12 Dec 2011 | Small Business
One of the sad truths of people who buy small businesses is that they often don’t get advice until after they have made the purchase. This can lead to too much being paid for a business or it being owned by the wrong legal entity.
People selling businesses justify their selling price by the profit produced. When this profit does not include a salary that should have been paid to the owner the purchaser can pay a lot for what in reality is a job rather than a business. If the plan is to own and operate a business and then sell it for a profit a company is the worst structure to use followed closely by a unit trust.
Q. My sister and I have run a small cattery for a bit over ten years on our property of 10 acres. I am over 65, and we are thinking of selling because I want to cut back my workload. The business turns over almost $100,000 a year and after all costs, including wages, we make a net profit of $15,000 a year. We have been told the real estate is worth about $650,000 and are not sure what to ask for the business. Can you tell us how to value the business and what tax will we pay on the sale?
A. There is no hard and fast rule for working out the value of a business. Some industries base the value on the turnover, such as professional practises like accountants, while others have established valuation methods that are peculiar to their industry such as newsagents.
Using accounting principles the goodwill value of a business is calculated by multiplying the sustainable net profit by a factor that relates to the risks associated with the business. Sustainable net profit is calculated by increasing the profit of a business for ownership costs, such as interest on borrowings, and decreasing it to allow for wages that have not been taken by owners that work in the business.
If your profit includes wages paid to you for the hours you have both worked, and there has been no interest deducted, your business could be worth between $45,000 and $90,000. The lower a purchaser perceives the risk, or the more they are attracted to the lifestyle of your business, the more they will be prepared to pay.
Because you live on the property the profit on the real estate will need to be split between your residence and the business. No tax will be payable on the gain you make on the sale of the portion relating to your home.
As you own the business through a partnership the profit on the sale of the rest of the property, and what you get for the goodwill of the business, will be decreased by the general 50 per cent discount and the 50 per cent active asset discount. The remaining profit will not be taxable if you claim the small business retirement exemption.