What Impacts the Purchase Price of a Business For Sale
There is a lot to consider when you sell a business. The final purchase price and deal terms are impacted by many different factors that a buyer, and ultimately the “market”, will consider.
Over the past 2-3 years is the business growing, flat, or declining? For example, “Business A” made $200,000 last year and $100,000 the year before. “Business B” made the same $200,000 last year, but $300,000 in the year prior. In almost every case, Business A is worth far more in the eyes of an individual buyer. They want to acquire a business that is growing, or, at the very least, is stable.
Ease of Transition:
Interestingly enough, most small business buyers will purchase a business outside of their area of expertise or experience. As such, it is important that the transitional period after the sale is something that the buyer sees as being reasonable.
A buyer must feel confident they’ll be able to have a good grasp of things within a short time after they take over. This can only be accomplished if the business is well managed with policies, procedures and systems in place. If you want to know how easily the business will transition to a new owner, ask yourself the following question: “If I get hit by a cement truck today, what will happen to the business tomorrow?” For example, if the seller possess highly specialized skills that are critical to the business, or if the seller has long-standing personal relationships with clients that drive the sales, then these will be obstacles to a successful transition.
The Buyer Pool
Just like the transition period, there is a direct correlation between the purchase price of a business and the ease in which someone new can operate it. In the market, there are tons of people always looking to acquire a business. The greater the amount of those people who can see themselves running the business, the more demand there will be for the business, and therefore the higher the price and the better the terms a seller can get. If a business simply requires good all around business/management skills, then the buyer pool will be quite large.
Conversely, if highly specialized or certified skills/licenses are required to operate the business, the number of potential individual buyers shrinks drastically. In extreme cases, a seller may have to think about a strategic sale to someone in the industry.
Books and Records:
I cannot emphasize enough the importance of having good, clean and accurate books and records. It may very well be the single most important influencing factor of the price and terms when a business is for sale. There is no quicker way to “kill a deal” than having the buyer learn that the actual company records are not in line with what was originally represented. It is terribly upsetting when a deal falls apart, and though some may be salvaged, when it’s due to poor financial records often times the buyer will be: “out the door…see no more.”
Another aspect is unreported income. If you are taking in cash sales and not reporting it, then you cannot expect to be paid for it when the time comes to sell the business – you can’t dance at all the weddings. If you had the benefit of not paying taxes for years on this money, and you have no quantifiable means to prove the number, then surely you cannot expect anyone to pay you anything, let alone a premium for this “alleged” revenue.
Typically, a seller wants to have this factored into the price. However; one must consider the provability of this unreported income. The questions becomes:
- Can you prove it?
- Do you even want to prove it?
You may want to be very cautious about this situation.
Having said all this, there is a way for you get the best of both worlds, as long as you’re willing to make a small, short-term sacrifice. As soon as you decide to sell a business, start putting all the income on the books. The average business will sell in 7 – 8 months. During that time you can demonstrate to any buyer the increase in the top line revenue when you reported all the income. The difference in the selling price can be significant. More importantly however; it can be undeniable proof and full validation of your claim although you may need to agree to structure this portion as an earnout in order for the buyer to feel comfortable.
Back to our example of Business A and B. Both companies generated the same profit to the owner for the past two years. Business A has one hundred clients, none of which represent more than five percent of the revenues. Business B has the same hundred clients, but two of them contribute forty percent of the revenue. Which company is worth more? Business A of course! If one or two of Business B’s clients stop buying, the business could decline by almost half.
Exclusive Products or Services
If there is an element of exclusivity to the business, whether in product or territory, this can be a huge selling factor. Naturally, the buyer will want to see this transition to them and so you need to consider this situation. For example, in a distribution business that has an exclusive territory, it will be paramount (and definitely a deal contingency) that the relationship with a particular supplier for example will continue. Conversely, if the entire business relies on this relationship, it can hurt you. It’s the supplier version of customer concentration. However, if the relationship is solid and a new contract will be granted to a buyer, it can be worth a premium in the sales price.
Any business with a strong recurring revenue base is both highly sought after and will almost always command a premium. Examples are alarm monitoring companies, marinas, self storage facilities, and some pest control businesses. The lure is that a new buyer is almost assured of continuity and can count on revenue from day one. If any part of your business has a recurring revenue component, then play it up. If not, think about ways that you can possibly generate some; it will be well worth the effort and expense to do so.
Grimes, McGovern & Associates provides expert advice during all phases of a transaction. Contact us today for a confidential consultation: John McGovern, CEO, firstname.lastname@example.org, (917) 881-6563.
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