Selling A Home-Based Business
A home-based business is where its administrative and managerial activities take place in the owner’s personal residence. As such, a home-based business has no commercial lease with a physical footprint. Home-based businesses can often be quite valuable, and may eventually gravitate away from a home-based business model. One of the greatest businesses of all time, Amazon.com, started out as a home-based business. Common examples of home-based business are online businesses which offer products or services on the internet, and landscaping or pool routes. When it comes time to sell, key steps to take include preparing an organized set of historical financials, determining the fair valuation of the business by using an experienced business broker, and effectuating a smooth transfer of the goodwill of the business to the buyer after the sale.
Valuing Home-Based Businesses
The value of a home-based business is ultimately driven by the cash flow or adjusted owner benefit that a buyer expects to derive from the business after the sale. Typically buyers pay a multiple of 2-4 x the owner benefit of a business. Given the high level of owner involvement in many home-based businesses for sale, it is important to remember that only the transferable cash flow or owner benefit after the sale is used for valuation purposes. This is why owners of home-based businesses should prepare a transitional plan that will assure prospective buyers that the sales and profits of the business will remain intact after the sale. Factors affecting the valuation of a home-based business include its Total Addressable Market (TAM), low overhead cost structure, and the participation of the seller in the business (more absentee businesses are more highly valued).
Total Addressable Market of Home-Based Businesses
- The Total Addressable Market (TAM) of a business is its overall revenue opportunity assuming 100% market penetration.
- This is a crucial component of valuing any business because it affects its future growth rate.
- A home-based business, for example, may sell consumer health products online.
- The distribution to the customer from the manufacturer may be outsourced while little or no employees are needed for the day to day operations.
- This negates the need for a facility or office to ship inventory or house employees.
- The TAM for this home-based business is quite large since its products are needed by a broad array of consumers, and may be sold to any consumer in the United States (or internationally).
- Note that this online business could grow while remaining home-based.
- In contrast, the TAM for other home-based businesses may be rather small.
- For example, the TAM of a home-based plumbing business is constrained by the limitations on the amount of customers it could serve.
- In order to reach more recurring customers, a plumbing business needs multiple vehicles, employees, and infrastructure.
- This would make it almost impossible for the plumbing business to remain home-based.
- The TAM must be analyzed and included as a major factor in the valuation of a home-based business.
Low Overhead of Home-Based Businesses
The low overhead of a home-based business is a major cost advantage compared to brick and mortar businesses. Many business owners would be quite pleased to not pay rent for a commercial space along with other costs such as utilities, insurance, and internet service. The cost savings from being a home-based business eventually leads to higher net margins for the business. The net margin of a business is the percentage of net profits divided by the total revenue. Higher net margins means more profits for the owner. The attractiveness of higher net margins for home-based businesses should enhance its valuation. This advantage must be carefully weighed against the inherent growth limitations for many home-based businesses.
Owner’s Role in Home-Based Businesses
The owner’s role in any business is a crucial component of its valuation. The more passive an owner’s role, the higher the business valuation. This is because an established management structure with proper policies, procedures, and trained employees in place means the cash flow of the business is more likely to remain intact after the sale. On the other hand, a business that depends on the relationship between an active owner and its customers, employees, and suppliers may have trouble keeping its cash flow intact after a sale. After all, who knows what will happen with these relationships once the active owner/seller is no longer around. For home-based businesses with active owner-operators, it is crucial to determine how the cash flow of the business will transfer to the buyer after the sale.
Example of Active Owner in Home-Based Business
- Let us assume that Paul owns and operates a home-based pool service business which he is selling to Jim.
- Paul’s pool route includes about 100 residential customers, who pay Paul a monthly service fee to clean their pool every week.
- Jim understands that Paul’s customers are used to dealing directly with Paul, and is fearful that customers will cancel their account after the sale.
- Paul’s business broker coordinates a meeting between the two parties, and Jim details his fears directly to Paul.
- The parties agree to develop a post closing transitional plan whereby the customers are slowly introduced by Paul to Jim.
- Paul also agrees to sign a non-compete agreement which will prevent him from working in the pool service industry within the area of Paul’s current route.
- Lastly, Paul agrees to work together with Jim for at least two weeks after the closing so that the customers are assured of the continuity of their service.
- Developing this reasonable transitional plan assures Jim that most if not all of the pool route’s customers (and cash flow) will remain intact after the sale.
- Pool and landscaping routes are traditionally priced as a multiple of recurring monthly service revenue
- This valuation method tends to strip out the role of the owner and solely focus on the transferable customer base.
Home-based businesses may make excellent acquisition candidates for many buyers because of their inherently low cost structure and overhead, which generally results in higher net margins. Unless the home-based business is an online business, the low cost structure may inhibit the growth of the business. The key to evaluating a home-based business is determining the transferable cash flow (without the seller’s involvement) that a buyer may expect to receive from the business after the sale.
Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.