Let's look at how valuation methods introduced last week affect the price of two businesses. One is a garden service business, the other a gift shop. Both have been established for two years and have profits of R6 000 monthly. The garden service run from the owners garage has assets of approximately R60 000 including an old bakkie and various lawn mowers and hedge cutters. It has 50 monthly contracts of which a large part have been going more than a year. It operates a five day week. Its clientele is derived from advertising in local pamphlets. The gift shop has assets of R140 000, comprising stock at cost of approximately R120 000 and fixtures and fittings of R20 000. It has a good position in a busy centre and is open five and a half days a week with its sales coming from passing trade.

Payback period

As a guide, an older, more established business with a high asset base, say 60%, would need 15 to 18 months to recoup the investment. A younger business with a low asset base and particularly businesses perceived to be higher risk because they are easier to start from scratch, would need 9 to 12 months. The gift shop would be calculated at 18 months, times the net profit of R6 000 ( R108 000 ) and the garden service at 12 months times net profit ( R72 000 ).

Why the difference

With the garden service, being home based, it could be easier to start from scratch and have less valuable goodwill. Also the contracts can be cancelled on a months notice and the customers may not take too kindly to a change of ownership. With the gift shop the business stems from its good position in the centre, which is not easy to duplicate and most landlords will not allow businesses selling the same merchandise in their centres. As long as the same stock mix is maintained it won't matter who is behind the counter.

Return on investment

Assess an acceptable percentage return before tax and how much one would pay a manager to run the business. The norm is 45% before tax for small to medium sized businesses with a managers salary of say R3 000 a month, particularly as both ventures do not require highly skilled people to run them. One could accept that the gift shop has a lower business risk and the expected return would then be 40% and 45% for the garden service.

The sum would be as follows:
Annual net profit, less salary, times by the return. In both cases R72 000 - R36 000 = R36 000. The difference would now be: Garden service R36 000, divided by 45% = R80 000. The gift shop R36 000 divided by 40% = R90 000.

As can be seen, both the above methods look purely at the net profit of the business and don't take assets into account. The gift shop is therefore valued below its asset value.

Mike Hindle of Aldes Business Brokers, www.aldes.co.za

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