The Difference Between Price and Value

Determining what to pay for a business involves a host of factors, from overhead to customer loyalty. And don't forget the impact of a slowing economy

By Karen E. Klein

Q: I'm purchasing a Miami-based plant-care business that caters primarily to office buildings and restaurants. The owner is asking $30,000. How do I determine if that price is fair and how long it will take me to turn a profit?

---- C.K., Highland, Mich.

A: Determining the fair market value of a small, private company can be tricky, but when you're talking about a service business that's based out-of-state, it's going to be considerably more difficult. You ought to be cautious and investigate this company thoroughly. In fact, you'd be doing yourself a favor if you could hire a business broker or appraiser to do a professional calculation of the company's value. For more information on appraisals, check with the Institute of Business Appraisers and the American Society of Appraisers.

Before you make any commitments, gather as much information as you can about the company, via discussions with the current owner and examination of financial records. You -- or a professional you hire -- should comb the company's books and tax returns for the past several years, noting trends in cash flow, expenses, owner's compensation, and payroll.

Ask how the company was financed originally and what kind of debt it has accrued. Find out what kinds of assets it owns, such as property, vehicles, equipment, and inventory. Other things to ask: Does it have a location with a long-term lease? What are the accounts receivable? What's the customer base? Is the business struggling? Growing? Is there potential for expansion? If the bottom line is healthy, why is the owner selling?


  Unless you're planning to relocate, you have to ask yourself if you really have the time and means to operate the company from a remote location. Are you hoping to have the owner or a long-time manager stay on and run the day-to-day operations? If not, assessing a company's reputation in the community, strength of (claimed) customer loyalty, marketing penetration, and general goodwill is much more difficult for someone who is a long way away and unfamiliar with the local situation. Also, determining how much need there is for a service like this would be harder to do if one is not familiar with the potential customer base locally.

Intangible assets -- name recognition, credibility, long-term customers, vendor relationships, and overall goodwill -- are additional factors to consider when calculating a company's value. This is especially true in a service business, where tangible assets like equipment, property, and inventory are less important. How much of the company's goodwill is dependent on the current owner's personality and relationships? Will that goodwill evaporate when he or she moves out of the picture -- and will you be able to compensate?

Find out how profitable the company is now. Does the owner take a regular salary with benefits? Is he or she going to make money on the sale? Will you incur debt with the purchase? If so, what will be the terms for repayment?


  To figure the company's profit potential, you need to determine its breakeven point. Set up an "operations statistics summary" based on estimates from records. List all the annual expenses, such as insurance, interest on loans, and taxes. Then figure monthly expenses -- rent, telephone bills, payroll, etc. Add your total annual expenses to 12 times your monthly expenses. Then divide that figure by your gross profit margin (revenues minus cost of goods sold), which tells an entrepreneur what percentage of gross sales will be available to pay overhead and make a profit. There are standard gross margins for various industries that can be accessed by research. For instance, the grocery business typically has a slim 2% margin, while in some industries the margins run at 70% or more.

After exploring the financials, you should get a figure that shows how much business the company will have to do annually to break even. Income over that figure will be your profit. If, for example, your yearly expenses totaled $1,400 and your monthly expenses are $2,450, you'd have $30,800 total expenses. Divide that by your gross margin -- 42%, let's say, minus 5% sales expenses -- and you'll find you need to gross $83,243 in sales each year just to break even. Is this figure realistic? Does the company's revenue currently exceed that figure?

And don't forget to investigate the service industry in the Miami area. What's the market for the plant-care business? With the economy slowing, will your service be seen as expendable? Canceling your contract and having an employee take over plant trimming and watering might be an easy way for an office or restaurant manager to cut expenses.

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