When buying a business, the first thing most people want to know is how to value a business.  Not all businesses are created equal.  Either through rational or irrational market behavior, the returns on one business versus another will be very different - and can be substantial.

As you will see below, there are MANY areas for potential gain when buying a business.  As always, the more you can buy low and sell high the better your return.  When it comes to buying a business, you should know what your options are, as the variance between high and low looms large. 

Businesses sell for a multiple of their "cash flow", or the amount the buyer can expect in future earnings based on historical earnings.  A higher multiple means higher return for the seller - lower return for the buyer.  But there are many pathways.  And if you have the ability to optimize financials, there are MANY ways to:

• Buy at a low multiplier. (see chart above and example below)
• Sell at a high multiplier.
• Use leverage to FURTHER increase YOUR return.

But you have to know what you are doing and understand the risk - or click here to team with us - it is PART of what we do.

Anatomy of Increasing Return - an simple example for ease of understanding:

Businesses sell for a multiple of their "cash flow", or the amount the buyer can expect in future earnings based on historical earnings. So, how can you turn a fictitious $100,000 investment into over $4,000,000 in 3 years?  ANSWER:  Carefully Orchestrated Optimization!  Remember, this is just a simple example for illustration - not intended to cover ALL the bases:

Evaluating the Basics - a hypothetical $100,000 investment:

In a typical world, for your $100,000 investment, you might have businesses available with a multiple from 1 - 4 as follows:
        

Investment	100,000.00	100,000.00	100,000.00	100,000.00
Loan	-	-	-	-
Interest	-	-	-	-
Term/Months	-	-	-	-
Total Purchase	100,000.00	100,000.00	100,000.00	100,000.00
Multiple	1.00	2.00	3.00	4.00
Expected Earnings	100,000.00	50,000.00	33,333.33	25,000.00
Return Rate	100%	50%	33%	25%

 
As you can see, as the multiple goes up, the return goes down for the buyer.  This is generally due to less risk, market conditions, industry conditions, etc.

Keeping It Simple - optimizing the 1 multiple business

If we continue with the 1 multiple example, we can see how other influences affect return.  If we leverage our $100,000 with $100,000 of debt - we buy twice the return and increase our return on cash from 100%/year to approximately 163%/year.
  

Investment	100,000.00
Loan	100,000.00
Interest	8%
Term/Months	36.00
Total Purchase	200,000.00
Multiple	1.00
Expected Earnings	200,000.00
-	16,666.67
Return Rate	163%
Payment	($3,133.64)

It must be understood that there is risk in debt - but with properly managed risk comes great reward.  Just changing the terms of our agreement allows us to buy a bigger cash flow and gain a bigger return.

REAL Gains - leveraging debt to 1 multiple business.

If we buy a 1 multiple business that has the capability to become a 3 multiple business.  Then optimize that business over the next 3 years, it the following is not unforeseeable:

Investment	100,000.00
Loan	100,000.00
Interest	8%
Term/Months	36.00
Total Purchase	200,000.00
Multiple	1.00
Expected Earnings	200,000.00
-	16,666.67
Return Rate	226%
Payment	($3,133.64)

Now you see the power of growth.  We've taken that same $100,000 investment leveraged with $100,000 in debt - and added substantial, but not unreachable growth of 7%/month for 26 of the 36 months.  And now, instead of our business being worth the $200,000 we paid for it if we maintained the status quo - now it is worth $3,000,000.  AND, it has paid us over $1,000,000 along the way.  So, on our $100,000 investment, there is somewhere close to a $4,000,000 return. 

We've used leverage and optimization sized growth to turn 100,000 into $4,000,000.  A return of about 226%/year or 40 times our original investment.  Maybe you don't get 7% growth a month - maybe you fall short to 3% - you still end up with a business worth $1,000,000 that provided about $735,000 along the way.  Almost two million is not a bad return for $100,000.

Far more to consider:

Would that was all there was to consider.  But items like working capital, sustainable growth rate, assets, and many other factors all contribute to risk/reward relationship - and therefore the expected return.  You need to understand these things or team with someone who can help you - click here to email us your question.

Let us show you the possibilities - click here to contact us.