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© Copyright 2002-2003. All rights reserved.
Page 39
How To Investigate Any Business Opportunity
decimal.
Assume for the moment that the future profits of a business have been projected for the next 5 years
and are estimated to average $20,000 a year. (This is in addition to compensation for the services of the
buyer and any members of his family.) What should be the sales price for the buy-sell transaction?
If this investment were as safe as Government bonds that yields 6 percent, the buyer should be willing
to pay 333,000 ($ 20,000 / 0.06 ). If the investment is considered as safe as an investment in an excel-
lent corporate stock that earns 10 percent in dividends and price increases, the buyer should be willing
to pay $200, 000 ( $ 20,000 / 0.10 ).
Very few small businesses, however, have as low a risk factor as these two investments. What rate,
then, should be used in capitalizing the earnings of a small business? Usually, 20 to 25 percent is con-
sidered adequate. This means that the buyer should pay between $80,000 and $100,000 for this busi-
ness. If it earns the projected $20,000 a year, the buyer will recover his initial investment in 4 or 5 years.
This time will be extended by income taxes to be paid on the income, but this would also be the case for
most alternative investments except nontaxable securities.
In using a computation such as this, the importance of long run profits should be kept in mind. Unless
profits are possible over a long period of time ( 10 to 15 years), investment in a small business may be a
poor decision. The trend of profits is also important. If all other factors are the same, a company whose
profits are declining is worth less than one whose profits are increasing.
Valuing the Business on the Basis of Asset Appraisal
The majority of buy-sell transactions are based on a value established for the assets of the company.
This approach is not recommended, but if it is to be used, the suggestions that follow should be consid-
ered. A most important point is to find out early in the transaction just what assets are to be transferred.
Usually, the seller has some personal items that he does not wish to sell. Prepaid insurance, some sup-
plies and the like, in addition to cash, marketable securities, accounts receivable, and notes receivable
usually are not sold. 
If the buyer does purchase the receivables, the seller may guarantee their collection, but such a guaran-
tee should be established.
The assets most commonly purchased in a small business buy-sell transaction are merchandise inven-
tory, sales and office supplies, fixtures and equipment, and goodwill.
Evaluating goodwill. One of the assets that must be considered in a buy-sell transaction is goodwill.
Goodwill, in a general sense, arises from all the special advantages connected with a going concerns
good name, capable staff and personnel, high financial standing, reputation for superior products and
customer services, and favorable location.
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