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SMART ANSWERS
By Karen E. Klein
FEBRUARY 15, 2000


Buy a Sure Thing or Start Your Own Business?

It's a matter of your appetite for risk and some complex calculations

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Q:  I'm not sure whether to start my own business or buy a 20-year-old manufacturing company with $2 million in annual sales. What rule do I use to determine what the existing company is worth? What value do I put on its name and current contracts?
--R.S., Merced, Calif.

A:  The first issue to consider when you're trying to decide between a startup and an existing business is risk, says Chris Pedersen, a certified business appraiser, whose company, Affiliated Business Appraisers, www.business-appraisers.com, is based in Temecula, Calif. A company that has survived 20 years is a proven commodity. New companies, on the other hand, suffer high failure rates. "A startup is the way to go if you're able to put in the time and money initially and you're willing to assume a high risk," says Pedersen, who has been in the appraisal business for 22 years. "Nobody intends to fail, but a great many people do." Private business valuations are based on a series of financial calculations, complicated by fluctuating markets and industry idiosyncrasies.

Unless you are very knowledgeable about this company's sector and comfortable with number-crunching, hire a certified business appraiser to give you an informed opinion about what the company is worth. A professional appraiser will go over the company's books and evaluate its industry position, taking into account economic projections and national-sales databases. You may have to pay as much as $6,000 for the service, but that's a small price for an objective assessment when you consider how much of your personal resources you'll sink into any business you buy.

There are some general guidelines that appraisers use to put monetary values on intangible assets such as name recognition, credibility, customer lists, vendor relationships, long-term contracts, and overall business goodwill. Leonard Sliwoski, an accountant and certified business appraiser based in Fargo, N.D., starts by combing through four or five years of company income statements, adjusting for what he calls the "oddities," such as excess travel and entertainment expenses and relatives on the payroll, to come up with a realistic income number. Most small, privately held businesses will sell their stock for three to six times that income figure, Sliwoski explains. "If $200,000 is the annual income figure I come up with, then the stock is probably worth between $600,000 to $1.2 million," he says.

Another way to determine the value of intangibles compares two measures. First, calculate the current market value of its tangible assets -- i.e., property, equipment, inventory, accounts receivable -- and subtract total debt. Then subtract the net asset value from the stock value. What's left is goodwill, Sliwoski says. "If the stock calculation is $1.2 million and the assets-less-debt figure gives you $1 million, you know that the business has $200,000 in intangible assets, such as its name, longevity, and pending contracts. Those intangibles are the things that allow a small company to earn a nice return," Sliwoski says. One way to check the validity of the figures an appraiser gives you is to use a database of national sales for businesses of similar size and industry, such as the one maintained by the Institute of Business Appraisers (IBA) at www.instbusapp.org.

Pedersen says the bottom line when it comes to valuing a business is profit -- over and above a fair salary for the owner: "It all comes down to how much money are you going to make out of the business? How much cash can you take out? A small company will generally market its value as the earnings [before-tax profits] plus the owner's compensation, perks, and other benefits. That's known as the company's adjusted income." Manufacturing companies generally sell for about 2.5 times their adjusted income, he adds. The multiple typically rises when adjusted income is higher and may also fluctuate based on the company's current assets and liabilities. For more information on appraisals, and referrals to local certified business appraisers, contact the IBA in Plantation, Fla., at (954) 584-1144, or the American Society of Appraisers in Herndon, Va., at (703) 478-2228, www.appraisers.org.


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