How is the value of a company established? I have been offered the chance to purchase a company that has minimal assets but a very lucrative contract that generates substantial cash flow and profit. The problem is calculating the value of the contract. On a straight cash flow, profitability standpoint, it would appear fine. However, the contract can be canceled with 30-days written notice. How can the risk/reward of this deal be quantified?
Establishing the fair market value of a company requires skilled professional help. Business brokers, industry consultants, and accountants are all able to help you determine the true value of the business.
In general, a business has many valuable assets, ranging from the building in which it operates to the tough-to-measure “goodwill” generated by providing quality products or services to customers. The inventory on hand, pending orders, manufacturing equipment, computers, software, trucks, and other vehicles also must be considered when you calculate the value of a company.
If the main asset of this particular business is the one contract with the 30-day cancellation clause, I would be wary of buying it. First, obtain a copy of the contract so you can review all the details. Meet with the customer to discuss the ongoing relationship and contact details. You want to make sure they feel comfortable working with you if you decide to buy the business. You might be able to change the terms of the contract and extend the cancellation provision to 90 days. This would at least give you more time to line up new customers if things fall apart.
You also might work with the current owners to expand their customer base before you buy the business. Bringing in more secure contracts is essential to the continued success of any business.