How would you come up with an approximate valuation of a 7-year-old U.S. music school business that has $224k gross revenue, made a small profit of $10k last year, and owes $120k in loans? The profits (after all expenses) were $5k, $3k, and $0 in the previous years. The business is well-known in the area and has a solid reputation.
 
From: "The Legal Guide for Starting & Running a Small Business"
by Fred S. Steingold

"Generally, the assets of a business consist of inventory, fixed assets (furniture, fixtures, equipment) and intangible assets (such as a lease, trade name, customer list and good will). The most important factor in establishing the fair market value of these assets is this: Given the realities of the business and the industry in which it operates, what kind of return would a buyer reasonably expect on his or her investment? To arrive at this number, an appraiser will look both at the business's earnings and what similar businesses typically earn.

Be very careful about what you estimate for good will, the portion of the purchase price attributed to such intangible factors as the reputation of the business, its location and the potential of its customers. Despite what sellers will almost surely tell you, many small businesses have little or no value beyond the value of the hard assets such as furniture, fixtures and equipment. How can this be, if a business earns a good yearly profit? Easy. Most of the profit is commonly attributable to the hard work, clear vision and good judgment of the owner, not to the inherent value of the business. Think of it this way: most rug cleaning businesses, hardware stores, print shops and restaurants don't make a substantial profit. Those that do are usually run by uniquely talented people. When these people move on, many of those businesses quickly lose their appeal.

Good will isn't always a myth. Some profitable businesses usually those that have been established for years and have strong name recognition are worth significantly more than the value of their tangible assets, because they have a good reputation. Even if the owner retires or sells out, this reputation will continue to bring in business. Unfortunately, deciding that a business has good will is easier than deciding how much."
 

Edvin

MVP
How much is owner salary and how long until the $120k loan is paid-off.
What is fixed/variable cost and cashflow like?
What is the valuation of the assets if you had to liquidate?

As a rule of thumb, I wouldn't pay more than cost of starting a franchise.

Valuation seems to be all over the place; but, I would start by googling music business for sale (see example) and get a sense of other businesses on the market (or even service oriented franchises for sale).
 
No salaries. Instructors working at the school are contractors and earn roughly 60% of the cost of the lesson (so the operational cash flow is roughly 40% of the total gross revenue, before paying admin staff, rent, bills, etc).

The business has just started paying off the loan, and it will take another 5-10 years to completely pay it off at the current rate.

Assets are $15-20k at most.
 

Edvin

MVP
Disclaimer, I'm not a broker nor have I acquired a business before; but, happy to share my thoughts.

The business is obviously not going to be absentie ownership.
The owner, like an employee, needs to be paid.
60% of gross for the contractors leaves $90k for operational cash. After paying admin, rent, bills, etc there doesn't seem to be anything left for you to payoff the purchase loan. Remember you still have to pay personal taxes, social security, pay for medical benefits, etc. You will need to take a loan (or use your own liquid assets), which means there is 3-5% opportunity cost on the assets.

Why is the loan just starting to be paid now; this seems like a red flag.

Unless there is something-else that you are getting out of this business (i.e. keeping busy and staying involved with community), or it is part of multi-location strategic expansion, I don't see any benefits to this investment.

I'm going to assume that the owner is able to to pocket $30-50k/year; so, it might make sense to have a conversation around $30k because the business is established + has existing clientele + has signage, etc. But I would rather get this number closer to liquid assets.
 

djbaxter

Administrator
a 7-year-old U.S. music school business that has $224k gross revenue, made a small profit of $10k last year, and owes $120k in loans? The profits (after all expenses) were $5k, $3k, and $0 in the previous years.

What jumps out at me is, with that kind of gross revenue, why are the after profit expenses so low?
 

Edvin

MVP
What jumps out at me is, with that kind of gross revenue, why are the after profit expenses so low?
That is a great point.

I'm going to suggest franchise playbook here, and would say that the store should keep about 70% of gross revenue and pay contractors 30%. In education sector, the franchise owners pay certified educators about $15/hr and charge clients $50/hr. Admittedly there is high turnover; but, that is the nature of the business.
 
What jumps out at me is, with that kind of gross revenue, why are the after profit expenses so low?

The expenses are very high... high rent, bills, etc.

Is there a way to come up with a number for the cost of the brand itself? I.e. the unique company name, concept, logo, brochure/flyer designs, website, etc.
 
Valuation can sometimes be subjective. It depends on locating a willing buyer interested in buying at a price they are willing to pay. Now business brokers use a certain calculation to determine a possible fair value. That valuation has a couple of components. One being annual cash flow and two comparable recent businesses that are similar and what they sold for. But we refer to the brand, soft assets like reputation, or the assets that are not tangible as goodwill.

The article poster above is correct in that small business usually don't have a lot of goodwill.

This is how a valuation could be arrived for the music school. Average cash flow (add back depreciation) last three years, sounds its 10+5+3=$18k divided by 3 years is average cash flow $6k.

Looking at other comparable sales we use something called a multiple of average 3 year cash flow.

If you find in your area in the last year a couple of business similar to yours selling for 2 to 3 times cash flow then that is a reasonable asking price.

In your case if 3 times is common for schools then your fair asking price for your business is $6k X 3 or $18k. It could even be 1 times average annual cash flow or even 5 or 10 for some technology companies.

How do you get the cash flow up. Be sure to add back depreciation and amortization if they are included and reduce your profit numbers. Also, if the owner were taking anything out of the school you can add that back and then do the multiple. You indicated the owner was not taking out any funds then that's fine but again they should, they need to be paid like everyone else.

If say the owner draws $20k a year from the business you can add that back to each year to calculate cash flow before owner payments to use as the basis of the calculation. That means your average annual cash flow goes from $6k to $26k and times a multiple of 3 you get a business value of $78k. But you must support/substantiate the calculation. You see depending on what the details are the value varies wildly. Additionally, some hard assets can be negotiated, equipment etc to add to the asking price but you must negotiate its value based on what its worth.

Talk to a business broker and get their thoughts too you don't have to list with them but they have a wealth of information. If you find a music lover who loves teaching with passion and they have money and they are willing to purchase what you ask then that's the price and its value.

As you can see if you don't get at least $120k+ then the debt will not be extinguished in the transaction. Frankly and just being honest I don't see the business being worth that. Try to see if you can pay down the debt and try again in a couple of years. Never give up but pivot if you have too.

It's encouraging that cashflow is improving that is major win.

To your continued success,
I advise business brokers on financial models.
Nexlevelbusiness.com
 
When it comes to getting acquired, there are a couple forums that come to mind that may provide you with more details information:

1) Reddit (threads like r/startups and r/entrepreneur) – This site has quite a few founders who’ve been a part of successful exits and do AMAs occasionally
2) Acquired Social – This is Q&A site that is used by investors and startups and it specifically centers around how to get acquired.

But ultimately, the ins and outs of how startups get acquired are still a bit of a mystery.

Link to acquired social invalid; removed. ~ djbaxter
 
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