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What does the business valuation look like? - view tip
What the buyer sees when pricing a company - view tip
What the lender may see when valuing a company? - view tip
Why use a 3rd party valuation? - view tip
#1 How to price your company - view tip
#2 Value perceived by potential buyers - view tip
#3 Why do a valuation if not selling - view tip
#4 Calculate an estimated company valuation - view tip

Valuation Tip #6

What the Buyer Sees When Pricing a Company

"Cash is King" In Any Valuation Parameter

The pricing point from the buyer's position is whether the cash flow from the business will justify the purchase price for the business.

The basic formula is as follows:

Pricing Formula:

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

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 & benefits
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 Asking Price: $550,000
Buyer Down Payment: (20%) $110K
Financing Terms: $440,000
8.0%
7-Yr Note
Market Value of Operating Assets $35,000
Estimated Return on Down Payment: 5.0%
   
Step 1:
Forecast Annual Cash Flow
$210,000
Step 2:
minus annual debt service
$82,295
Step 3:
minus 20% debt service cushion *
$16,459
Step 4:
minus owner salary & benefits
$90,000
Step 5:
minus market value of assets
$7,000
Step 6:
minus lost value on down payment
$5,500
Cash Flow Remaining $8,746

The asking price is justified in this example given the positive cash flow position after deducting financing cost, management salary, return on the initial investment, and capital expenditures.

*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 and would be an additional amount to cash flow.

Another Example
(increase the asking price by $100K):
Estimated Asking Price: $650,000
Buyer Down Payment: (20%) $130K
Financing Terms: $520,000
8.0%
7-Yr Note
Market Value of Operating Assets $35,000
Estimated Return on Down Payment: 5.0%
   
Step 1:
Forecast Annual Cash Flow
$210,000
Step 2:
minus annual debt service
$97,258
Step 3:
minus 20% debt service cushion *
$19,452
Step 4:
minus owner salary
$90,000
Step 5:
minus market value of assets
$7,000
Step 6:
minus lost value on down payment
$6,500
Cash Flow Remaining -$(10,210)

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

How much is your business worth? Contact us

Contact us

for a FREE consultation

Krayton M Davis
Executive Director, Novars Group, Inc
1-804-527-1103

or e-mail your inquiry to:
kdavis@novarsgroup.com

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