How would you value a business if you considered investing in it

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Gamma Ray
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How would you value a business if you considered investing in it

Post by Gamma Ray » Tue Dec 05, 2017 1:06 am

Let's say I want to offer to buy a share of the company I am working for. What are the steps involved in finding real value of any company?
I can find out yearly operational revenue for last few years, and overall cost (with a ballpark salary/compensation) which would give me an idea how much it makes. Then how does it go generally? Thanks in advance.

smitcat
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Re: How would you value a business if you considered investing in it

Post by smitcat » Tue Dec 05, 2017 8:45 am

Gamma Ray wrote:
Tue Dec 05, 2017 1:06 am
Let's say I want to offer to buy a share of the company I am working for. What are the steps involved in finding real value of any company?
I can find out yearly operational revenue for last few years, and overall cost (with a ballpark salary/compensation) which would give me an idea how much it makes. Then how does it go generally? Thanks in advance.
"I can find out yearly operational revenue for last few years, and overall cost (with a ballpark salary/compensation) which would give me an idea how much it makes. Then how does it go generally?"

Once you have the EBITDA it is a multiple of that number dependent upon the size of the business and the type of the business.
If it is a smaller business you can get an idea of the numbers and multiples by looking at what is for sale on bizbuysell.

garlandwhizzer
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Re: How would you value a business if you considered investing in it

Post by garlandwhizzer » Tue Dec 05, 2017 1:17 pm

It is almost impossible to accurately value a company's true worth on a consistent basis. This is one reason why active management on the whole is a losing proposition. Very smart, very knowledgeable, and very highly paid professional fund managers try to do it and most fail to beat a beta index. Looking at numbers like PE, B/M, free cash flow, change in debt levels, net stock issuance, profit growth rates, etc., is helpful but insufficient. Clever accounting maneuvers can distort those numbers. Junk in, junk out can be the result, not to mention unforeseen major macroeconomic/geopolitical events that can disproportionally impact a single company. Having been burned on individual stock picking a time or two myself, I would advise avoiding specific stock risk and diversifying. If you must try to pick individual stocks I suggest limiting that exposure to no more than a 4% "play money" allocation of a portfolio. That rule has saved me a time or two in decades past. I believe it more productive for most of us to diversify broadly into an index, trusting that the market as a whole (which sets prices) is likely to do a better job than we are.

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Re: How would you value a business if you considered investing in it

Post by alex_686 » Tue Dec 05, 2017 1:26 pm

smitcat wrote:
Tue Dec 05, 2017 8:45 am
Once you have the EBITDA it is a multiple of that number dependent upon the size of the business and the type of the business.
If it is a smaller business you can get an idea of the numbers and multiples by looking at what is for sale on bizbuysell.
The correct answer is to calculate the discounted Free Cash Flow to Equity (FCFE). However this is hard value to estimate even for professionals. A multiple of EBITDA is a decent shortcut if the business is stable. However, IIRC, that gets you the enterprise value. Enterprise Value is Equity + Loans - Cash. So you will have to make a few adjustments here.

In short, expect to do a little leg work.

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Re: How would you value a business if you considered investing in it

Post by GibsonL6s » Tue Dec 05, 2017 1:33 pm

It would also be wise to check in with some business brokers and see if there are comparable sales "comps". This will give you an idea of value and multiples to use. Good luck

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Re: How would you value a business if you considered investing in it

Post by bigred77 » Tue Dec 05, 2017 1:34 pm

The "real value" of a private company is 1 of 3 things.

1.) Unknowable (this would be my position)
2.) What someone is willing to pay for it
3.) Estimated Calculated by taking some metric (EBIT, EBITDA, FCF, etc.) and applying what you deem to be an "appropriate" multiplier depending on perceptions of growth, risk, market segment, industry, etc.

I would probably not consider investing in a private company unless I was either a professional, experienced investor, was buying the whole thing and had complete operational and financial control, or at the very least buying a large enough percentage where I had real input and influence over operational, financial, and strategic decisions.

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Re: How would you value a business if you considered investing in it

Post by Gamma Ray » Wed Dec 06, 2017 12:02 am

Thanks, this is actually a company I am working for and I thought about investing in it and get into a profit sharing, and also have some say in how things run. I totally understand everything you all mentioned, the company has several offices, but each branch operates as individual company, so I would be taking a share of the company not completely buying it. It's not a publicly traded company so there are no shares at the moment, and if I decide to go in I'd probably have a small share in return for same amount of profit on top of my current salary.

I don't know any attorneys but I suppose I would need to find one who can review the books and advise if it's advisable to go in or not, or is it not how it works? I thought maybe with a fee someone can review company books and can give us some insight?

So it's not really an investment on appreciation of company value, more of a return of profits year to year because I don't think I am getting anywhere with salary increases. It's limited.

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Re: How would you value a business if you considered investing in it

Post by Gamma Ray » Wed Dec 06, 2017 12:03 am

Sorry - Doublepost by mistake
Last edited by Gamma Ray on Sat Dec 09, 2017 10:58 am, edited 1 time in total.

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Re: How would you value a business if you considered investing in it

Post by lsp12 » Wed Dec 06, 2017 8:36 am

Generally, in the sale of a share of a privately owned company, there are a series of metrics that one can look at to think about price.

These would be things like P/E, Price to Book Value, Price to Revenues. There is no right or wrong answer, but you have to be comfortable with what you're willing to pay.

I would say that, unlike in the public markets where p/e's are in the range of 15 - 20X, in a private market you may be looking at paying between 3X and 8X earnings. That is obviously a big range and is a function of many variables. Things like the purchase of a minority share will argue for a lower multiple (because there is a 'control premium'), likewise if there is no clear way to sell the shares down the road. You also need to understand how/when your profits will be paid out. For example, as an owner, will your ownership require helping to fund the company's working capital? If so, then the cash flow from the investment will be delayed. Tax treatment may also be relevant -- the new tax proposal has a pass-through provision, but if you earn a salary from the entity then you may lose that tax benefit (not sure whether in whole or in part). If the company is a sub-s or an LLC, then all earnings, whether paid out or not, are treated as regular income to the owners in the year the company earned the money.

So, it is a pretty complex topic.

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Re: How would you value a business if you considered investing in it

Post by Flashes1 » Wed Dec 06, 2017 8:47 am

The banking world's go-to measurement is an EBITDA multiple. Depending on the Company's growth rate, the multiple is currently 6x-10x EBITDA. There's many exceptions, but that will get you in the ball park.

More concerning to me is the OP seemingly having difficulty finding the numbers needed to calculate EBITDA. It sounds like he has Sales and Salary Expense? but is missing COGS, all SG&A, and D&A. And hopefully the numbers are audited by a reputable firm. If you can't get that kind of info. I would be reluctant to invest in the company.

However, I should be careful what I say, because I just invested a in start-up that won't be fully operational for another 18 months.....talk about just making up a valuation! However, I love its business model, and firmly believe it will be a major success.

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Re: How would you value a business if you considered investing in it

Post by boglewill34 » Wed Dec 06, 2017 9:30 am

EBITDA would be great, but as someone else above I've found that a multiple of revenue is a common metric with small business. The multiple will depend on some perception of credit worthiness and competitiveness.

More importantly imo is a very honest personal portfolio assessment of how the risk profile of this investment will fit into your personal asset allocation. Grind up the rose before doing this assessment, it's hard to be objective about it sometimes. Considering the probable risk of being in a small business and being leveraged to it with salary cash flow AND share ownership, I'd only consider it if it's a small part of your AA.

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Re: How would you value a business if you considered investing in it

Post by smitcat » Wed Dec 06, 2017 10:11 am

Flashes1 wrote:
Wed Dec 06, 2017 8:47 am
The banking world's go-to measurement is an EBITDA multiple. Depending on the Company's growth rate, the multiple is currently 6x-10x EBITDA. There's many exceptions, but that will get you in the ball park.

More concerning to me is the OP seemingly having difficulty finding the numbers needed to calculate EBITDA. It sounds like he has Sales and Salary Expense? but is missing COGS, all SG&A, and D&A. And hopefully the numbers are audited by a reputable firm. If you can't get that kind of info. I would be reluctant to invest in the company.

However, I should be careful what I say, because I just invested a in start-up that won't be fully operational for another 18 months.....talk about just making up a valuation! However, I love its business model, and firmly believe it will be a major success.
6X-10X multiples are very high and not typical.
On companies that are reasonably established with typical growth curves between $2 and $30 million in sales they will tend to be 1/2 that multiple range.

nimo956
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Re: How would you value a business if you considered investing in it

Post by nimo956 » Wed Dec 06, 2017 10:20 am

If you're looking for an academic text to help you work through the calculations, you can check out Investment Valuation by Aswath Damodaran. It's fairly comprehensive (and long!).

https://www.amazon.com/Investment-Valua ... +damodaran
50% VTI / 50% VXUS

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Re: How would you value a business if you considered investing in it

Post by boglewill34 » Wed Dec 06, 2017 10:45 am

boglewill34 wrote:
Wed Dec 06, 2017 9:30 am
EBITDA would be great, but as someone else above I've found that a multiple of revenue is a common metric with small business. The multiple will depend on some perception of credit worthiness and competitiveness.

More importantly imo is a very honest personal portfolio assessment of how the risk profile of this investment will fit into your personal asset allocation. Grind up the rose before doing this assessment, it's hard to be objective about it sometimes. Considering the probable risk of being in a small business and being leveraged to it with salary cash flow AND share ownership, I'd only consider it if it's a small part of your AA.
Self quoting!

I bought a company more than a decade ago at 1X revenue and around 3X ebitda. The credit profile was excellent, competitiveness at the time was good but very risky because it was a low barrier to entry business. The credit terms for purchase were very good. I gained decent wealth from it and had good equity built up, but competition crept in and with it profit margin dropped. It was to be expected, and it was something I knew could happen going into it.

However, I ended up draining wealth to prop up cash flow. Then leveraging personal equity. The upshot is that had I made an honest assessment at the time of how the business risk was much higher than what I would have wanted my personal wealth subjected to (and stuck with that assessment), I wouldn't have leveraged that wealth against the risk.

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Re: How would you value a business if you considered investing in it

Post by randomizer » Wed Dec 06, 2017 11:10 am

I wouldn't have the stomach for something undiversified like this.

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Re: How would you value a business if you considered investing in it

Post by betablocker » Wed Dec 06, 2017 3:50 pm

Gamma Ray wrote:
Tue Dec 05, 2017 1:06 am
Let's say I want to offer to buy a share of the company I am working for. What are the steps involved in finding real value of any company?
I can find out yearly operational revenue for last few years, and overall cost (with a ballpark salary/compensation) which would give me an idea how much it makes. Then how does it go generally? Thanks in advance.
Gamma Ray. I own a business and bought out a partner along the way. It is a very complex and risky decision to buy into a small private business. It's working out in my case but I know everything about the internal operations of the business. I would consider working out a profit sharing plan as an alternative. This could be a commitment to pay x if your branch delivers y. Then you don't have to value the business but you also don't get any control.

If you want to buy and are buying a minority share even before you get to valuation think through the control and legal issues. If you are a minority share holder, what rights will you have? That would be defined in a buy sell and operating agreements. The majority holder can keep you from selling your shares or specify how you can sell them in that agreement. Also a majority shareholder doesn't need to pay out profits unless it is spelled out in an operating agreement. That majority owner could also pay themselves excessive compensation in order to reduce profits and your share. You'd need legal protection in both cases. Also take a look at the legal structure of the business: llc, s-corp, etc. If the entity is passing through all corporate income, it could have an effect on your taxes. Will the company distribute to cover those taxes? Most likely yes but you want it in writing. An s-corp will also generate a K1 (W2 for your part of the business profits) and additional tax complexity. If you do buy you will definitely need a valuation. I'd would think the majority shareholder would pay for it. Be skeptical though as the valuator works for the owner not you. I would have a CPA evaluate the books but if they don't really understand small business valuation, it will be dicey to rely on the opinion of someone focused on paying taxes. You'll also need a lawyer with experience in this area. It's expensive to go through all that.

Finally I'd say that unless you think the value of the company will appreciate and be liquid at some point (making the stock valuable) and/or that you will get a majority share, I'd look at a written profit sharing contract rather than buying in. You could do something where you improve your percentage as you grow the total amount of profits to help defray the cost to the owner. Good luck.

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Re: How would you value a business if you considered investing in it

Post by mrgeeze » Wed Dec 06, 2017 4:16 pm

bigred77 wrote:
Tue Dec 05, 2017 1:34 pm
The "real value" of a private company is 1 of 3 things.

1.) Unknowable (this would be my position)
2.) What someone is willing to pay for it
3.) Estimated Calculated by taking some metric (EBIT, EBITDA, FCF, etc.) and applying what you deem to be an "appropriate" multiplier depending on perceptions of growth, risk, market segment, industry, etc.

I would probably not consider investing in a private company unless I was either a professional, experienced investor, was buying the whole thing and had complete operational and financial control, or at the very least buying a large enough percentage where I had real input and influence over operational, financial, and strategic decisions.

Big red's comment holds true to me. A critical piece of information is what sum buyers generally pay for a company in the business segment you are in.
For example in some industries 1x sales would be reasonable, in others it could well be too much or too little.
EBITDA is often used but for me I REALLY would want to know the industry before I use any derived calculations.
You have to know what's fair and reasonable on the expense side. Its often the best indicator of a well run business.
Just because he's got 1million in inventory doesn't me he's got a million dollars worth of stuff anybody wants to buy.

That said, buying into a privately held firm is mostly about knowing the management team.
Did they build the company? Do they plan to stay? How old are they. Have they planned for succession?
What is their (and your) exit strategerie? What about share dilution?
These last two are important because private money often tends to linger in a firm for a long time.
You can't normally just up and sell your shares.
You need to understand how and WHEN you can get paid.

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Re: How would you value a business if you considered investing in it

Post by betablocker » Thu Dec 07, 2017 10:06 am

It's helpful to know the norms of the industry in the context of the negotiation but the variation between companies in the same industry can be extreme. Norms are all about pricing and not about valuing. I'd try to get a really good handle on yearly cash flow to the owners and how persistent you think it will be and then use the norms/pricing information in the market as a comparison tool or as a way to know what you are up against. The exception though are small companies in the $1-4m in EBITDA range which sell for multiples like 2-4x EBITDA unless the are some sort of SaaS company or other technology driven startup. That benchmark I would use because it is a reflection of investors experience of risk and I'd keep it south of 4x. Effectively you are saying if I can't get my money back in 2 or 3 years it isn't worth the risk.

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Re: How would you value a business if you considered investing in it

Post by smitcat » Thu Dec 07, 2017 10:33 am

betablocker wrote:
Thu Dec 07, 2017 10:06 am
It's helpful to know the norms of the industry in the context of the negotiation but the variation between companies in the same industry can be extreme. Norms are all about pricing and not about valuing. I'd try to get a really good handle on yearly cash flow to the owners and how persistent you think it will be and then use the norms/pricing information in the market as a comparison tool or as a way to know what you are up against. The exception though are small companies in the $1-4m in EBITDA range which sell for multiples like 2-4x EBITDA unless the are some sort of SaaS company or other technology driven startup. That benchmark I would use because it is a reflection of investors experience of risk and I'd keep it south of 4x. Effectively you are saying if I can't get my money back in 2 or 3 years it isn't worth the risk.
Yes , agreed. Not knowing the business, the overall earnings history and many other things those multiples are a good median.
Generally the lower EBITDA the lower the multiple - people will not offer a 4X multiple for a $50K a year business, more like 1-2.
Business's with higher barriers of entry, EBITDA's above $500K, and longer history will often go above a 4X multiple.
Pizza places and most restaurants typically go on the lower end of multiples, while 5 day a week and 9-5 business can go for more.

In summary we are attempting to help the OP with detail that is impossible to supply with the limited information that has been supplied so far.

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Re: How would you value a business if you considered investing in it

Post by Gamma Ray » Thu Dec 14, 2017 3:56 pm

smitcat wrote:
Thu Dec 07, 2017 10:33 am

In summary we are attempting to help the OP with detail that is impossible to supply with the limited information that has been supplied so far.
So far the information has been great, at least I know it's not as easy as looking at a few simple numbers and make a decision, even though I am actually working here and have a ballpark figure of what goes in and out. One thing I have no information on is the taxes and other relevant mandatory expenses, which I don't think I can get full access. I don't know if those numbers are usually based on given revenue, or if they are actually revealed during any business/partnership situation. Business owner may not want to reveal they are taking advantage of certain loopholes until the partner is committed to buying it, I suppose.

There are three choices ahead of me, 1) stay where I am and work on salary+commission (I know how much I am bringing and to be honest my profits are probably the driving source for this office), 2) Invest and expect more profits in return, and also have a say on how certain things are run, 3) Look for a different job where my overall pay might be a bit more (need to investigate this, it's been very hard finding out what others in my field makes since it is mainly commission based, and every source I found gives fixed X amount of income and not by profit sharing/commission details).

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Re: How would you value a business if you considered investing in it

Post by MrPotatoHead » Thu Dec 14, 2017 8:49 pm

A lot of things seem to be missing in this story.

One, why are the owners willing to sell you a piece of the action? What exactly is their motivation?

Also very, very, very few lawyers are trained in business in and of itself. That is why so many franchisees end up in the barrel every day, because they hired a lawyer to review the FA and thought that was the same as having the business itself vetted.

Also the way you described the operation of the business itself raises a caution flag. This may be a case where a small business is actually an inadvertent franchise. By that I mean if you envision you operating one of the offices and taking a share of the profits in exchange for an investment they may run afoul of the franchise rule. But there is too little information to know if this a valid concern or not.
Last edited by MrPotatoHead on Thu Dec 14, 2017 10:34 pm, edited 3 times in total.

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Re: How would you value a business if you considered investing in it

Post by Sandtrap » Thu Dec 14, 2017 9:02 pm

MrPotatoHead wrote:
Thu Dec 14, 2017 8:49 pm
A lot of things seem to missing in this story.

One, why are the owners willing to sell you a piece of the action? What exactly is their motivation?

Also very, very, very few lawyers are trained in business in and of itself. That is why so many franchises end up in the barrel every day, because they hired a lawyer to review the FA and thought that was the same as having the business itself vetted.

Also the way you described the operation of the business itself raises a caution flag. This may be a case where a small business is actually an inadvertent franchise. By that I mean if you envision you operating one of the offices in exchange for an investment they may run afoul of the franchise rule. But there is too little information to know if this a valid concern or not.
+1
This is the elephant in the room. It is not quantifiable. Can't put it on a spreadsheet or pro forma statements. And, even if disclosed may not be entirely truthful. It is often the reason for business failure, whether retail, service, or franchise. Buying someone's problems.

This is no different than buying a used car. If the car is as great as the fellow that is selling it for top dollar claims, why is he selling it?

I have often used this when purchasing income property, whether residential building or commercial property rental. If the CAP rate is so high and the market doing so well, why is it for sale? In the case of commercial property; is the anchor tenant moving or going out of business? Are they selling it at the peak of income knowing it will fall soon? And so forth.

This is one circumstance where it pays to be very very suspicious and due diligence is in order because you are the one that has something to lose.

j :D

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Re: How would you value a business if you considered investing in it

Post by MrPotatoHead » Thu Dec 14, 2017 9:11 pm

I should also point out that if you buy into the business and do not structure the agreement correctly and follow explicit rules you also may have bought yourself a huge personal liability issue.

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Re: How would you value a business if you considered investing in it

Post by smitcat » Thu Dec 14, 2017 9:37 pm

Gamma Ray wrote:
Thu Dec 14, 2017 3:56 pm
smitcat wrote:
Thu Dec 07, 2017 10:33 am

In summary we are attempting to help the OP with detail that is impossible to supply with the limited information that has been supplied so far.
So far the information has been great, at least I know it's not as easy as looking at a few simple numbers and make a decision, even though I am actually working here and have a ballpark figure of what goes in and out. One thing I have no information on is the taxes and other relevant mandatory expenses, which I don't think I can get full access. I don't know if those numbers are usually based on given revenue, or if they are actually revealed during any business/partnership situation. Business owner may not want to reveal they are taking advantage of certain loopholes until the partner is committed to buying it, I suppose.

There are three choices ahead of me, 1) stay where I am and work on salary+commission (I know how much I am bringing and to be honest my profits are probably the driving source for this office), 2) Invest and expect more profits in return, and also have a say on how certain things are run, 3) Look for a different job where my overall pay might be a bit more (need to investigate this, it's been very hard finding out what others in my field makes since it is mainly commission based, and every source I found gives fixed X amount of income and not by profit sharing/commission details).

Very little detail but your limited words include:
- my profits are driving this office
- my filed is mainly commission based.

A WAG would say that it is a low barrier of entry business with a few key clients where sales and sales contacts are the key.
If that guess is near correct you know the old saying....
"Why buy the cow when the milk is free?"

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Re: How would you value a business if you considered investing in it

Post by rrppve » Thu Dec 14, 2017 10:07 pm

It really is unclear why you really want to buy into this business. It doesn’t sound like you will own enough of a stake to be a partner and have real influence over how the business is run. It also doesn’t sound like there is a widespread employee or management ownership plan that is used to provide profit sharing to a group of employees. It's pretty clear that you are likely to get screwed over as a naive minority shareholder down the road, as you are unlikely to be able to properly protect yourself.
My 2cents is that you should just ask for some profit sharing, no cost phantom stock or stock options in the business. Don’t put any cash in. If you must invest in the business, use a note to buy your shares and have the note paid off from your compensation in the business.
If you want to put a value on the business, besides reading Damodaran on Valuation which is a classic, find out the prices of previous transactions. Also attorneys do not review books/numbers, that’s what accountants do. Attorneys review the corporate docs, contracts, operating agreements etc. You probably need advice from both. Are the financials audited? Also in valuing a small businesses, there is an old saying, cash doesn’t lie. Take a look at the bank statements.

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Re: How would you value a business if you considered investing in it

Post by MrPotatoHead » Thu Dec 14, 2017 10:32 pm

rrppve wrote:
Thu Dec 14, 2017 10:07 pm
If you must invest in the business, use a note to buy your shares and have the note paid off from your compensation in the business.
LOL. That my man, is pretty awesome. I love it.

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Re: How would you value a business if you considered investing in it

Post by boglewill34 » Fri Dec 15, 2017 8:54 am

Gamma Ray wrote:
Thu Dec 14, 2017 3:56 pm
One thing I have no information on is the taxes and other relevant mandatory expenses, which I don't think I can get full access. I don't know if those numbers are usually based on given revenue, or if they are actually revealed during any business/partnership situation. Business owner may not want to reveal they are taking advantage of certain loopholes until the partner is committed to buying it, I suppose.
Explain bolded? If you are saying you can't get access to last 3 or 5 tax returns, I wouldn't invest in the business, full stop.

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