I am often asked by potential business buyers how sellers determine their asking price. Even though he has been active in the buying and selling business for 34 years, my answer remains the same. They close their eyes and throw darts. Of course, it's a little dramatic in some cases, but not always, and not in most situations, especially in lower sales markets.
Buyers should keep in mind that what a seller thinks their business is worth has nothing to do with its actual value.
Sellers usually enter the exit process with much stronger emotions than buyers. Their business is often their life's work, their legacy, and their purpose. When they set their prices, they take into account all the “blood, sweat and tears” they have invested and factor these into the equation. Of course that's the wrong approach, but it's understandable.
On the contrary, potential buyers understand this from a logical point of view, at least initially. Rest assured, their solidity can often fluctuate significantly as companies move through the various stages of the purchasing process. However, when it comes to valuations, valuations are usually very rigorous, and this is a good approach as long as you don't get so attached that you become closed-minded and miss out on opportunities.
From a buyer's perspective, the key to valuation is making sure it's quantifiable and defensible. The emotions that the seller puts into the valuation cannot be countered by a series of emotions from the buyer's perspective.
This gap between buyers and sellers is part of the journey. Not surprisingly, a recent study by Axial found that “of the 73 investment bankers surveyed, only 1.4 of the surveyed respondents said buyers and sellers often agree on valuations. It was found that %.
i don't have any of it
adobe
Why you need to forget about prices
The seller's asking price serves two purposes. One is to give the buyer insight into what the seller thinks about its value, and the other is to prove that it's not breathing oxygen from the earth.
Well, maybe a little overkill, but not by much. If you ask a seller how they determined their asking price, some of their answers may surprise you. One of the things you learn is that except in rare cases, there is no science or deep thought behind it. Rarely is the overall market, the buyer's risk, or how much the buyer is prepared to pay considered.
Additionally, the seller's asking price should be set aside as it is not important as it may confuse the buyer's thinking. You, the buyer, decide how much to pay – end of story!
rules of thumb are stupid
I've never understood the concept of using rules of thumb as a basis for placing value on a business. All businesses are living things. No two businesses are the same. They may have some similar or common attributes, but are they completely duplicates? Never. In general, it is advantageous for sellers to focus on rules of thumb that, given their scope, can significantly inflate a company's value, but buyers should not use them. They are biased and mostly irrelevant.
There are some exceptions to this.
- When rollups occur in an industry, more than one tends to be established.
- In the world of franchising, scope can be established because there are commonalities between individual franchises and information is shared within the system.
- Trendy industries sometimes get carried away with multiples that influence valuation modeling when industries enter into trades at ridiculous multiples, usually based on earnings, which is completely unwarranted in my view. It's common sense.
Appropriate evaluations are based on facts, not emotions
The beauty of numbers is that they don't lie. Humans do, but numbers don't. Once you know the numbers, the question becomes how do you weight the different time periods and what multiples should you put on them? For the former, we never use less than three time periods, taking into account recent time periods. Based on all the research we've done, we give the most weight to the time period that most accurately reflects what the business will look like going forward. Near future. Regarding the latter, the multiple should reflect the return on invested capital compared to other investment opportunities and whether the business is growing, stable, or in decline.
These are the most basic considerations, and after evaluating hundreds of companies for sale, we determined that there are approximately 50 important factors for buyers to consider. All of this incorporates several key elements into the personal assessment model I use. They are:
- growth potential
- Terms and conditions
- impact of competition
- Barrier to entry
- Dependence on key personnel
- How quickly new owners can take over the business and run it effectively
- Condition of books and records
- Regarding issues such as customer and supplier concentration
- Specialized skills necessary for company management
- Stock status
The complete list is much longer, but I hope you get the concept.
It has been said that valuation is an art, not a science, but I don't completely agree. The science part is numbers, facts about the business, the future, potential risks and returns, threats, etc. These components do not require any artistic interpretation. those are facts.
Don't worry about insulting the seller
Buyers worry about submitting offers or reviews that insult sellers. My view is simple. Feel free to insult them as long as your assessment is factual and defensible. You can't simply pull numbers from what you know, and you can't try a lowball approach to all sellers in hopes of desperate acceptance. In the latter scenario, I guarantee you'll end up with a garbage business.
price that must be paid
You must be prepared to pay a fair price for good business. The trash business isn't cheap. But a fair price means it reflects reality. If it's an advantage for someone, it should be an advantage for the buyer. This is because the buyer assumes all or the greatest risk in these transactions. The only way for buyers to do that is to make a fact-based valuation, with over 50 attributes to consider, and be able to defend that valuation. The only way that can happen is if it is based on factual data and logic, not emotion.
This is the art part of creating a valuation.
When you find the business that's right for you, when your skill set perfectly matches what drives revenue and profit for your business, don't listen. Get ready to raise your ratings. If the business is right for you, it's okay to pay a premium if necessary. At the end of the day, a few extra fees will be negligible when you consider the impressive benefits that business ownership brings.
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