Liquidity Affects Business Valuation

A fundamental tenet of the law of supply and demand is that a market-based price is determined by an agreement between a willing buyer and a willing seller. More demand from more buyers raises the market-based price while less demand lowers the price. Business sale transactions also follow this fundamental tenet. In business sales, a liquid market – as opposed to a thin market – ensures a sufficient number of buyers are exposed to the business for sale. A liquid market allows for a quick and efficient business sale and is characterized by high market demand for the business, standardized valuation, and a fast transaction process. Without a liquid market, business owners can not rely on the power of the market to help attract the best possible price and terms for their business.

Liquid Market Creates Transparency

A thin or narrow market is characterized by a very low number of buyers and sellers. Because there are not enough buyers, prices will not be in balance and will be extremely volatile. Not enough buyers results in lower demand and hence a lower price for whatever is being offered. In a marketplace, a chief cause of having not enough buyers is often – ironically enough – not having enough sellers. When there are not enough sellers, buyers will want to go where they can shop around and sellers can not compare what they are selling with similarly situated sellers. A thin ‘business sales’ market lacks transparency and does not allow buyers to compare the value of businesses. By contrast, a liquid market has a sufficient level of both buyers and sellers to create transparency and price-awareness.

Example of Selling A Business in A Thin Market

Some sellers of businesses sometimes try to sell a business on their own by means of a ‘For Sale by Owner’ (or FSBO).
A ‘FSBO’ sale usually results in a very thin market for the offered business.
Let us suppose that Don owns Don’s Plumbing Service and wants to sell his business and retire.
Don decides to sell the business himself, and tells his friends and family members to be on the lookout for a good buyer.
He also calls his colleagues in the plumbing industry to see if they would be interested.
Moreover, he mentions the sale to select employees and hopes one of them may make an offer.
At his wit’s end, Don may also place an ad in a plumbing trade journal hoping to attract a buyer.
A big problem with Don’s attempt to sell his business is attempting to sell the business in a thin market.
Although Don may think otherwise, he is advertising the business to a very small and local group of possible buyers.
Further, Don’s buyers are not being exposed to other similarly situated plumbing companies for sale, so they have no way to compare valuations.
In short, Don is trying to sell his business in an illiquid market.
The business is being advertised to a very small and limited set of buyers which results in extreme price volatility.

Defining A Liquid Market for South Florida Business Sales

A thick or liquid market is defined as a market with many buyers and many sellers, resulting in sufficient volume so that price volatility is lessened. Selling a business in a liquid market allows the seller to receive the best possible purchase. With a liquid market, a seller of a business can much better determine its fair market value by observing the sale of similar businesses. Critically, a liquid market feeds on itself with many sellers resulting in more buyers and more buyers resulting in more sellers. The seller will not be pigeon-holed into one or two buyers when negotiating the purchase price. Rather, the seller in a liquid market will be able to receive feedback and potential offers from a wide array of buyers from all over the world.

Example of Selling A Business in A Liquid Market

In re-examining the sale of Don’s Plumbing Service, let us now suppose that Don wisely chooses to locate a professional business broker in order to sell his business.
The business broker should properly market and advertise Don’s business (confidentially without disclosing the name or specific location of the business through a blind ad) in as many markets as possible.
Such online business marketplaces are bizbuysell.com, businessbroker.net, businessmart.com, mergernetwork.com, and bizquest.com.
By advertising the business to a large world-wide network of buyers, and by being advertised in a market with many sellers (including similarly situated plumbing companies), Don’s business is now advertised in a liquid market.
Don and his broker can now see what other plumbing companies are selling for, and conversely, potential buyers can now compare the value of Don’s business to other plumbing companies for sale.
There is now some degree of price transparency, and a much greater amount of possible buyers.
This means that Don will have a far better chance of realizing the full value of his business.

Business Sales Should Be Conducted in Liquid Markets

A liquid market means more buyers and more sellers, with price transparency and less price volatility. A seller of a business should not fear a marketplace with other similarly situated businesses for sale. Such a marketplace actually results in more buyers (who are attracted to the sellers) and an efficient means for both buyers and sellers to ‘shop around’ and understand the correct value of the business.

At the end of the day, selling one’s business by use of a professional business broker within a liquid a market as possible will result in the best possible purchase price.

Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.