Selling with certainty
Before anything can be bought, sold, or transferred, the buyer and seller must first determine, and then agree to, the intrinsic value of the object. Business transactions are no different.
a seller’s view of valuation
History and experience tell us that there is usually a difference between the value a buyer places on an object and the value a seller will place on the same object. Therefore, the success, or failure, of any business transaction begins and ends with whether the buyer and seller can find a common value for that object. And, that common value is usually somewhere in the middle.
Business owners generally confuse the value of the business with their desire to walk away from the sale with a specific amount of money in their pocket. So, they ultimately end up asking a price for the business that is based more on their feelings than on an objective estimate of what the business is worth to a prospective buyer. Or, worse yet, they think in terms of how much money is owed against the business, which has absolutely nothing to do with the value of the business. However, this type of valuation of a business is more common than you might think.
When I first began selling main street businesses such as retail shops, cabinet manufacturers, service companies, and the like, I would begin the valuation process by determining what I thought the business was worth. I would then ask the business owner what they thought it was worth. More than 50% of the time, the business owner’s value equaled a little more than what was owed on the business. When I asked them how they came up with such and such price for the business, their response was always that it was how much they needed to pay off the business and have enough money left to relocate, buy another business, or hold them over until they could get a job.
Don’t fall into the trap of thinking your business is worth what is owed on it or what it will take to get you out of it and moved on. This idea and the real value of the business are not the same. Be sure you have an intermediary who will be forthcoming and honest about the true market value of your business.
To further complicate matters, there are even subcategories of buyers and sellers who don’t agree among themselves on the value of a business. This is because different types of operators have different business models and overheads; thus, they see different profit pictures. All of this may factor into the value a person will place on a business.
Generally, owners don’t know
how to arrive at fair market value. Unrealistic owners are the biggest reason why deals fall through. The number-one reason most sales do not get completed is that the seller is unrealistic about the value of their business. Get the facts and understand the reality of what businesses like yours are selling for in the current market. Never believe anything you read in the trade magazines, or what you may have heard from street talk as the gospel regarding valuations, because no two situations are the same. Valuations are determined by many different factors.
Fair market value can be defined as “the price a willing seller and a willing buyer, both possessing complete information, agree on; when there is no undue pressure to act on either side.” And of course, fair market value will be influenced greatly by the economy, availability of financing, and the number of similar businesses for sale in the same market.
We like to say that valuing businesses is like working with Jell- O. It is very hard to get your hands around the business because the business is always changing. A competitor may move in across the street and change the business landscape. Conversely, a competitor may move out and leave you with more customers. Perhaps your city decides to rebuild the road in front of your store. The time it takes for the construction to finish will certainly impact your business.
The most recent example of this type of change is one where the closing of the sale was scheduled for a Friday, and on Thursday, the state highway department showed up and began construction to install a new turn median in front of the business, which closed one of the business entrances. Ultimately, this meant there was an adverse change in the business and the value of the business. This was why the transaction did not close— because the business value changed overnight.
There are many variables to consider in determining the value of a business—too many to list here. The point is, nothing stays the same. Change. Change. Change. So, what we are searching for is what the business is worth today. Not last year. Not next year when they put in the new subdivision or build a new factory across the street or when a competitor comes out with a new innovational product that changes the landscape of the industry. Think of new entrants like what Amazon has done to the retail business or how digital media has changed the landscape of magazines and newspapers—and cameras. What is your business worth today?
The value of a business is like a financial statement that a bank would have you prepare before it will consider giving you a loan. With a financial statement, the banker learns what you are worth today. Basically, it is a snapshot in today’s market of your present value.
You’ll need to answer the following questions before you can arrive at the fair market value of your business.
what do the numbers say?
Look at the income and expense numbers for the past three years. Why? Buyers are looking to purchase an income stream and want to see what the business has been doing for at least the past three years. Have the sales numbers been trending up or trending down? All business owners have goals to continually increase sales, thereby increasing the net profit of their business. A successful business will show incremental sales and profitability continually, year after year. However, there are sometimes situations, which a business owner cannot control, that will affect the sales and profitability of the business, stopping the positive trend of increasing sales and profitability.
Fair market value can be defined as “the price a willing seller and a willing buyer, both possessing complete information, agree on; when there is no undue pressure to act on either side.”
The preceding is an excerpt from Selling With Certainty: Straightforward Advice For Cashing In On The Full Value Of Your Business by Terry H Monroe published by Greenleaf Book Group Press and ©2018 by Clayton Investments, LLC; published with permission from the author.
Terry H Monroe Greenleaf Book Group Press 2018, 160 pages, Paperback