Once you have found a business that you may want to buy, what things must you look at to determine how much the business is worth and whether this is a good acquisition for you? The process of determining what a business is worth is known as valuation. There are several formulas that can be used to place a value on the company, which we have outlined below. Before we get into the formulas, we need to start by looking at hard and soft factors that affect the value of a business.

Hard & Soft Factors

During the process of assessing a business you need to place a value on the tangible assets, such as buildings, product and equipment, and the intangible assets, such as intellectual property, and location.

Tangible assets such as a building and the company's products normally appear on the company's financial statements, and have a fixed price that can be decided upon with reasonable assurance, says Wise.

Intangible assets like intellectual property, goodwill, location and brand name recognition can be harder to assess. They can also drive up the price of the business. Wise explains that intangible assets are worth what they can earn, and are normally valued on the earnings potential that the intangible brings to the business.

Different types of businesses will measure the value of their intangible assets in different ways, says Wise. Consider location as an example. For a retail business, being located in the downtown core of a major city may lead to a higher valuation than the same type of business located on the outskirts of town. For a manufacturing company, the value of the company's location will be affected by things like the proximity to suppliers and the cost of shipping inventory - things that have a direct impact on the overall operating cost of the business.

Goodwill, a term that is often used loosely, really arises from a company's ability to generate super profits or excess earnings, earnings that are above a normal commercial return on the tangible assets of the business, says Wise.

Market trends are another key consideration. Consider how the value of a small print shop would have changed as desktop publishing technology started to emerge, enabling companies to bring a large portion of their document services in-house. You want to buy a business where the trends are rising, not declining.

Watch out for ill will when considering a purchase. We've all had negative experiences with a product or service at one time or another, and these experiences can generate a lot of anger, especially if a company is a repeat offender. To get a handle on this aspect of a company's reputation, talk to people who deal with the company. You may find that a glowing business will look a little more tarnished when you get specific and start talking to customers and suppliers, but it's better to find these things out before the deal is signed.

Advisors can play an important role in your assessment of acquisition targets. Meeting with financial and legal advisors might be expensive, but it is better to spend some money in the early stages, as it could save you thousands of dollars in the future. If you can, get a quote from your advisors before engaging their services, but don't overlook the value of professional input. The last thing you want is to buy a business for $10,000, only to learn after the deal is signed that the business is on the brink of bankruptcy and is involved in a $50,000 lawsuit with a past employee. Or that you've bought a business based on location only to learn that the lease is up and can't be renewed three months after you've taken over the company.

Where to Look

Digging for Truth