No Offer is Good Enough: A Common Fallacy

Some business owners feel no reasonable offer is enough to entice them to sell their business. Some, especially those who founded, built, nurtured, and grew their businesses may fall into this category. They probably invested most of their capital to launch their business and worked long and hard hours and have more sweat equity invested than anyone but their spouses and families would believe. Certainly, this and all the customers who have for years patronized their business must translate to a huge amount of goodwill and increased value and price for their business.

More…In a word, NO! The factors mentioned above have little bearing on the value of a business. Small businesses are valued by assessing the earnings of the business, known as net cash flow or seller’s discretionary earnings (SDE). Critical consideration is given to the performance of the business over the past three years.

The market value of a business is generally determined by multiples of SDE. Sometimes these multiples are based on ratios common to a specific industry or are based on average multiples for businesses in the same size and revenue range. Other times, market value is based on an industry factor that divides into gross revenues.

Risk assessment, efficiencies, trends and most importantly the likelihood of a continued income stream and earnings from the business are the determining factors as to whether a buyer will even submit a purchase offer. The amount of money a buyer will agree to pay for a business beyond the tangible or hard assets of a business is the intangible part. This is usually allocated to the covenant-not-to-complete and to goodwill. Usually, a multiple of SDE or a factor of gross revenue less the value of normal trade fixtures, furniture, and equipment is what determines the value of the goodwill and a portion of that value are assigned to the covenant-not-to-complete.

Recently, I gave a presentation before a Business Network International (BNI) Chapter regarding the need to inform and educate sellers as to the factors that realistically impact and determine the value of their businesses. When I meet with first generation owners who have built their businesses from inception and who have owned their businesses for many years and who may be nearing retirement age I assume they will have a much higher expectation of the value of their business than the market will realistically bear.

Often times such sellers refuse to acknowledge and accept the reality of the market. This may result in the listing price being so unrealistically high that prospective buyers are turned off and don’t consider an overpriced business to be a viable or serious opportunity. Lowering the price will not likely win back serious, qualified, and knowledgeable prospects.

Ultimately, the owners may receive far less for their businesses when they finally do decide to sell. They may be forced to sell due to compelling reasons like ill health, divorce, partnership breakup, or the passing away of a principal. This may even result in eventual liquidation of the business assets and closing the doors. Instead of properly preparing and marketing their businesses within sensible and justifiable parameters, the leverage and appeal they may have had is lost in the urgency of their pressing need to sell.