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How much should you pay for a business? 2 or 3 times the free cashflow?

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Answers (12)
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Jul 27, 2014
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Jul 6, 2014
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I like how people are still saying "rule of thumb " the rule of thumb is the rule that you could beat your wife with a stick as long as the stick was no thicker than your thumb loo. I'm currently offering someone half of the weekly net income (no money down) not knowing what he is wanting for the snapple route. He said it nets 2000 on an average week. 1000 is more. than I make in a week as a welder in a Multi billion dollar Corp. I could use. the. . supplimentainry income right now

Jan 14, 2014
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Rules of thumb are just that, rules of thumb. You really need to deal with the specifics of the situation as capably pointed out by most of the other answers. The answer to the question of how much to pay depends on your level of confidence. How confident are you that you can match or beat performance under the current owner? Unless you have unique and specific expertise in this industry, that usually means that the performance that you see reflected in the financial statements is systems and process based. And not too dependent on unique skills or charisma of the current owner. Particularly critical business activities like attracting customers and creating revenue.

Aug 31, 2009
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hi, u would like to know how much u pay for a business its depend on location and if its with or without propert if u buying a business without property than u should pay more than two times. If u r buying with property than u should not pay more than four times these are also depend on competion is there or not if there is competion u should bargain for the business price.

Aug 21, 2009
Fayaz Karim, MBA, CA
Asset Valuations, Business Searches
Consultant
Orange County, CA

This is precisely why you need a Business Valuation. You wouldn't buy a house without one, so why buy a busines without one? Every region and industry is different. Take a simple example: a Quizno's makes $50,000 and may sell for $50k-75k. A Subway makes $50,000 and may sell for $75k-150k.
Why? same bottom line.
Answer: depends on lease term, remodel, competition, rent, financing, cash flow, area.........and so on
It takes professional eyes to evaluate the deal terms and price...

Fayaz Karim,

Aug 21, 2009
Steve Simmons, MCMEA, SBA, CBB
CME Appraisals, LLC
Business and Certified Machinery and Equipment Appraisals
Charleston County, SC

Paying 2 or three times cash flow is a bit of a myth. There are certainly businesses/industries that justify paying such multiples of cash flow (perhaps even more). The reality is, every industry is different and each business performs differently in comparison to its industry. Working with an appraiser and/or analyst that understands and can value the specific business may cost a few dollars but, if you are purchasing a business the savings can be in the thousands.

As a business analyst, certified appraiser; if I can help or, provide services, please contact me.
Respectfully,
Steve Simmons, CMEA, CBB, SBA
843.813.8792

Jul 8, 2009
Gerald Kong
Trinity Transaction Advisory, LLC
TX

We concur with most of the responses; rules of thumbs are senseless as each business's value differs based on a variety of characteristics. There are a lot of factors to consider in valuing a company, such as; is there existing managment that will transfer with the business; how has the business been trending; are there high or low barriers to entry; what is the customer concentration like; any EPA issues; Union issues; pending lawsuites; what type of capital expense is required to grow; etc.

Jul 1, 2009
David Collins
Glentyde Capital Advisors, Inc.
CEO / Owner
Mecklenburg County, NC

I gotta add a big "ditto" to the previous posters who advise against a reliance on an overly-simplistic rule-of-thumb multiple. Our lives would be easier if it were indeed that simple, but the reality is otherwise. A whole lotta businesses have traded hands in severely over- or under-priced deals, thanks to a misguided belief that "simple formulas are good enough".

You're definitely on the right scent, though, with your intuition that "free cash flow" is the key value-determinant. I like to allow for different risk levels in the cash flows, and here's a simple variant you can use or adapt in some way:

Slice the forecasted FCF into three layers: That portion that you feel is almost certain (the "slam dunk" layer); a second layer that's not as certain, but still reasonably attainable; and a third that has a significantly lower probability of occurence, but still possible under the right conditions. Then, give each layer its own multiple--higher for the "nearly certain" layer; lowest multiple for the "yeah, it'd be nice but don't count on it" layer.

That way, you're at least taking a stab at bringing the "uncertainty" factor into your pricing, and in so doing, your pricing model is one degree more sophisticated that the very simple 2X or 3X rule of thumb.

Quick example: I'm vetting a biz where the forecasted CFs are $100 a year. (Here's where it gets situation-specific.) My examination of the factors leading to that forecast might tell me that I should really think of it this way: I could get $65 of positive cash flow practically without trying. With reasonable effort, employee and customer retention, etc., another $30 per year on top of the $65 is do-able, but by no means a 'gimme'. Finally, I might be able to get the annual CFs up to $110, total, with a whole lotta work, and whole lotta luck. That gives me my third layer of $15.

Now, if the market tends to price low-risk, medium-risk, and hi-risk companies at, say, 6X, 3.5X, and 1.5X, respectively, then I might attach those same multiples to my three layers.

Not difficult at all, and at least you've moved one step up the ladder from the most base-line simple rule of thumb multiple (and hopefully tweaked the accuracy of your pricing a bit). When you consider how many dollars you might throw away my over-pricing, it's not a bad little exercise.

As a side note, I also really like Mr. Burton's suggestion that you "weight" the cash flows, giving the greatest weight to the most recent. It's another way of incorporating a better pricing of the uncertainty factor into your analysis. And Mr. Barrick is spot-on saying that your pricing absolutely should take into account any changes to the CFs that YOU can bring to the biz, post-acquisition. Excellent advice.

Best of luck,

Jun 29, 2009
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United Business Brokers
Maricopa County, AZ

My partners and I are currently looking at an acquisition that's 1x - mainly because the books are a mess and there's no solid tax returns - higher risk business purchase.

Using a flat rule of thumb of 2-3x free cashflow is difficult, because some businesses don't warrant such a high multiple, while other businesses in other industries may get 5-7x or more on a multiple - depending upon many factors (patents, forecasts, contracts, etc.)

One rule of thumb I like though: value the business based on how well it performed the last 12 months (1 year) - 70% of the value, 2 years ago: 20%; 3 years ago 10%. Again, this rule of thumb is subject to change if the business is in a high-growth industry or tech, where there may not be any proven track record just yet.

What type of business are looking to buy? Email me at brigburton@gmail.com and I can give you a better idea on the multiple.

Jun 29, 2009
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The BAF Group LLC
MD

Mr. Ahmed's answer is good, but I believe needs more detail. Multiples are normally okay for rough estimates, but the pricing needs to be backed up by your own Cash Flow analysis: What will YOUR acquisition look like? Moreover, what has been the growth, or erosion of Cash Flow in that business over the past three (3) years? A simple multiple is not necessarily the only way to make a final decision on the Price you ultimately offer. It is HIGHLY dependent upon the type of business, as Mr. Ahmed says.

Franchises CAN be beneficial, but some of them do nothing more than just get your doors open. What is the real benefit of the name? Does that brand REALLY bring you customers? Does the franchise provide ongoing marketing? Training? Technical support? What is the difference between what this franchise earns, compared to that of a non-franchise operation of the same kind, in a similar setting? If you go from a 2x mutiple to a 3x multiple because it is a franchise, does that franchise really earn 50% more Profit than a non-franchise operation of the same kind?

Another difference between multiples has to do with the nature of the business itself. Things that can lower the price have to do with whether the income is rather passive, and unless you cut margins, there is relatively little you can do to promote the sales, and therefore increase your income. Gas Stations and C-Stores are businesses like that.

Are customers bound to the business by contract? If they are, and they MUST stay with you when you take over because of a contract, the multiple can be higher.

What about the terms of the sale? Do these impact the sale price? Is the Seller financing the deal? Is the Seller staying with the business, or leaving immediately? Is there an incredible amount of equipment being worked into the Price, that will affect the outlook on whether to even use a simple multiple?

Don't rely just on multiples. Look into the Revenue pattern, what can be done to grow the business, what the Cash Flow is compared to other businesses of that type - in short, you have to THINK through all of the tangible and intangible aspects of the business, in order to come up with a specific offer of Price.

Jun 29, 2009
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MNJ LLC
President
Pinellas County, FL

Its depend on the business if its franchise it may go for 3 or 4 times the cash flow if not a franchise 2 or 3 times is ok but not more than 3 times. This is what I have seen in business as a business owner. I hope this will help you.

Jun 28, 2009

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