2. Value A Small Business

Describe a small business model

• The owner (outside)
• The business
• The customer

How money flows through a small business

Total revenue (from customer) - Cost of revenue - Taxes = Net Income or Earnings (Net Income / # Shares)

Owners can decide two things:

• Put money into the owner's pocket (dividends)
• Or, keep the money in the business (stacking the equity)

A comparison of a small and large business

In large business,

• Owners == Board of directors who represent the shareholders
• The business: the CEO to the bottom are employees all working for the owners

How do you value a small business

If the net income is $20,000 per year,

Would you pay $400,000? -> 5%
Would you pay $200,000? -> 10%
Would you pay $100,000? -> 20%

The business never changes

Depending how much you paid for the business owning, your return rate changes

The value of the company was what you'd be willing to pay for. If you're happy with an estimated return of 5%, then buy the company for $400,000. If not, then pay less. The value is a function of how much risk you're willing to assume and how much you think you'll get back each year. Warren Buffett likes to find companies that trade for less than 15 times the earnings.