New Venture Lab: Equipping Christian Entrepreneurs

Question

I've been managing a business on behalf of an absentee owner for the past few years and he has offered to sell it to me.  The business involves assembling and shipping a product to customers that submit their orders via the phone or internet.  The revenue in the past 12 months has been $590k and the earnings have been $307k.  He has stated that he wants between $1.7 million and $2.3 million based upon his valuation of 2.5x revenue and his projections for the revenue in the next 12 months.  In terms of growth, the business has grown 70% in the past 12 months.  Any idea if that is a fair price or not?  Any idea for how I might structure and finance the deal?

Answer

First of all you are in a great position because you know the business so well, having been the manager of the business.  A typical buyer starts out knowing nothing and tries to find out as much as he can about the business.  Meanwhile, the seller manages the information flow and tries to put his best foot forward, resulting in imperfect information flow and often leads to a very disappointed buyer after the deal has closed.  In this case you have very little due diligence to perform - which will save you a lot of time, energy and third-party advice.  It also saves on the document complexity since you need fewer representations and warranties in the purchase agreement.

 

As far as price is concerned, pricing is typically determined as a multiple of earnings and not revenue -- and based upon the past 12 months, rather than any forward timeframe.  (See a previous post here on valuing a company.)  For a typical product business, the price would likely range from 4x to 6x earnings over the last 12 months (known as Trailing Twelve Months or TTM.)  Given the TTM earnings of $307k, then the value would likely be in the range of $1.2 million to $1.8 million.  Having said what is typical, given the high growth rate of the business and the relative attractiveness of business and its industry, the business could well demand a healthy premium over the typical market valuation stated above.

 

In terms of structuring the deal, a typical deal involving an owner/operator selling his business to another owner/operator would involve the buyer paying the seller cash at closing of 25% - 50% of the total value and the balance would typically be paid in a seller note of 50% - 75%.  The buyer's 25% - 50% would typically be financed through his own personal savings or some form of equity capital such as venture capital, private equity, angel investors, etc.  Often, the key to sealing a deal of this nature is to offer the seller the confidence that you can and will repay the note in full, that you can and will run the business properly, etc.  Of course, this structure is "typical", but there are many ways to structure the deal including different mixes of cash and debt, no debt, the use of an earnout, a lease management agreement and other such arrangement in which the seller gets paid a variable amount based upon how the business performs.