Founding a startup company can lead to excitement and rewards. On the other hand, if you want a way to own a small business with all of the rewards and a little less excitement, you might consider buying an existing business. If you buy the right company, you should already have a customer base, revenues, employees, equipment, and an effective business model on the first day.
How to Calculate Your ROI When You Buy an Existing Business
To ensure you’re investing in a good business, you should learn how tocarefully calculate the business ROI. ROI calculations are pretty simple, but ferreting all of the information you need to perform the calculations may not be. This means you need to learn which questions to ask and how to verify answers.
These suggestions can help you figure out the real returns you can expect from an existing company before you write a check or apply for a business loan:
Should You Allow for an Owner’s Salary?
Most owners plan to run their companies as the manager or CEO. If so, they may plan to pay themselves a manager’s salary. For very small businesses, this income may consume a large part of the profits. You want to use ROI calculations to understand the returns that you can enjoy from your business investment. Still, you might wonder if you should include your own salary as part of the profits or as an added expense.
Different advisors have different opinions about which side of the equation to include the owner’s salary for managing the business on. Your business goals may help you decide how to treat the manager’s salary that you will pay yourself:
- If you plan to grow the business to sell it at a profit in the future, you might want to treat this salary as an expense. In this case, you’re mostly interested in the company’s value. Also, you will get a clearer picture of how profitable the company would be if you weren’t in the picture.
- If you plan to manage the company for decades and then pass it on to your heirs, you might leave the salary out of your expenses. Your main reason for investing in the company is as a way to generate income. You just want to be certain that your company can pay your salary and may not care about additional profits as much.
In either case, both the salary and the profits benefit you as a small business owner. Remember that these different ways to take an income may impact both your personal and business taxes. It’s probably best if you can run your calculations both ways, especially if you are comparing different businesses that you might hope to buy to determine which one will benefit you the most.
Calculating ROI Before You Buy a Business
Typically, calculating ROI only involves simple math. You simply divide profits by expenses. For instance, if you spend $100,000 to earn $40,000, you have an ROI of 40 percent. Of course, this figure is much more reliable if you use it to calculate a business ROI that you already control. If you’re trying to figure out the value and returns from an existing business that seeks a buyer, you may have to rely upon information that you get from the current owner.
This isn’t meant to imply that you can’t find reliable and honest business owners. You should just remember that the existing owner is also an eager seller. Even the most honest owners may neglect to account for all expenses because they may not have done a great job of tracking ROI in the first place. If you have the training and experience to properly value an existing company, you’ll know that you need to request tax returns, bank statements, and accounting ledgers from the past few years.
If not, you might hire consultants to help you. These professionals may be accountants or other financial professionals with the skills and experience to guide you properly. Even if the current business doesn’t provide the returns you may have hoped for, business consultants might also provide you with some simple guidance that can help you cut costs or enter new markets.
What’s a Good ROI to Expect From a Small Business?
Large corporations might enjoy great success with an ROI of 10% or even less. Because small business owners usually have to take more risks, most business experts advise buyers of typical small companies to look for an ROI between 15 and 30 percent. Of course, If you decide to take a salary from your business, you may not need an ROI of 15 percent, but you still need to consider how you could profit from your business if you decided you did not want to run it any longer.
This article is presented by Kabbage, Inc. The Kabbage team aims to help small businesses access the funding for growth. Kabbage empowers small businesses through straightforward, flexible access to capital.
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As a seasoned entrepreneur with a background in founding and growing startups, I bring a wealth of practical experience and in-depth knowledge to the discussion of founding versus buying an existing business. Having successfully navigated the challenges and rewards of entrepreneurship, I understand the intricacies involved in evaluating business opportunities and maximizing returns.
Now, let's delve into the concepts presented in the article:
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Startup vs. Existing Business: The article introduces the choice between founding a startup and buying an existing business. It highlights the excitement and rewards of startups but suggests that purchasing an established business can offer rewards with a bit less excitement. This sets the stage for a discussion on the considerations and calculations involved in buying an existing business.
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Benefits of Buying an Existing Business: The article outlines the potential advantages of buying an existing business, including an established customer base, existing revenues, employees, equipment, and a proven business model from day one. This provides a solid foundation for future growth and success.
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Calculating ROI: The core of the article revolves around the importance of calculating Return on Investment (ROI) when buying an existing business. It emphasizes the simplicity of ROI calculations but underscores the challenge of gathering all necessary information for accurate calculations.
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Owner's Salary Consideration: The article raises a crucial question about whether to include the owner's salary in ROI calculations. It explores different perspectives based on business goals, such as treating the salary as an expense for those planning to sell the business for profit versus leaving it out for those intending to manage the business long-term.
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Factors Affecting ROI: The article advises prospective business buyers to consider factors like business goals, the intended duration of ownership, and the impact of including or excluding the owner's salary. It emphasizes the need to run calculations both ways to determine which approach aligns best with the buyer's objectives.
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Due Diligence in Business Valuation: Recognizing the challenges of obtaining accurate information from eager sellers, the article stresses the importance of due diligence. It recommends requesting essential documents like tax returns, bank statements, and accounting ledgers from the past few years to properly value an existing business.
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Consulting Professionals: Acknowledging that not everyone may have the expertise to value a business accurately, the article suggests hiring consultants, such as accountants or financial professionals, to assist in the process. These professionals can provide guidance and identify areas for potential improvement, even if the initial returns may not meet expectations.
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Expected ROI for Small Businesses: The article concludes by providing a benchmark for expected ROI, suggesting that small business buyers aim for returns between 15 and 30 percent. It notes that, due to the inherent risks in small businesses, a higher ROI is often advisable compared to larger corporations.
In summary, the article offers a comprehensive guide for individuals considering buying an existing business, covering key concepts from ROI calculations to the nuances of owner's salary considerations and the importance of due diligence in the valuation process.
