Understanding How Businesses are Valued

Question 1

After-Tax debt service must be 2.0 or greater. Why?

Answer 1

Taxes, Depreciation and amortization must be re-introduced in your pro-formas since loan
principle is paid with after-tax dollars. This doesn’t show up on the income statement!
It is a mistake to assume that you will manage the business better than the seller immediately.

Question 2

Why is it difficult to compare your target with what similar businesses have sold for with respect to multiples of cash flow and percentage of annual sales?

Answer 2

Databases are not publicly available.

Question 3

What business asset is left out when using the replacement (cost) approach?

Answer 3

Goodwill

Question 4

What will happen if you use the income approach to value a business but don’t understand how to build a capitalization rate?

Answer 4

If you don’t understand how to build a capitalization rate you will overvalue the business.

Question 5

What kind of investment is buying a business?

Answer 5

Wholesale

Question 6

What does a wholesale investment require that a retail investment does not?

Answer 6

You have to do work to make sure you make your money back.

Question 7

What is ‘blue sky’, and should you pay for it?

Answer 7

Blue sky is an additional premium paid for good will, or the potential to make more money by adding services or products. No, you should not pay for it.

Question 8

What is ‘goodwill’, and should you pay for it?

Answer 8

Goodwill is an intangible asset that offers long-term value (e.g., brand name, customer base, customer relations, employees, good reputation, patents, etc.) that arises when another company acquires a new business.
Yes, you should pay for it.