How Others Perceive Value
Price is Derived at What the Buyer Will Pay
The pricing point from the buyer's position is whether the cash flow from the business will justify the purchase price for the business.
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Company Valuation Using Cash-Asset Position
Use this simple but non-substantiated business valuation formula to value and price your business:
Measuring Cash: |
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Take the: company's discretionary cash flow |
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Reduce this by: Annual debt service Owner or manager annual salary Capital Expenditures Return on Down Payment |
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Equals: Remaining Cash Flow |
Example:
Estimated Sale Price: | $450,000 |
Buyer Down Payment @ 33%: | $150,000 |
Business Financing @ 67%: | $300,000 10.0% 7-Yr Note |
Market Value of Operating Assets: | $50,000 |
Estimated Return on Down Payment: | 5.0% |
Annual Sustainable Cash Flow: | $175,000 |
Less: Debt Service | $59,764 |
Less: Debt Service Cushion @20% | $11,953 |
Less: Annual Capital Expenditures | $5,000 |
Less: Return on Down Payment | $7,500 |
Less: Owner's Salary | $80,000 |
Cash Flow Coverage: | $10,783 |
The example shows that my "down-payment" and "sweat equity" will generate a positive cash position after paying financing costs and deducting a cash salary.
*Note: Standard cushion required by lenders when underwriting this loan. This amount covers the cost of financing in the event of economic or market turndown. The amount is not an expense and would be an additional amount to cash flow.
Another Example:
(increasing the asking price by $100K)
Estimated Sale Price: | $650,000 |
Buyer Down Payment @ 33%: | $130,000 |
Business Financing @ 67%: | $520,000 8.0% 7-Yr Note |
Market Value of Operating Assets: | $35,000 |
Estimated Return on Down Payment: | 5.0% |
Annual Sustainable Cash Flow: | $210,000 |
Less: Debt Service | $97,258 |
Less: Debt Service Cushion @20% | $19,452 |
Less: Annual Capital Expenditures | $7,000 |
Less: Return on Down Payment | $6,500 |
Less: Owner's Salary | $80,000 |
Cash Flow Coverage: | $(210) |
By increasing the asking price another $100K with everything remaining equal, the cash flow position from the buyer's perspective is negative and does not support the asking price, unless the buyer is willing to cut his or her salary.
*Note: Standard cushion required by lenders when underwriting this loan. This amount covers the cost of financing in the event of economic or market turn-down. The amount is not an expense
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What the Lender May See
The lender is interested in two things:
- Does the historical cash flow (and projected cash flow) cover the cost of financing with a 20-25% cushion in the event of economic or market turn-down?
- If in the event of a default, can the bank recover the financing by selling the company assets?
If the answer is "no" to question 1, the lender will not finance the deal.
If the answer is "no" to question 2, the lender may finance the deal if you (via the buyer) can demonstrate that the business is a growing entity that support increasing cash flow.
- Lenders assume a lot of risk when financing business purchases. Their only security in the event of default is the operating and fixed assets.
- Lenders will not lend on goodwill and brand equity only. They are looking for a business that has been managed well, has a management plan in place to grow the business, and has a history of financials that support the projected earnings expected.
Helpful Tools
Some helpful forms business owners:
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