NovarsGroup Business Brokers

----- quick business valuation summary -----

how others perceive value

What the Buyer Sees When Pricing a Company

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

The basic formula is as follows:

Cash / Price 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 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: Forcasted 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	$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 turndown. 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: Forcasted 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 turndown. The amount is not an expense and would be an additional amount to cash flow.

 

What the Lender May See

The lender is interested in two things:

1. Does the historical cash flow (and projected cash flow) cover the cost of financing with a 20-25% cushion in the event of economic or market turndown?
   
2. If in the event of a default, can the bank recover the financing by selling the company assets?

If the answer is "no" to question 1, the lender will not finance the deal.

If the answer is "no" to question 2, the lender may finance the deal if you (via the buyer) can demonstrate that the business is a growing entity that support increasing cash flow.

• Lenders assume a lot of risk when financing business purchases. Their only security in the event of default is the operating and fixed assets.
  
  
• Lenders will not lend on goodwill and brand equity. They are looking for a business that has been managed well, has a management plan in place to grow the business, and has a history of financials that support the projected earnings expected.