Buyer Cash Flow / SA
On-Line Newsletter
Nov 1999

brought to you by Business Resource Associates, Scottsdale, AZ

This newsletter brings to interested business brokers, financial intermediaries, buyers and sellers important updates, news items, user comments and suggested deal structures for actual businesses for sale. Please feel free to send us comments and questions of a general nature and concern for all users of BCF/SA.

What is the value of a business?
What about assets?
Case study #1: Sales/repair equipment
Case study #2: Computer software.

Email: Business Resource Associates
WEB SITE: (http://starman.com/business)

What is the value of a business?

While there are several accepted methods used in valuing a business, we follow the general theory of the value of a business, as defined by a leading pracitioner, S. Pratt in this book, Valuing a Business:

"In the simplest sense, the theory surrounding the value of an interest in a business
depends on the future benefits that will accrue to the owner of it".

BCF/SA has been designed to add flexiblity to the cash flow scenarios offered by several business valuation software programs. Using the value obtained by such a program, or the price given and required by your seller, our approach looks to see if the deal makes sense. Does the seller get an acceptable price? But, if the buyer can't make a decent living then the deal doesn't make sense and there's a high probability that the business is re-sold, or closes, or somebody gets sued.

As a broker, isn't this the real reason to perform a valuation for a business sale? To find a realistic price so you can advise the seller accordingly and to decide whether or not you want the listing? In short, it's TO MAKE MONEY FOR YOURSELF, RIGHT? And as a seller, to explore what price can reasonably expected from a sale? And as a buyer, to explore what price to pay for the business?

We see the value of a business not as some intrinsic value somehow attached to a thing called a business like the appraisal value of a house. We see the value as the price paid by a buyer to a seller, each of whom is not acting under duress. The buyer wants cash flow to him either as a dollar amount or a percentage return. The seller wants the best possible price under this requirement of cash flow. And this view will usually alter the value, as determined by the valuation programs, to the price actually paid by a seller.

In short, we look at the cash flows generated by the business. In the words of Alfred Rappaport in his book Creating Shareholder Value,

"A well-conceived evaluation program that minmizes the risk of buying an economically unattractive company or paying too much for an attactive one is particularly important in today's seller's market."

 

Your cash flow approach is great, but what about a business with substantial assets?
How do we use BCF/SA in these cases?

In these instances you should look to remove the cash flow from the assets from the cash flow generated by the business. This breaks the cash flow into 2 components:

Shouldn't we give some value to the return on assets? After all, the buyer can put that money into a mutual fund, for example, and get a 10% return. In our analysis we should remove this portion of the cash flow -- 10% of the asset value -- and look at the what business generates in excess of investing elsewhere. This is one reason for buying a business rather than a mutual fund -- the excess cash.

This excess cash can then be used in the BCF/SA program to see how 'good' a business it really is. For example, if the 10% return reduces the cash flow to 25% of the actual cash flow, the buyer may have a concern. The amount of cash for buying a business instead of some other asset has been greatly reduced in this example and maybe the incentive to buy the business is lost.

No research was performed on the effect of substantial assets since that information was not available.

case #1 sales/repair equipment

Initial Listing Data

Adjusted Data
Price $175k Price $200k
Down $75k Down $75k
ADJ CASH FLOW $81k ADJ CASH FLOW $81k
Gross sales $206k Gross sales $206k
COG $94k COG $94k
Expenses $31k Expenses $31k
Adustments 0k Adustments 0k
BUYER IRR 75% BUYER IRR 75%
P / E 2.2 P / E 2.5
b(uyer)-val $105k b(uyer)-val $107k

In this case we decided to classify the business as "service" rather than as "distribution", although it is a Rep for some lines. As a service business, it is priced very well -- a 75% IRR as compared to an expected 77% for a distribution business. However, for above P/E of 2.2 the return should be only 60% (because it is priced low), yet the buyer is getting a 75% IRR, well above the expected return. And, we can get another $25,000 for the seller if he is willing to go from 5 - 7 years at 10% and still be within the "guidelines" of a deal.

As a 'distribution" business (not shown) we could get $225,000 for a nice improvement of $50,000 to the seller! For a distribution business the buyer is still getting a very good deal at a 57% IRR and for a P/E value of 2.8, an outstanding return.

case #2 computer software

Initial Listing Data

Adjusted Data
Price $360k Price $350k
Down $360k Down $150k
ADJ CASH FLOW $159k ADJ CASH FLOW $159k
Gross sales $240k Gross sales $423k
COG $137k COG $137k
Expenses $125k Expenses $125k
Adustments 0k Adustments 0k
BUYER IRR 38% BUYER IRR 77%
P / E 2.3 P / E 2.2
b(uyer)-val $295k b(uyer)-val $274k

In this instance of an "all-cash" listing, the listing Buyer IRR is at 38% with a P/E of 2.3. The P/E for this categeory is 1.8 with an IRR of 77%, much higher than the buyer 38% is getting. Can we do better for the buyer? YES! Simply reducing the price bit and offering terms with $150k down (6 years at 10%) the buyer is "put into play" with an acceptqble 77% IRR. And, the seller is getting a P/E of 2.2 which is higher than the historical 1.8 P/E.

"Innovative software solutions"
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602-996-3007/ 602-788-1922 (fax) / starman@starman.com