Multiple Bidders Creates Negotiating Leverage
Some business owners mistakenly assume that they may safely rely on only one buyer when selling their business. Such a buyer is often an employee, family member, or competitor in the industry who has expressed interest in buying the business. It is generally not a good idea to attempt such a sale without first setting a firm asking price, obtaining accurate and transparent financials which justify the asking price, and creating a liquid market by exposing the business (in a confidential manner) to a wide range of buyers. A liquid market is a marketplace with a sufficient number of buyers and sellers where price transparency is attained while price volatility is reduced. When a business owner solely relies on just one buyer to purchase their business, negotiating leverage is lost as no other prospective buyers have an opportunity to make an offer.
Maintain Negotiating Leverage
Negotiating leverage for the business seller is always enhanced when both parties know that other buyers may emerge. This is especially the case when buyers make their initial offer. After an offer is accepted, the parties still must negotiate the purchase agreement and the buyer must complete their formal due diligence as a contingency to close. Business owners should be aware that there is about a 50% chance that their deal will fall through at some point after an offer is accepted. Sometimes a buyer may also seek a lower price with more favorable terms based on the information received (or not received) during formal due diligence. By maintaining negotiating leverage within a liquid market, sellers are not compelled to accept a lesser price and terms than what was originally agreed upon. Confidentially exposing the business to multiple buyers (within a liquid market) allows for back-up buyers and new buyers to constantly emerge. A seller who is solely relying on one buyer will have little if any negotiating leverage.
Price Transparency
Many business owners who attempt to sell their business to just one buyer do not have a firm asking price. Instead, they expect the buyer to make an offer and assume they can then negotiate a successful deal. Instead of relying on a price tossed out by a buyer, sellers should have a firm asking price based on the comparable valuation multiple of adjusted owner benefit that similarly situated businesses receive. When the asking price is justified and firmly set, feedback from multiple prospective buyers allows the seller to understand the degree to which their asking price is reasonable. Setting a transparent price puts the seller in charge of the selling price (rather than just one buyer) and provides a mechanism by which buyers may compare the valuation of the seller’s business with other similar businesses. This price discovery process is the most effective means for prospective buyers to understand the value they will be receiving for a business compared to the price that sellers are willing to accept.
Example of Business Sale Without Negotiating Leverage
- Let us suppose that Joe has attempted to sell his air conditioning (or HVAC) repair business without the assistance of a professional business broker.
- Joe’s business has been in his family for several decades, and he has verbally agreed to a price of $2M with Bob the buyer.
- Bob owns another HVAC company in the region, and approached Joe about buying his business.
- Bob made an offer of $2M (which Joe verbally accepted) based on Joe’s assurances that the business generates $800K/year in adjusted owner benefit (or true economic profit to Joe).
- Bob then presented his proposed purchase agreement, and Joe is dismayed to now learn that Bob has included a $1M earn-out as a part of the $2M purchase price.
- The earn-out money is only paid to Joe over time after the sale if the company meets future financial targets.
- Joe does not want to accept an earn-out, and contacts a business broker for assistance.
- Joe explains to the broker that he has allowed Bob to meet with his general manager, and is now worried that the general manager may leave when learning that the deal with Bob has collapsed.
- Where did Joe go wrong and what can be done to remedy the situation?
- Joe has made two critical mistakes.
- First, he did not set a firm asking price and did not allow other buyers to make offers prior to verbally accepting Bob’s offer.
- Joe should have had an asking price of at least $2.5M, which is a slight premium (3.12 x $800K) to the median multiple of 2.78 x annual owner benefit for HVAC companies in Florida.
- The premium is based on the historical financials (showing growth in the business), recurring nature of the service revenues compared to new installations, and longevity of operations.
- Confidentially listing his business within a liquid market would have allowed any buyer throughout the world to have substantially beaten Bob’s offer of $2M.
- Second, Joe errored by solely relying on Bob as a buyer of his business with no back-up buyers.
- As a result, Joe had no negotiating leverage (which Bob realizes) when faced with the unexpected earn-out provision in Bob’s proposed purchase contract.
- To remedy his situation, Joe should allow the broker to list his business in a liquid market with a transparent asking price that is justified based on the attributes of his business.
- This way, Joe’s business broker will deal with many different buyers, each of whom will be competing against one another in hopes of buying the business.
- The breach of confidentiality in allowing Bob to prematurely speak to his general manager is a costly mistake and would not have happened under the guidance of a professional business broker.
Avoid the mistake of solely relying on one buyer to purchase your business. Instead, set a firm asking price that is justified based on the adjusted financials and comparable selling prices of similar businesses. Then create a liquid market where any buyer throughout the world may make an offer, and always have back-up buyers in order to maintain negotiating leverage during the formal due diligence process with a particular buyer.
Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.