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Return On Investment

Tags: adjusted net income, business valuation, deal structures, financing

Comments & Replies: 4     Views:     Post ID:     Comments About This Glossary Term

In looking at "return on investment," a prospective business buyer of an absentee-owned business does need to factor in the cost (in time and dollars) of monitoring and verifying everything that the manager and employees are doing, particularly those activities that involve access to financial control and liquid assets.

Contributor: Business Appraisals, Valuations Advisor
ROI should not always be the key issue in having a manager run a business for an absentee owner. The important part is the lack of invested interest ($) on the part of the manager. I did an appraisal on a business where the manager and two other employees worked together to steal $200,000 from the business over a three year period. They created false invoices, expenses and other documents to cover their tracks. The manager had been around for over 10 years and had the owner's trust. They went to jail but the owner lost $200,000. This has been the most elaborate scheme I have run into but many other of my clients have had similar situations.

Contributor: Business Broker, SF Bay Area
Although Timothy's comment is exactly to the point about how to calculate ROI, the problem in many small businesses is that it is difficult to hire a "President" who can truly run the business completely independently without the owner having to spend time on it. So many times, Buyers would say my time is worth X amount. They will then subtract X from the SDE and say that is their ROI. So Buyers who are currently making a lot of money (high tech jobs) will claim that they have a much lower ROI than someone who has a more modest income will see a much higher ROI. So it does become subjective. In businesses where the hiring of a manager who can truly run the business is well defined, we as broker's can clearly argue and convince them of the true ROI.

Most businesses advertised will provide information regarding "net cash flow" or SDE ("seller's discretionary earnings"). While this is of particular interest to the "owner-operator" or "owner-manager", the investment- or absentee-buyer is more interested in Return on Investment ("ROI"), how much will they earn yearly on the amount invested. This can be calculated simply by the buyer determining the actual SDE to the buyer's satisfaction, then deducting from that figure the full payroll cost of hiring a manager--the resulting number is the annual dollar amount of the return on investment ($ROI). Expressed as a ratio, the buyer can determine the effective percentage of return: $ROI/Price=ROI%. And, this is a more relevant figure for the absentee or investor buyer to consider.

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