Let's hypothetically say someone was considering the purchase of a gun shop in Massachusetts. For the purposes of assigning and negotiating a value for the business, what would reasonably be done? For starters I assume that the value would include the (wholesale?) value of inventory plus some amount based on the historic cash flow and net margin of the business plus any corrections that may be necessary to tidy up the balance sheet.
I'm sure the folks in this forum could provide some useful feedback. Thanks in advance.
Find out about any loans on the books, and accounts payable. A gun shop is primarily cash and carry, accounts receivable probably isn't much of a factor.
The most important part of valuing a business is the owner's cash flow or owner earnings. In short, the annual profit. The current owner needs to open up his books and prove what that figure has been over the past 2+ years. Typically, negotiated small business acquisitions settle on prices in the 2-5 times neighborhood of recent annual owner earnings.
Owner earnings are probably not the same as what the current proprietor paid himself, depending on whether he ran it, or hired someone else to run it. If he ran it himself, you need to estimate what fraction of his take home would otherwise have been paid to an employee to do what he instead did himself. If you figure it would cost $50,000 annually to hire a manager to run the shop, then you should back this out of the net cash flows and add it to the operating costs. If he took home say $80,000, then I would figure the owner earnings to be $30,000 and not $80,000. The reason for this is that the enterprise must be considered as a standalone entity to be properly valued. If you do not figure that part of the operating costs of the business includes paying someone to run the place, then you are underestimating the costs, and overestimating the profits. IOW, you must value the business based on what it really costs to run, and not assume that it could run without someone behind the counter, handling finances, purchasing stock, paying bills, maintaining the building/facilities, opening and closing each day,
etcetera,
etcetera,
etcetera. Imagine you become bed ridden; then what would it cost to run, and what would it yield in profit?
Of course, if you already have a retail organization, such that you have economies of scale, you can value the business higher. If you have some reason to believe that you'll be able to create higher sales and profits than the current owner, again you can value it higher than simply based on recent owner earnings. But the current owner doesn't need to know either of these things, probably best that he didn't.
As far as inventory/stock, the current owner should have everything on the books at the prices he paid. This number could be considered something like the list price for a new car; try to never pay it. You need to value the inventory advantageously and thus conservatively. Excess inventory, obsolete inventory, and damaged inventory all work to reduce the value of the inventory in determining how much it adjusts the value of the business. Everything on the books, you should insist on seeing. Don't let him tell you he has a back room with stock - go see it. Make sure it's in good shape. Make sure it's all there. This is due diligence.
I just listed some things here that aren't the most obvious things to think about, but it isn't everything. Good luck!
