Valuing A Business For Sale Should Never Be A Guess

It is very common for a buyer and seller to have a huge difference of opinion when it comes to valuing a business. It is certainly a topic that I have written about extensively in past newsletters, and it is a very subjective stage within the process of buying a business.

It would be wonderful of course if there were set prices for various businesses just like a buying a donut at a retail store, but there are not, and there never will be; so trying to make valuations a homogenous exercise is a complete waste of time. That is why I am so staunchly opposed to any “rule of thumb” theories. Since their very foundation is nothing more than a benchmark, they do more harm than good in trying to get a buyer and seller aligned on the purchase price.

That aside, they (Rules of Thumb) can play a role but that is specifically limited to allowing a buyer or seller weigh in additional theories when compiling a valuation, but enough on that point.

The fact is that getting a buyer and seller to agree on a price is a challenge, and it is mostly a result of both sides being poorly informed. A seller who takes their business to market without an intermediary uses establishes an asking price based solely upon what he or she believes the business is worth, or worse, based upon how much they may need to either retire, or enter a new venture, etc. These are by far the most dangerous scenarios simply because there is no logic whatsoever behind their asking price.

Granted, when a broker is involved there is usually more thought behind it, but not always, because often listings are accepted by brokers at inflated seller prices with the old adage that the price will be adjusted over time. This “take the listing first” mentality usually generates more grief than benefit to all sides of the deal (if any deal materializes at all).

On the buy-side, the challenges can be more daunting. Very few active buyers have any experience whatsoever in the valuation process and so they are looking at arbitrary asking prices, or trying to compile their own valuations with zero experience. Talk about the “blind leading the blind”.

From a buyer’s perspective, the one thing that should be tabled early on when discussing the valuation with a seller is to find out exactly how the seller arrived at their valuation. There is no reason to go around in endless circles trying to find common ground if the parties are light years apart. Sometimes there is no common point where the parties can agree. However, by determining the rationale behind a seller’s valuation early on, a buyer can, at the very least, provide counter-points to the asking price. Often, there is no rationale, but this way you can know what you are dealing with. I remain steadfast in my belief that most businesses listed for sale are overpriced and so having the right ammunition is critical for any buyer to get a deal done.

I do not believe that much attention needs to be paid to the asking price of a business for sale – the asking price is not the selling price! But again, it provides insight to a seller’s thought process and level of motivation for a sale.

Since a buyer cannot defer to the seller to determine the price, they (the buyer) must approach a business valuation with highly focused logic. It is useless to table offers without being able to provide a meaningful explanation for how your price was determined. This is especially important in cases where a seller’s price has been “plucked out of the air”. A buyer must clearly outline the background to their valuation, why it makes sense in light of the financials, the industry, the competition, the business threats, possible capital expenditures, sustainability of the business, and the necessary and acceptable return on their investment.

There’s an old adage that a business is worth what a buyer is willing to pay and what a seller is willing to accept. True enough, but that is a tad altruistic in my opinion, and may oversimplify what is involved.

Of course, all this is moot if or when a buyer is willing pay the seller full asking price and terms for their business. However, that is rarely the case, and it is more likely that a buyer’s offer will be “insulting” to a seller, at least initially. I have never been bothered about the idea of “insulting” a seller with any offer that is way below their price or expectations – they get over it. But if you are going to offend them, you must at least have concrete data to back up your theory.

Click here to read more information about the different methods to use and how to value a business.

Have a great week.

Comments

[Tom Gledhill]

You seem to be a bit "old school" in your presentation. I find buyers to be much better informed than when I first got involved with business brokerage. I find that buyers are much better informed due to all the information available on the internet - including your blog & e-book. Business owners, on the other hand, are so engrossed in running their business & so emotionally involved that they usually have an unrealistic expectation of the value of their business. But even with business owners, they are better informed tha they used to be.

[Clinton]

Brilliant post as usual, Richard. I find that when sellers are asked to explain the reasoning behind their valuation they come up with the wildest theories.

As you know, I deal a lot with websites. It's amazing how often a seller provides as justification the pretty design of his site ... or the fact that MySpace sold for $580 million despite making no profit as all. (Sub-text: My business is worth a lot of money even though it's never made a cent.)

[Indiana Business Broker]

I often find buyers have done much more research into valuation techniques than sellers. Getting sellers to understand the true market value of their business is sometimes difficult, but a broker must back up the valuation with data. "I've been in business 30 years...I'm well known in the industry...it's got great potential" are all things sellers say to try to convince me of the value of their business.