There are four pillars that make up the foundation of a successful business sale: a marketable business; a motivated seller; a realistic price; and a professional Business Intermediary to guide the deal process. The unfortunate reality is that many listings do not sell, and the number one reason is high price. Having realistic expectations about the value of the business going into the sale can make all the difference. Let’s explore what does, and what does not drive the value of a business.
While we can establish any “market price” that we want, the consideration paid for a business transaction that closes is the market value, as negotiated between a buyer and a seller. Buyers these days are sophisticated, and have considerable information available to them. Be assured that they will do considerable research and compare the value of your business to others that have similar performance. Often, they are guided by a professional Business Intermediary themselves.
The law of substitution is a guiding principle in the purchase of business opportunities, as it is with all other investments. Buyers have many choices, and they are unwilling to pay more for a business than comparable sales would warrant.
My Business is Different
With a few exceptions, businesses are very unique. It is relatively easy to point out why a given sales comparable is different than the target business. However, the consideration that buyers pay in a typical purchase of assets + goodwill is the future expectation of cash flow. This future expectation of cash flow is primarily based upon recent historical financial performance, which acts as the common language for business value. The differences in the business has been part of its success, and that success is already reflected in the financial performance. The unique qualities of the business do serve another purpose: all other things being equal, these advantages often create a strong connection for the buyer and lead to better offers and quicker sales than businesses that have less to offer.
Paying for Potential
Business Intermediaries spend a considerable amount of time helping to educate buyers and sellers about the valuation and deal process. One topic that is frequently discussed is the future potential of the business, how much can it grow, and what are the mechanisms for that growth. It is critical that this growth potential can be demonstrated to buyers for a successful transaction. Once a transaction is completed, though, buyers must spend considerable resources of time, money, and talent to realize and be rewarded for that growth in the business. While future growth potential is a necessary ingredient for a business, it isn’t something for which a buyer will pay a seller.
There are a lot of factors that go into the timing of a business sale. If there is low hanging fruit in the growth potential of a business, and the seller has the time and other resources to harvest that success, then it may be appropriate to do so. This growth will add to the valuation of the business in accordance with the valuation multiple. Business Intermediaries are great resources for helping business owners plan for a future exit from the business, while taking steps now to maximize its value.
Years of Hard Work!
Sellers sometimes feel exasperated about the value of their business, given the many years of hard work equity that they have invested in the business. But recall that your business provided many years of income to you and your family, maybe even a lifetime of income. And your income and quality of life as a business owner were probably far better than those with merely a job. Additionally, when you sell your business, you will receive a lump payment and/or payment stream that is quite significant, may last for several years, and requires no additional work. Very few people with a job exit with such a payout as this.
From a buyer’s perspective, the investment in a business is also significant, and may represent several years of hard work “for free” before they are able to recoup their investment. Additionally, a buyer assumes all future risks of a business once purchased, included internal as well as external factors that may affect the financial performance. Thus, the market value paid for a business is a balancing act, and a true representation of the forces of supply and demand for that type of investment.
Maximize value by using a Business Intermediary
If a seller does not use a Business Intermediary, then the net proceeds to the seller automatically go up by the amount of the brokerage commission, right? Sales data does not support this for business sales, and in much the same way that this logic does not work for the sale of numerous other types of assets. Hiring and expert gets the transaction completed for a higher price, less cost, fewer (if any) mistakes, and considerably faster.
It’s Not an Appraisal, It’s a Valuation
Business Intermediaries generally are not interested in an Appraised Value for a business, are not fully trained in Appraisal methods, and are not licensed to perform Appraisals. This formal process is left to Certified Business Appraisers who perform their work for lawyers, lenders, and courts. This is a time consuming and expensive process, and goes well beyond the scope of what a Business Intermediary is trying to accomplish.
Business Intermediaries are trained in a more simplified valuation approach called the Direct Market Data Method. This is a fancy way of saying that comparable sales transaction data is studied to determine the underlying valuation multiples for a give business segment, size, and location, and then applied to the target business’s financial metrics to arrive at a Most Probable Sell Price (MPSP). We use the MPSP to arrive at an Asking Price. Once the Asking Price is advertised in the market, buyers and sellers then arrive at the final market value through negotiation.
But I Heard It’s Worth This Multiplier
In the field of business valuation, there are many different multiples used to calculate value. Common multiples used are for Revenue, Owner’s Benefit (also known as Seller’s Discretionary Earnings or Adjust Net Income), EBITDA, and EBIT. All of these multiples have a different value because they are applied to different metrics of the business’s financial performance. Of course, the multiples are also different for various business segments, and even different sized businesses within the same segment.
Sellers have often heard of some multiple number that has stuck in their mind, but apply it to the wrong metric, segment, or business size. Unfortunately, this may lead to a false belief in what the valuation for the business, and even to unrealistic price expectations that prevent the business from being sold at all.
The best way to understand the value of the business is not to guess, but have a professional valuation completed by a Business Intermediary. Furthermore, ask the Business Intermediary to show you which sales comparable data was used, how the multiples were selected and what is the level of variation in that data set, how the finances of the business were recast to arrive at the appropriate metrics, how the sell prices were calculated, and how those various values were reconciled to a single Most Probable Sell Price (MPSP.)
If the process used was robust and appropriate, then a seller can be confident that the MPSP is an accurate reflection of the market value for the business.
Put the Shoe on the Other Foot
Business owners are smart, savvy people. They frequently use their experience and reason to calculate whether an investment is a fair value. When the seller of a business is considering the appropriate value of that business, think like a buyer instead. How would they view the business if they were a buyer considering an investment in the business? What time horizon would they expect to recoup their investment? What are the risks associated with the business that could affect its future financial performance? What changes could be made that would positively impact the value? If an owner can step outside their present relationship with the business momentarily, thinking like a buyer will give them a much better sense for how the market will value that business opportunity.
Business owners make better decisions when they have better data. When it comes to selling a business, contact an expert Business Intermediary to complete a valuation. They will point out what does and does not drive value for the business, based on actual market data, so that a pricing decision can be made with better precision. Being confident and realistic about the Most Probable Sell Price will make it much more likely that a successful sale will be completed.