valuating a business for buying

[beastmonkey]

I have recently been looking at buying an auction business, the owner wants £100,000, but I believe the profits are artificially inflated.

The company has made on average 50k profit for the past 3 years. However, the director only drew 12k salary last year and 20k the year before, as he has drawn a low salary, it make his profits look higher, which is good from his point of view of selling.

the advice I received on how to value the business was to add the director drawings to the profits, this year it was 46k profit plus 12k salary. so 58k.

then to decide what would be an industry norm for a manager of the business who wasn't risking anything to be employed, this I set at 40k plus 5k for tax, NI, (I am an auctioneer and I know that a general auctioneer and valuer earns between 25-35 in our area, so I don't think it too far out for the manager of the business to earn 40k) so that would leave 13k profit (58k-45k) also the business seller would keep the property and wants 24k a year rent, the company currently pays 20, therefore another 4K needs to come off.

This reduces the figure to 9k, so this is the premium I would receive each year for taking the risk, bank loan etc to buy the business, as opposed to a manager of a business who just works and runs it.

3 times the 9k is 27k, this is obviously far less than what the owner is looking for, but I think it is closer to where it needs to be.

the director will argue that the salary plus the profit is a good earning, but If at the end of a tax year you took all the money out, you would have no cash to start the next tax year. Therefore, I think the price is too high, any comments or thoughts appreciated.

[redcrx]

if you think its over valused then either walk away or chance your arm with a low offer.

[buildersmate]

In addition, you perhaps need to consider what assets you are getting in the business - mostly fixed assets, I guess - since I can't see there being much in the way of current assets. Both the (theoretical) book value and whether they are any use to you.
I'm not a 'business valuer' but your approach to this sounds about right to me.

[beastmonkey]

i put my offer in over the weekend and it wasas expected refused, the current owner has run the business sinnce 1984 so obviously feels he needs a good return for his years work.

as for assets, there aren't many. however, his fixed asset register is at 38k, this however has items such as wiring, and building work. which from a tax point of view are good as a write down, but in terms of buying the business they are classed as fixtures and fittings, as to remove them would destroy them and make them worthless.

i myself do alot of work for the insolvency industry so i'd like to think i have a good idea as to how a business ought to be valued, the owner obviously thinks differently.

[buildersmate]

As you know, as it nought to do with how long he's been in business and everything to do with future revenue streams and potential profits arising.
Agree with your point about assets - he shouldn't be depreciating buildings improvements over a long period on a leased property.
Unless you want the premises, it sounds like your interest is in paying for just the goodwill - since there is no 'intellectual capital' in the business to transfer.

[beastmonkey]

buildersmate, that is just what i was hoping to buy, but as the owner is being unrealistic, i have decided to walk away. I did get a moody email from him this morning, once i told him i was no longer interested, but I just replied saying I was only offering what my accountant thought was a true valuation.

the one thing the owner did do was underestimate me, i think he believed he would say a price and then we would negotiate a little bit, I don't think he realised that due to my work I have a strong network of contacts and friends working for some of the biggest accountany companies in the uk and the world, who advise on company purchase alot.

[Skyline D]

The valuation of a business is always a "how long is a piece of string" question. Generally, the negotiations can start at the fair balance sheet value of assets to be purchased (which should be the low end of it) and a multiple of the adjusted profits. That multiple tends to be five years rather than the three you appear to be using but at the end of the day it's up to you how long you are prepared to in effect wait to make your investment back.

I'd agree with the claculation adjustment you are doing on profits, though if you are actually intending to work the £40k management position yourself, which is how I read it, then you should bear in mind how much more than your current earnings that is because that's relevant. If you currently earn £30k and are going to earn £40k then there's an extra £10k to be brought into the calculation too.

Buildermate is wrong about the depreciation of improvements. It would indeed be normal to capitalise and depreciate such items, and indeed the Revenue would insist on it most likely. However, that doesn't mean you need to pay to take over such items. I would deduct them from the worth of the balance sheet since you will not take over those assets as they are integral to the building you don't own.

[buildersmate]

I didn't say it wasn't right to depreciate improvements - it's the depreciation period I commented on.
How long would you reckon over, then?

[tamborine]

Restaurants, takeaways deal in cash - not easy to track the value.

Valuation depends on type of business.

[Skyline D]

I'm maybe missing something somewhere but I don't think anyone mentioned a period to comment on did they? He just said they on the fixed asset register and being written down. It actually doesn't matter what period they are being written down over at the end of the day because it's a capital allowance position that matters, not the depreciation one (except insofar as the depreciation is suppressing the profits for calculation). It's unlikely these qualify for any capital allowances at all so they are probably irrelevant in the scheme of things and should be ignored for valuation purposes as I said previously.

For the sake of argument though, on an open ended lease, tennants improvements would normally be depreciated over about 25 years. If it's a short term lease with no security then a whole lot shorter period or perhaps charged directly to P&L in the first place. As the previous owned owns the building too I'd have thought it was perfectly correct for him to depreciate such items over the longer term. He's in no danger of being thrown out of it.

[cassa333]

Also is 24k reasonable rent?

It seems that you are buying the goodwill of the business and not tangible assets such as the building and service equipment (such as restaurant equipment).

Therefor, for me at least, is the goodwill worth what he is asking? Can you 'take the goodwill' and transplant it to other premises?

Could you infact just open up another auction house yourself anyway?

[beastmonkey]

cassa333 that is the next option, currently looking for suitable premises.