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:
	Take the: company's discretionary cash flow use a 3-year or 5-year weighted average: see calculations

	Reduce this by: Annual debt service this will include the principal and interest payments for financing the purchase price of the business less the down payment Owner or manager annual salary the market rate for managing the business either as the owner or through a hired manager Capital Expenditures the amount that must be paid to maintain, service, and replace business equipment and other fixed assets. A good benchmark is to replace all operating assets within five years. Take the market value of the operating assets and divide by 5 Return on Down Payment the investment return on the down payment

	Equals: Remaining Cash Flow this amount needs to be positive to justify the asking price.

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.