While we’re on the subject, here is some good advice on valuing (and, improving the value of) you business from a business broker …

… if you like the info, here are the next three videos in the series:

http://www.youtube.com/watch?v=pbIbNZ-mHpA&feature=related

http://www.youtube.com/watch?v=4iwSIlo8VDA&feature=related

http://www.youtube.com/watch?v=XfKFvMUmc8c&feature=related

That’s it!

BTW: The last video is the only one that really answers the question about how to value a business 🙂

Last week I told you about a reader who thought that he wanted to sell his business, but pretty quickly realized (after a bit of prodding from me) that he was really selling a product as he had not made any sales as yet.

So, this week, I wanted to cover the basic ‘street smart valuation’ methods for selling (or, part-selling) various types of businesses:

1. Professional Practices

These types of businesses (e.g. accountants, finance/insurance/stock brokers, doctors, attorneys, etc.) generally are the easiest to value as their sale price is usually governed by industry-standard formulas, often based on some multiple of fees rather than profits.

So, an insurance broker may sell for, say 2 x annual fees/commissions.

The easiest way to find out how to value your professional practice is to buddy up to a few of your peers and see what experience they have and to ask your industry association. It is also useful to see if your accountant (or another) has experience with any of their clients who may have bought/sold practices in your specialty.

2. Small businesses

Most other sole practitioner and/or small businesses sell for a multiple of their profit (per their most recent income tax returns); typically the business is bought/sold for a multiple of 3 – 5 times after-tax profits, but the range can vary widely.

Brad Sugars claims that his opening (and usually closing!) bid is zero … but, he may take the over the business’ leases (premises and/or equipment); since most small businesses lose money – barely paying their owners a ‘salary’ – this can be a surprisingly good deal!

Of course, if a large company (preferably one listed on a stock exchange) wants to acquire you – and, you can demonstrate a history of good profits – you may be able to negotiate a larger multiple … perhaps heading in the direction of the multiple that the public company itself is getting on the stock exchange (you can find a company’s P/E ratio on any good finance web-site).

Somewhere around 7 to 10 times after tax profits would be considered outstanding.

3. Venture Capital Ready

Let’s say that you have a small business and feel ready to take it to the next level, but you need some additional cash, effectively by selling them part of your business (i.e. trading some of their cash for a lot of your equity) … after watching Shark Tank you feel that you are ready to negotiate with some venture capitalists. What will they pay for a share of your business?

Well, you really need to know what sort of return they expect on their money:

If a company does have the qualities venture capitalists seek including a solid business plan, a good management team, investment and passion from the founders, a good potential to exit the investment before the end of their funding cycle, and target minimum returns in excess of 40% per year, it will find it easier to raise venture capital.

Think about it; a venture capitalist may invest in 10 businesses and lose their money on 7 of them, break even on 2, and rely on your business to make up for the other 9 duds 😉

If they could make (say) just 4% on their money just by letting it sit in the bank, then surely they’re going to need at least 10 times that return if they give it to you on a 10-to-1 failure:success ratio, aren’t they?

Now, 40% returns means that if they give you $1 million, they will expect to be able to get out in 5 years and walk away with well over $5.25 million!

So, here (in simple terms) is how they will make their offer to you (if you are still in self-delusional mode and think that you will be making the offer to them, watch some more Shark Tank!?):

1. Assess how much investment they will need to make in order to meet the growth needs of your business (this WON’T include giving you a pay-rise or any cash in your pocket … at least, not until THEY cash out first),

2. Decide how long they are prepared to wait to realize their investment (i.e. take their cash out by selling or IPO’ing the company)

3. Calculate the % and $ return they would need (in our example, this is the $5.25+ million that I mentioned above)

4. Assess what sale price the business is likely to get

5. Divide 3. into 4. and this is what minimum % of your company they will expect to get for their investment (in our example, this is $1 mill.)

So, if they think you have a $10 mill. business on your hands, they will want at least 53% of the company for their $1 mill. investment …

… and, I assure you, you will only get the $1 mill. if you are already doing really well 🙂

Like you, I receive a lot of spam … fortunately Google’s g-mail picks most of it up and automatically dumps it into the ‘trash’ folder for me.

Most of the spam that I receive is of the “congratulations you have won the Dutch lottery” or the “Mr Nagambi, a senior official in the Uganda government needs your help” varieties. It seems that most spammers are happy with my current vitality and physical dimensions 😉

The problem is, this kind of spam receives no attention, because it takes more than it gives: “give me your credit card number and I will give you some purple tablets” [AJC: either that, or steal your money … spam ‘n scam!].

Good marketing, whilst often bordering on spam (be very careful not to cross the line, though!) gives in order to get: this could be free products (i.e. give me your e-mail address and I will send you my free report … followed by 7 carefully worded and timed sales letters), or simply some free information, like this unsolicited e-mail that I recently received:

Hi Adrian,

Only 43% of consumers will cut back on holiday spending this year, compared to 55% in 2008, according to a Consumer Federation of America survey. While increased consumer optimism spells good news for retailers, for Americans planning to “stretch” the budget, the New Year could bring falling credit scores, and with it, serious consequences.

Here are some fail-safe tips from FICO Credit Guru Shon Dellinger to help enthusiastic shoppers stay financially sound:

1. Be Smart with Credit. Using a credit card is ok – experts agree having 3-5 credit cards helps your credit, if used responsibly. But carrying a balance on your credit card leaves you (1) stuck paying interest that could cost you, in some cases, double or triple the cost of those gifts in the long run and (2) with a much lower credit score, which could jack up interest rates on your credit cards and jeopardize your chance of getting lines of credit elsewhere (buying a house, a car, etc.). Services like FICO Score Watch combat this by providing emails or texts alerting you to any changes in your FICO score (either positive or negative), and notifying you when you’ve qualified for a better interest rate. A credit score increase of 30 points will save the average consumer $105 per year.

For more information on FICO Score Watch, go to: www.myfico.com/Products/ScoreWatch/Description.aspx.

2. Resist “Short Savings.” The salesperson at your favorite department store offers you an instant 20% savings just for opening up a credit card in their name. While that $20 seems tempting at the time, it can quickly put you in debt if you’re not careful. The temptation of the deal is also one reason why the average consumer has a total of 13 credit cards. Opening new lines of credit can also hurt your credit score, so make sure the card meets your overall needs and not just your desire for quick savings.

3. Don’t Wait Till April! Many holiday shoppers use their Tax refund to pay off credit card balances left over from the holidays, which can be incredibly expensive, not to mention detrimental to your credit standing. A credit card balance of $500 dollars from January until April will cost you $237 dollars based on today’s average credit card interest rate.

Please let me know if you are interested in speaking with FICO credit guru Shon Dellinger about these credit saving holiday tips and what else consumers can do this year to assure that their 2011 New Year’s resolution isn’t fixing the damage they did to their credit in 2010. Also, the myFICO Forums can offer your readers helpful tips.

Cheers,

Ashley Kleinstein

Access PR for FICO

Now, I didn’t mind receiving this e-mail because it seems to offer useful information and isn’t directly asking for a sale, although I only gave it a cursory scan because my FICO score is just fine [AJC: and, thank you very much for asking 🙂 ].

Also, I know why this was sent to me: since it was sent under a PR agency’s moniker and I am a blogger, I surmise that they are really hoping that I (or the other personal finance ‘media’ people out there) will publish their content as an article [AJC: as I have ‘cleverly’ done here …. for all you new and aspiring bloggers out there, see how I just lifted some random content and made a post out of it? 😛 ]

What do you think? Is this an automatic delete? If you are not vehemently opposed to it, how would you improve the e-mail?

[Hint: I would present it as a free sample of an online newsletter and ‘click here if you would like to continue receiving it monthly …. usual price $79 for a year’s subscription, but free to you and no credit card required!’ to make it seem valuable]