I am often asked by potential business buyers how sellers determine their asking price. After 34 years in the trading world, my answer remains the same: they close their eyes and shoot darts. Obviously, this is somewhat dramatic in some cases, but not always, in most cases, especially in a down market business.
Buyers should remember that what sellers think their business is worth rarely has anything to do with its true value.
Sellers typically enter the exit process with more emotion than buyers. Their work is often their life’s work, their legacy, their purpose. When they set their prices, they will take into account all the ‘blood, sweat and tears’ they put into the equation. This is, of course, the wrong approach, but it is understandable.
On the contrary, potential buyers see it logically, at least initially. Be sure that continuity often fluctuates significantly as they move through different stages in the business acquisition process. However, as far as evaluations are concerned, they are usually quite strict, which is a good approach if they don’t get carried away too far and lose opportunities due to closed-mindedness.
From the buyer’s perspective, the key to valuation is making sure it’s quantifiable and defensible. The emotion that the seller puts into his price cannot compete with a second set of emotions from the buyer’s point of view.
This gap between buyer and seller is part of the journey. No wonder Axial’s recent study found that “only 1.4% of 73 Investment Bankers surveyed frequently match valuations between buyers and sellers.”
Why You Should Forget Price
The seller’s asking price serves two purposes: either to give the buyer some idea of how the seller thinks about value, or to prove that they don’t breathe oxygen from this planet.
Okay, maybe a little higher, but not much. Ask a seller how they found their asking price, and some of their answers will surprise you. One thing you will learn is that, except in the rarest of cases, there is no science or deep thought behind it. Rarely is the overall market, the buyer’s risk, or what the buyer is willing to pay considered.
In addition, the asking price of the seller can distort the mind of the buyer, so put it aside, it is not important. You, the buyer, determine what you are willing to pay – end of story!
The rule of thumb is stupid
I’ve never really understood the concept of using Core Rules to deliver value to a business. Every business is a living entity. No two businesses are the same. They may have some similar or common attributes, but an exact duplicate? Never. While it is useful for the sell-side to look at Rules, given their range, which can grossly increase the value of a company, buyers should not use them; they are skewed and often irrelevant.
There are only a few exceptions to this:
- When hoardings occur in an industry, clusters tend to form;
- In the franchising world, since there is a point of commonality between individual franchises and information is shared within the system, ranges can be set;
- Trendy industries sometimes deal with multiples that affect valuation modeling when business types start trading at ridiculous multiples and are usually based on earnings, which in my opinion is completely insane.
A proper assessment is based on facts, not feelings
The beauty of numbers is that they don’t lie; people do, but numbers don’t. Once the numbers are known, the question becomes how to draw the various periods and how many times they should be added. For the former, with recent periods to consider, I never use less than three, the largest weighting per period that most closely reflects what I believe the business will look like, based on all the research I’ve done. near future. With regard to the latter, the multiple should reflect the return on invested capital and whether the business is growing, stable or declining compared to other investment opportunities.
These are the most basic considerations, and after evaluating several hundred businesses for sale, I’ve determined that there are about fifty critical components that a buyer should consider, all of which we’ve incorporated into my personal evaluation model that I use with a few keys. those who:
- Growth potential
- Terms of contract
- The effect of competition
- Barriers to entry
- Trusting key personnel
- How quickly the new owner can take over and manage the business effectively
- Terms of books and records
- Regarding issues such as customer or supplier concentration
- Specific skills required to run a company
- Inventory status
The full list is much longer, but hopefully you get the concept.
Although valuations are referred to as an art rather than a science, I strongly disagree. The science part is numbers, facts about the business, its future, potential risk and return and threats among others. These components do not need artistic interpretation. They are factual.
Don’t worry about insulting the seller
Buyers are concerned about submitting an offer/price that will insult the seller. My perspective is simple: go ahead and insult them as long as your assessment is factual and defensible. You can’t just throw out the numbers you know or try a low-balling approach hoping that every seller will be desperate enough to accept it. In the latter scenario, I guarantee you’ll be running a junk business.
The Price You Should Be Prepared to Pay
You must be willing to pay a fair price for a good job. The junk business is never cheap enough. But a fair price means that it reflects reality. If it is beneficial to anyone, it should be to the buyer, because he bears all or most of the risk in these transactions. The only way a buyer can do this is to base their assessment on facts and be able to defend their assessment, taking into account the fifty plus attributes to consider. The only way that can happen is based on factual information, logic, not emotion.
Here is the Art Part of Scoring
When you find a job that’s right for you, meaning your skill set perfectly aligns with everything that drives business revenue and profits. Be prepared to raise the price. If the business is right for you, it’s okay to pay a premium if you have to. After all, a little extra will likely be insignificant based on the great benefits that business ownership can provide.
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