value of liabilities.

Other factors

When buying into a small business or selling a business in Atlanta, there are a number of important factors to be considered. For example, growth, market conditions, risks, and how a business is adapting to these are important. External factors like the state of the economy, market returns, competition, customer concentration, etc. must also be considered.
As mentioned earlier, value determinations may also need to consider the effect of intangible assets that may not appear on a balance sheet. Strength of a brand, goodwill, intellectual property, licenses, key people, customer relationships, etc. are all drivers of cash flow that may exceed the cash flow just generated from tangible assets (i.e., excess cash flow).

Not an exact science

When buying into a small business, it’s important to remember valuing a business is not an exact science. Any value established will, more often than not, be open for negotiation with more than one method used in the process. A fully documented and justified business value is paramount to getting the deal accomplished and at a fair price.