Entrepreneurial Finance: Fundamentals of Financial Planning and Management for Small Business

CHAPTER 3 SMALL BUSINESS PURCHASE PRICE

An existing business can be valued based on many factors related to the business itself and the way it stands on its own, such as the status of its assets, cash flow, earnings, profits, and the like. The value of a business can also be based on factors related to the market in which the business operates, and to how that specific business fares against its major competitors in its own industry. The estimated value, regardless of its source and the valuation approach would serve as a base to determine the price that the buyer is willing to pay. There are many methods by which a business value can be calculated. All of those methods can only give an approximate value from one perspective or another. It would be wise for the prospective buyer to look at more than one method of valuation to have a better sense of where the candidate business stands. The following are briefly the major methods to estimate the core value of an existing business from the perspective of a potential buyer. Later on, in Chapter 11, we will discuss in more detail the general valuation process and its connection to harvesting a business.

3.1 Asset-Based Value

In this method, it is assumed that the value of a business can be estimated based on the value of its assets after deducting all of the liabilities. This is basically to say that a business is valued as equal to its own net worth or equity. However, although the value of all assets is not easy to estimate, ...