Buying an established business question

It is a service business. The most common valuation metric is earnings before owners compensation x some multiple (the negotiated part). Basically you take out all real expenses from revenue and the remainder is what the owner would actually have received.

You typically can't just use what the owner's income was because most small businesses have expenses that are actually owners comp. The seller should want you to go through their expenses to see if there are items like "business travel, corporate vehicle, dining and entertaining, memberships" that really should have been paid by the owner out of pocket then charged to the business as a deductible expense.

The multiple would depend on the industry and how in demand their business is. Typical multiples would range from 3 to 7 times.

The biggest thing to remember is not to buy a job. The real value of the business as an investment is what it brings in after a manager. So let's say the owner brings in $120k of that $600k but he also has $25k of personal business expenses. Well if you'd have to pay a manager $80k plus those expenses, then the business is really only bringing in $40k a year that's worth investing in.

No small business owner really wants to hear that real "income" number though. In my experience almost every body overvalues their business in the beginning. Also keep in mind if he can't sell it, where is the business going to go? If all he is selling is a book of business that someone else will acquire upon his retirement anyway for free, well that may devalue the business even more to someone in the same business. Why pay for something that you would get for free?

So really the way to value the business is what will someone else pay for it and is that worth it to me? Now if it is able to open up other means of growth, than that's something that is more difficult to put a value on.

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but I'd highly recommend getting someone who knows what they're doing when you're valuing a business with 600k+ annual income.

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Risky purchase as value of company is primarily in whomever has relationship with customers. If that is one of the employees remaining, you need a commitment, nda and non-compete as part of the purchase.

ETA: I wouldn't pay much more than the value of the current contracts on a forward going basis.

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he real value of the business as an investment is what it brings in after a manager

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This is the key point.

75% of net revenue for a service business. Look at owner compensation and things like key man life insurance and long term care insurance that lots of business owners pay for through the business. Also, dive into the expenses for reasonableness and ask about any large variances from year to year on the financials for the last 3 years. If office space is leased, look at the lease, especially the CAM or tenant operating expenses. 9 times out of 10 this lease is probably in favor of landlord. Also, look at any office equipment leases.

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From what I understand, the owner is phasing himself out and would probably shut the business down. I don't think he was even looking to sell it until last week.

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I don't think I'd be under this impression if I was you. He's a business man, why give something away or stop a business that has a value?

He may not have considered selling it yet, but when it came time for him to actually retire I doubt he'd rather lay off his employees and make $0 on his business closing then keep his employees working and make some money.

It looks like he is thinking of working out a partnership with the existing owner. Essentially, buy into a 50% ownership stake, and have the owner transition out over a 2 year period. This would give him time to learn that side of the business, while ramping up the consulting side. If it doesn't work out in two years, he will sell his share of the company. If it does, he will buy out the rest of the current owner.