Hi, I've been working for a man who wants to retire. He's been a friend of mine for many years but he's also a hard-headed businessman. We are in early negotiations in finding a mutually beneficial way for me to take over the business. He is playing things very close to the chest and I'm only getting the minimum of the necessary information from him at this stage. I'm just a working man with a family and the usual mortgage, so I can't afford to take any big risks.
Please can anyone tell me, is there an established procedure where I can employ some kind of expert who would have access to the accounts and other details of the business? Is there a way of getting this sort of work done that would not land me with a big bill if the business, or terms offered, turned out to be non-viable?
If you give some clues about the business then we may be able to help. What kind of business is it? Does it have premises? Does it have a list of clients worth buying or if you already do the job can you just do it yourself when your boss retires. Would you have to buy anything vis a vie if people are dealing with you anyway would they still deal with you after the retirement etc etc. Eric
It sounds like you need a formal valuation done. There are 4 broad ways of valuing a business:-
- replacement cost of the assets
- comparable transactions (i.e. sales of similar businesses)
- stock market cap if applicable, and
- net present value of future earnings.
Within which there are of course numerous sub-categories.
Accurate valuations are not easy and become more complex the larger the enterprise. Usually, if a business is for sale, the seller will make this sort of information available to potential buyers, who then do their own 'due diligence', i.e. they examine the business' assets, prospects, competitive position, potential synergies with their own business etc, and come up with a number for what the business is worth to them.
In the above list of 4 ways of doing things, the last is the one that is usually most reliable, although it's not really feasible to generalise. If the NPV suggests one value, but you could replace the entire business lock stock and barrel for half that figure, that will obviously set an upper limit on what you would reasonably pay.
Say the business is a hot dog stand. Buying a second hand hot dog stand might cost 500 but the net present value of the future cashflows might be
1,000. That tells you that the business is basically profitable, but also that you would be better off buying a second hand one, because it will give you cashflows worth 1,000 while costing you only half of that to set it up.
What you might then find is that good hot dog stand locations are tough to find, and that comparable transactions reflect this, showing values in a range of 200 to 1,500. You definitely don't want to pay 1,000 for one in a poor site, so your due diligence would focus on establishing whether this one is in the right site.
You also need to establish whether the fact of a sale will alter the business' value - for instance, if you were valuing a business which was heavily dependent on the skills of the retiring owner, then this will clearly affect its value. If you're buying Ron's Car Repairs, and Ron's retiring, the valuation basis would probably be the assets, because Ron *is* the business and if he goes away so do the cashflows.
You could maybe try a local firm of accountants and see if you can find one with expertise in this area. The company's own accountants won't do it as they will be conflicted but someone else might be able to help.
It has a considerable turnover. Not the sort of business where individual clients would return often, once their needs are provided for.
I already do the job. It's dependent on several outside services though.
Once peoples requirements are fulfilled, they may return later with a similar need but not on a regualr basis. The business doesn't function on a friendly personal level, so the customers wouldn't miss the boss.
Thanks very much for all the useful information. I'll work my way through all the points you raise. I'm sure they're going to be a big help. Regards, Mike
He is a friend who wants you to take over the business, yet he wont give you access to all of the information you want/need?
I would be initially suspicious, and may suggest that I would love to proceed further, but couldnt unless I got the information I needed to make an appraisal.
Why do you think he is being secretive?
Is there anyone else who is in the frame to buy it?
How much could we be talking about as your initial investment, (purchase price)? And what is the potential downside?
If you have been working in the business for many years, and are considering buying it - cant you put together a P/L forecast, and a cashflow appraisal?
In the sense that the others are either instantaneous or backward-looking methods, whereas the NPV approach requires you to think about the business' likely revenues and the threats and opportunities it faces. In theory this is also true of stock market cap, except that stock prices are driven by trend and sentiment as much as genuine value.
One of his desired possible options is to remain as a remote but contolling influence, with an as yet unspecified share of the profits. He knows it's an outside chance under the circumstances but he hasn't given up on it yet.
Considering the alternative possibilities I'd say that he would want me to succeed but if I had to work harder and make less by optimising his gains from the deal, that would be his preference.
This will almost inevitably happen. I want to know how to make the most of it when it does. If I can get he right advice at the right time it will reduce the chances of me making a costly mistake.
I think he's being cagey to keep his options open. If he's anything like most business people he's going to go for the best deal he can get.
It's a thriving business with a lot of potential. As his retirement gets nearer, more people will become aware of the opportunity and there will be some interest from other quarters.
This is why I'm looking for professional advice. I'm prepared to raise whatever loan is within my reach if it can be shown to be economically viable to do so.
Given the appropriate information and advice I would be glad to do this asap.
but at least they are based on the future rather than the past. The past has gone and is of no value other than as a source of data for forward projections.
The future is unknown. The past is known. How can the unknown usually be more reliable than the known?
"Phil Thompson" wrote
Suppose you had "30,000 worth" of premium bonds.
Which of the following is more reliable:- (1) Value the bonds at present/past levels, ie 30,000 exactly. (2) Value the bonds using future (unknown) cashflows....
Just one example which, I think, shows that NPV of future assumed cashflows isn't necessarily the most reliable method!
the past is the past and has gone. Reliably knowing what is in your rear view mirror does not stop you driving into the stationary HGV around the next bend.
So a sensible approach would be to look at the historical data as part of formulating a future projection, then value the future projection. Unless by some miracle the furture projection is identical to the past history it would be mor einformative, despite its inherent error.
I think you are confusing reliability in the sense of what is known accurately (eg certainty) with usefulness in terms of valuing a business. The value of premium bonds must be greater than their face value due to the small probability of making a future prize win, which is why people hold them (otherwise they would just keep the cash). This would be reflected in a NPV analysis.
The historical value of retailing handguns in the UK would be of little help in valuing a gunshop as they have been banned - so "past performance is no guide to the future".
Similarly, looking forwards out of the windscreen doesn't help either, because the HGV is out-of-sight (around the next bend).
It is very difficult to predict in advance when there *is* going to be a stationary HGV around the next bend, and when there isn't. But you can say with certainty whether there *was* a stationary HGV around any previous bend which you have driven around!
"Phil Thompson" wrote
Hmmm. It is exactly that "inherent error" that makes the future inherently un-reliable!
"Phil Thompson" wrote
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... defines reliable as "Something or someone that is reliable can be trusted or believed because they work or behave well in the way you expect". I'm pretty sure that the future doesn't always behave in the way anyone expects, but that the past has already shown how it behaves - and so should be expected exactly in that way.
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... defines reliable as "able to be relied on". Again, I'd suggest that the future cannot (reliably!) be relied on, yet the past can (since it is already known).
"Phil Thompson" wrote
Rubbish. No one is likely to pay you more than 1,000 for 1,000 face-value of premium bonds, as they could simply buy them from NS&I instead for just face-value!
"Phil Thompson" wrote
I'd like to see how! - Can you show us?
"Phil Thompson" wrote
That just shows that the immediate past ("no" gun sales) is a remarkably reliable guide to the (immediate) future!
There are many ways of valuing a business, depending on the type and size of it.
Suggest you approach an accountant and/or a business valuation agency such as Pinders.
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The price you pay will include an agreed value for fixed assets (premises, vehicles, equipment, fixtures & fittings, coffe cups, PCs etc.,), a price for Stock (if it is a business that holds stock) and (this is the hard bit) a price for the 'goodwill', i.e. the business name etc.,
If you look at the price earnings ratio of a PLC then the goodwill could be worth 15 years net profits, but at the other extreme a shop would likely be worth one to one and half times the adjusted net profit. By 'adjusted' (I mean that you look at the latest profit and loss account and adjust it for things that are peculiar to the current owner, i.e. cost of borrowings, current owners salary (if it is a LtdCo) etc.,
The multiplier of 1 - 1.5 is an arbitrary figure and when agreed should reflect the risk of the business and its ability to continue trading with you running it. This is the closest I would get to the Net Present Value argument in the other replies as that argument takes no account of risk, although that would be reflected by the discount rate applied.
If the vendor is reluctant to show you anything then run away as quickly and as far as you can. You must expect his full agreement to your appointed agents conducting a 'due diligence' exercise.
Also approach a commercial solicitor so that he can advise you on the contract, you dont want to buy a business that is going belly up without recourse to the vendor or buy it and the vendor set up again next door in direct competition.
What type of business is it?
One final thing, running a business and working in a business are two very very different scenarios, even if you are doing the same job. It isnt for everybody.
I have read this after sending my other response, so please excuse me barging into Eric's thread.
This business hasnt got a client base and I reckon its assets are just some PCs and stuff, so the main question is what are you buying?.
You could just resign and set up in the same business yourself, but that wouldnt be very gentlemanly.
I would be reluctant to pay the vendor a lump sum. Instead, why not agree to pay him a percentage of turnover or net profit over a period of time. You could afford to pay him more that way but it would be safer for you.
Referring to the goodwill multiplier mentioned in my other post, I would suggest offering a a multiplier towards the lower end of the scale, certainly no more than 1.
not as you round the bend it isn't. Equally if it were straight ahead and visible on a motorway being transfixed by the rear view mirror would be fatal.
an expensive QC told me that when one reaches for the dictionary one has clearly run out of real arguments :-)
If your just an a semantic kick about the word "reliable" then I can't be arsed.
however what if NS&I stopped selling them but still ran the prize draw and would honour them at face value. In the OP's case there is not an alternative supply at a fixed price.
in each year going forward put the average winnings per premium bond in then discount them back to today ?
depends on the point in time. Had one done this just before the Dunblane shoting for example. A forward projection may have included an estimate of the risk of guns being banned, a historical analysis would have no such element.
The answer is all in the discount rate used, though. And there is no *one* "true" answer.
For instance, if you use the *NS&I* premium bond "interest rate" for the discount rate, with *average* winnings, you should get a NPV *equal* to the face value of the PBs.
Alternatively, if you require a higher return than this from your investments, and therefore use a higher risk discount rate, then you'd get a NPV *LOWER* than face value.
In other words, your comment that "The value of premium bonds must be greater than their face value ... This would be reflected in a NPV analysis" translates to "In a NPV analysis, you *must* use a risk discount rate *less* than NS&I interest rate".
I'd suggest that's not true. Moreover, in fact (I believe) it is quite likely that you'd want to use a discount rate *higher* than the current NS&I rate of 3.25%.
This can be seen by noticing that someone currently holding premium bonds, and able to get more than 3.25%pa (after any tax) elsewhere, might think it worthwhile to cash-in the PBs and invest the proceeds somewhere else.
Unfortunately, the future behaves more like a rounded bend than a straight road - it's generally unlikely to have a crystal ball which shows the future in the same way as a windscreen shows what's happening ahead of the driver!
"Phil Thompson" wrote
Well, unless both sides of the argument are using the words to mean the same thing, there isn't any point in arguing at all - you each might as well be talking in different languages (with each not knowing the other's language!).
"Phil Thompson" wrote
If you want to use a different meaning for a word, that's up to you. But you can't expect anyone to understand what you mean, when you are using a word which actually means something else!
The whole reason I asked the question of what John meant by "reliable", was because the usual meaning didn't make sense in his comment.
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