Determine Optimal Asking Price
When it comes time to sell a business, the asking price should always relate to the fair market value of the business. The individual traits of the business, as well as the individual desires of the business owner, may result in an asking price that is significantly below or significantly above the fair market value. Specifically, the transparency of the company’s financials, the timeline of the seller, and the degree to which the seller is comfortable accepting seller-financing are all relevant factors in determining the best possible asking price. Before a business owner should determine their best asking price, they must first determine the fair market value of their business with the assistance of a professional business broker.
Determine Fair Market Value of Business
- Determining the fair market value of a business is a detailed and lengthy process that should be conducted by a professional business broker.
- The business owner must be prepared to give the broker their historical financials, a physical asset list, and other relevant information necessary for the broker to fully understand all aspects of the business.
- In general, businesses are priced as a function of their expected future cash flow, and are given a multiple of their annual profits or ‘owner benefit’ in order to derive its fair market value.
- The ‘owner benefit’ is defined as the true economic profits derived by a working owner of the business.
- Discovering the true ‘owner benefit’ involves taking the EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) from the most recent financial statement, and then adjusting the EBITDA by ‘adding back‘ the owner’s salary, personal expenses of the owner that flowed through the financial statement, unrecorded sales (if proven), and other non-recurring expenses that a buyer of the business would not incur.
- Once the adjusted ‘owner benefit’ is determined, a multiple of the owner benefit (typically between 1.5-4x) is used to determine its fair market value.
- Many factors are used when deriving the relevant multiple or valuation of a business including its industry, growth rate, longevity, competitive advantages, the lease and location, the physical or tangible assets, and the degree of the owner’s involvement or role in the business.
Transparency of Financials Relevant in Determining Asking Price
The financials (such as tax returns or profit and loss reports) of a business are considered transparent if they fully reflect the actual sales and profits of the business. Many business have unrecorded sales or use a large amount of personal expenses that flow thru the financial statement as business expenses. The transparency of the financials will affect the ability of a buyer to obtain bank funding backed by the Small Business Administration (referred to as SBA-backed funding).
Better Transparency Means Higher Asking Price
Most external lenders including the SBA generally assign lower valuations to businesses that lack clear and transparent financials. If the lender is valuing a business for significantly less than the agreed upon purchase price, then the buyer will not be able to obtain funding. This means that business owners that lack transparent financials must be careful in setting their asking price. Their asking price should no more than its fair market value (as discerned by the average buyer – not the bank). If the financials are non-existent or non-provable, then the asking price should be further examined. Conversely, business owners with clear and transparent financials often have asking prices at a significant premium to their fair market value because of the ease by which buyers may obtain third-party financing.
Timeline of Seller Impacts Asking Price
The average length of time to sell a business is six to twelve months. This is a lengthy process, since a business is not a liquid asset (although they should be sold in liquid markets) that may be readily convertible into cash. If a seller is in a hurry to sell their business, then their asking price should be less than its fair market value. There are exceptions, but a rushed sale often does not allow enough time to lapse before the right buyer may be located. A crucial way in which sellers may maximize their purchase price is by giving themselves plenty of time (at least six to twelve months) to find the right buyer in a confidential sale with a professional business broker.
Seller-Financing Affects Asking Price
Some business owners when selling their business accept part of the purchase price (50% or less) in the form of a seller-financed Note. The buyer pays off the Note to the seller over time (usually five years or less) at an agreed upon interest rate. Typically, the Note is secured by the business via a UCC (Uniform Commercial Code) Lien which the seller will place on the business immediately after the sale. The seller may negotiate for the buyer to put up more collateral including personal assets. In any event, the seller will be taking risk by allowing the buyer to obtain partial seller-financing. In exchange for the extra risk, the seller may often have an asking price that is significantly above the fair market value of the business.
Example of Seller-Financed Deal Affecting Asking Price
- Let us assume that Joe wants to sell his sushi restaurant, and consults with a professional business broker.
- The broker tells Joe that the restaurant’s fair market value is $500K.
- Joe thinks it through and is not quite satisfied with selling at that price.
- Then Joe agrees that he would be willing to accept $600K with $300K down from a buyer.
- Joe also stipulates that the buyer must have restaurant experience and sufficient credit-worthiness in order for him to accept a Note.
- By agreeing to partially seller-finance the asking price, Joe is essentially raising the asking price by 20% or $100K (from $500K to $600K).
- Many buyers will readily agree to pay a premium to the restaurant’s fair market value if they are allowed to finance a significant amount of the purchase price through the seller.
Once the fair market value of a business has been ascertained with the assistance of a professional business broker, the asking price should then be determined. Often, the asking price of a business may not exactly correspond with its fair market value. The business owner should understand that the transparency of their financials, their timeline, and whether they will allow a buyer to obtain seller-financing will affect their asking price.
Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.