BIDaWIZ Blog » VALUATION

Are You Planning To Acquire A Small Business?

The BIDaWIZ Team — Fri, 16 May 2014 21:04:56 +0000

If you are in search or have identified a small business that you would like to acquire, there are suggested best practices to follow. In addition, it’s important to note that while the current owner will want to have peace of mind that the business they put their blood, sweat and tears into doesn’t become a ‘going concern’ a year after the sale, price will usually dictate the sale. So, how to does one go about approaching a small business as a potential acquisition target?

How to approach the seller
While no business deal is exactly the same, anyone involved in a prior acquisition/merger will tell you that the relationship and personalities of the buyer and seller were important factors in finalizing the deal. As such, it would be in your best interest to obtain a very warm introduction from someone you know that also knows the owner of the business. This will help in gaining the confidence and trust of the seller and it should speed up the process as a whole. In addition, if the company is not currently up for sale, you will want to be strategic in determining if, at the right price, the owner may sell.

Preliminary due diligence
As the potential buyer, you should be assessing the value and growth prospects of the business. This means reviewing the current employees, company culture, business trends, expansion opportunities, customer feedback, competitive landscape, among other factors. In addition, not only do you want to ensure that this is a viable and growing business, but that you are the best person to lead it.

Formulating your offer
When you prepare to make an offer for the business, it is best to have an understanding of how the current owner values the business. Specifically, if you’re going to go through the process of negotiating, it is best to have a sense for how the seller views the valuation. You will need to come up with your own methodology, but if the numbers are far off, it’s quite possible a deal will not get done.

Closing due diligence
Once you reach an agreement in principle with the seller, you’ll still want to confirm the accuracy of the financial and business data provided by the seller. You may need to work with a few attorneys and possibly an accounting firm to complete this final part of closing the deal.

More Questions? Ask your business questions or find a bookkeeper online.

Valuing a Non-Compete Clause When Selling a Business

The BIDaWIZ Team — Wed, 02 May 2012 15:00:05 +0000

Most business owners that plan to sell their company are asked by the buyer to include a non-compete clause in the legal agreement. This can have significant tax implications to both the seller and the buyer.

The non-compete clause
A clause that a buyer asks the seller to include in a sales agreement is considered a non-compete, independent of whether or not the seller intends to compete. The consideration (monies) that the buyer provides for the purchase of those assets, at least in part, is to compensate the seller for agreeing not to compete against the buyer’s new business.

What are the tax implications to the buyer and the seller?
The portion attributable to the non-compete is considered an intangible asset and recognized as ordinary income for the seller (reference: internal revenue code – Revenue Ruling 69-643, 1969-2 CB 10). The other portion of the sale price will likely be treated as a capital asset taxed at capital gains tax rates which is generally much lower than ordinary income tax rates.

As an FYI, the buyer will likely want to assign the largest possible value to the non-compete clause as that will provide the largest future tax benefit to the buyer. The internal revenue code states that a non-compete clause can be claimed as a deductible amortization expense. In most cases, non-compete agreements are amortized over a 15-year period, regardless of the actual term or payment conditions in the agreement.

How do you determine the value of the non-compete agreement?
For tax purposes, the value assigned to a non-compete agreement must be economically realistic, bargained for separately, and agreed upon by both parties. Setting a realistic economic value involves balancing the probable damages against the value of the payments made through the agreement. In most cases, it is recommended to have an independent business valuation completed to determine the threat of competition. But, to provide you with an example, we can utilize the below methodology to determine an appropriate value. In this specific example, a website is sold to a buyer for its attractive search engine rankings and traffic since the business isn’t producing revenue.

Even though the website does not produce income, the buyer is interested in the website for its top of the page search rankings on Google and other search engines. We can begin to determine the value of these rankings by reviewing the monthly local and global traffic numbers for keywords provided by the Google external keyword tool. For instance, by entering the keyword “cars” in the tool, Google provides the total monthly global searches of 151 million and 37.2M locally for that keyword. This means that websites ranked on the 1st page of Google each receive a portion of all of that traffic.

Now, the question is, how do you know how many converted searches the #1 ranked site on Google receives vs. #2 site etc.? This information isn’t provided by the search engine providers, but there have been many studies detailing the estimated percentage of traffic each of the top 10 sites ranked on the 1st page of Google receive on a monthly basis. Since the seller already has their site ranked #1 on Google for certain keywords, they can just refer to their Google Analytics data for their average monthly traffic for those keywords. But, let’s suppose the seller doesn’t have Google Analytics, what study can we refer to for the percentage of traffic for the 1-10 1st page ranked sites? According to a comprehensive study completed by Optify, the top ranked websites on Google on average receive this amount of search traffic: #1 listing receives about 37% of the traffic, #2: 12% of the traffic, #3: 8.5% of the traffic etc. This means that if the seller’s site is currently ranked #1 on Google for a keyword, the buyer would likely receive 37% of the traffic searched. In addition, the buyer risks losing the top spot and falling to #2 or 12% of the searches if the seller decided to compete. This translates into a 25% lose of traffic for that keyword. So, how does that translate into dollars? The seller needs to understand how the buyer plans to monetize on the traffic which will help shed light on the impact of a 25% loss of traffic for that keyword.

Of course, these exact numbers do not need to be used but you can still apply the methodology. Obviously, make sure that it also makes sense with the sale price.

More tax questions? Browse answers or ask small business tax questions online.

How to Value a Partner’s Interest in a S Corporation

The BIDaWIZ Team — Tue, 09 Nov 2010 14:42:34 +0000

This is a very important process and one that involves a significant amount of analysis as you want to recognize the full value of your portion of the company.

Financial Metrics Used For Valuation
To reach a specific valuation, you need to analyze the company’s core financial metrics and compare it to the industry. The valuation metrics used for similar public companies would be a great place to start as well as the metrics used for similar private companies that have been sold. The financial metrics you may want to consider in your valuation method include book value, discounted cash flow, earnings, sales & cash flow multiples. Keep in mind that the type of financial metric(s) used largely depends on the industry. In addition, you don’t have to use just one metric to reach a valuation for the company – a combination or a blended valuation method can work as well.

Hire 3rd Party Valuation Analyst
Another option is to hire an independent 3rd party valuation analyst (appraiser) to review the company’s net worth. Sometimes this is the best approach since the analysis will be completely independent. But, be sure to do a thorough background check on the individual and/or company providing the valuation services.

Separately, make sure you consult with a tax expert because these situations can become complicated and you will want to make sure that you put yourself in the best possible position from a tax standpoint as well.

More Valuation Questions? Ask your business valuation questions online.

How to Value Inherited Rental Property You Want to Sell?

The BIDaWIZ Team — Mon, 14 Jun 2010 08:00:46 +0000

This is definitely a very important question & one that involves a significant amount of research as you want to recognize the full value of the property. Before reaching a specific sale price you need to gain a strong understanding of the market. More specifically, the sale prices of similar properties as well as a keen understanding of the value of the differences of your property vs. those similar properties.

Valuation of Inherited Property
I’m wondering when you received the property, because when you inherit property the fair market value is assessed at the date of the death. If it was fairly recent then that value may be used as a starting point, but be sure you are comfortable with the valuation method used. If the deceased passed away a long time ago, then the valuation probably wouldn’t be so relevant.

Analyzing the Market
A method that many sellers use to gauge the value of their property is to look at the sale prices for similar properties in the area. So, if there is another rental property that is similar to what you own that was recently sold, you can use that price as a starting point.

Reviewing the Income Generated
There is also a valuation tool called the gross rent multiplier (GRM) which is used to figure out a sale price by comparing it to a similar property with rental income. Specifically, compare your rental income by a comparison factor, or the monthly rental income and actual sales prices of comparable properties that were recently sold in the area. For instance, if a similar property generated $5,000 in rent a month & was sold at $1,000,000, the rent/sale multiplier would be 200 ($1,000,000/5,000=200). So, if your family’s property was rented for $15,000, then the estimated sale price would be 3,000,000 ($15,000*200=3,000,000).

Separately, make sure you consult with an estate tax expert because these situations can become complicated & you will want to make sure that you put yourself in the best possible position from a tax standpoint as well.