Have you considered the pros and cons associated with buying a business versus starting a business from its inception?
If you acquire a business you will pay for the tangible assets such as inventory, raw materials, vehicles, machinery, office furniture, etc. and an intangible asset known as “goodwill”.
The tangible assets can be valued at replacement cost or at book value. The actual method of valuation is one of the items that might be negotiated in determining the total acquisition price of the business you are considering acquiring. However, under most acquisition scenarios the tangible assets are sold at book value.
The intangible asset, “goodwill”, is the amount that you pay for the business above the book value of the assets. People will give you a long list of what goodwill includes, however when put in the context of the acquisition of a business, goodwill is what you pay for a history or potential if you are acquiring a franchise, of profitability.
In the case of a franchise the goodwill, which is generally termed the franchise fee is based on the proven profitability of similar franchises that are currently in existence.
This history of, or potential profitability is due to one or more of the following factors:
- Location
- Name (which is synonymous with a reputation and length of time in business)
- Clientele
- Contractual agreements with customers
- Contractual agreements with suppliers
- Patents
- Designs
- Key Employees
- A business methodology and/or structure that has proven to generate profits in other locations (the franchise scenario).
You should only consider creating your own business if you have extensive experience in that industry and when your experience spans most job functions or in other words a total understanding of how the business that you are contemplating creating operates.
As an example, you have been the manager of a retail men’s wear store, part of a national chain, for the past ten years that only sells private label clothing. You are now considering the pros and cons of buying an existing men’s wear store or opening a brand new one. You feel that your ten years of experience as a manager of a men’s wear store more than qualifies you to open a store from scratch. But does it? As a manager of a store that deals in private label clothing you would probably have little if any experience in actually buying men’s apparel for resale, as most of your current product lines would be purchased through and delivered by the corporate entity. Starting a store, without this expertise, could be disastrous.
Let’s create a sample scenario.
You have identified a business that you wish to acquire. You have been working in that industry for a number of years and because of that, training by the current owner is not something that you believe you require. The current owner wants $1M in goodwill because the business has earned $250K net profit in the last year (depending on the type of business paying 4 times last years earnings is reasonable). Providing the business maintains its previous pattern of profits you should earn back the goodwill in 4 years or less.