Play the Pricing Game
Negotiation is a big part of the business world. So when it comes to buying or selling a business it should come as no surprise that this practice plays a large role in determining price. Both sides want a smooth transaction as well as what they view as a fair price. But arriving at that price point may take some work for both the buyer and seller. Most businesses sell based on the “owner’s benefit,” a number that simply represents the seller’s annual discretionary cash, says Jim Robertson, a counselor with SCORE, the national small-business resource center. Robertson said that, depending on the type of assets a business has, the market value will likely be one to three times the owner’s benefit number. But if that sounds cut and dry, it’s not -- there are plenty of factors that both sides need to study and discuss when determining what should affect a business’s sale price. Knowing details, from how much inventory is worth to routine maintenance needs, is key in negotiating the price of a business.
Step 1: Assemble a Team
Buying or selling a business is a complicated process, and so is price negotiation. Both sides -- especially the prospective buyer -- should consider working with an attorney and an accountant. Robertson says an accountant’s expertise in particular helps to calculate the owner’s benefit number and to spot anything in the books that may need closer examination.
Step 2: Determine the Value
That means not just what the business is worth now, but what it will be worth in the future. Some of that calculation is straightforward. The business’s tangible goods and assets minus the debt will give you a rough number. But also consider harder-to-determine assets like goodwill and customer loyalty. Factors like compensation for a noncompete agreement will also affect the selling price.
Step 3: Factor in the Economic Climate
Depending on what’s going on with the economy, either the buyer or seller could enter negotiations with an advantage. Either way, the economic climate will almost certainly affect the terms of the sale. A good economy may favor the seller, since it’s easier and sometimes smarter to hold out for more money when the economy’s going strong. But in a downturn, the buyer is likely to have more bargaining power.
Step 4: What Are the Reasons for Selling and Buying?
Both sides should have a clear idea of why the other party is either looking to buy or sell the business, as well as an understanding of the other party’s financial health and other investments. Is the seller putting the business on the market for financial or personal reasons? If so, the buyer may have more negotiating power. But if the business is for sale because the owner knows it’s going strong, the buyer may have more competition and less leverage. Both sides should also understand that the more a buyer wants the business, the more concessions they’ll be willing to make.
Step 5: What’s Being Purchased?
Robertson says the most common type of transaction is one in which the purchase includes the building and business name and nothing else. More complicated and uncertain is the type of purchase that involves taking on an entire corporation, including debts. “That’s pretty risky, because you don’t know what will crawl out of the woodwork,” he says. “When you go into the discovery phase, the buyer has to satisfy himself that everything’s been done and documented the way it should be, and that the inventory and value are all there…it’s very much ‘buyer beware.’ If you sign a contract, it’s yours.”
Step 6: Know the Market
Prospective buyers should research the business’s market and determine how healthy that market is, as well as how profitable it’s likely to be in the future. Sellers should also have a good idea of market trends, as they can spell an advantage in price negotiations if, for instance, the business is part of a growing market such as technology or a recession-proof area, like health care.
Step 7: Be Diplomatic
When it comes to all the little details that might alter the price of a business -- and there are plenty of them — it pays to take a deep breath and keep negotiations on a professional plane. If either side starts nitpicking every detail, it may drive away the other party. Instead, explain your figures and give an offer that’s not insulting. For buyers, keep in mind: if all those little details look like they’re starting to add up to what you feel should be a big discount, you may want to look elsewhere.
Step 8: Be Realistic
For the seller, this means not letting your memories bias the pricing too much. Robertson says most people who are selling a successful business tend to overprice it because they remember all the hard work it took to get it to this point. “They tend to lose objectivity. It’s a big psychological adjustment for the owner,” he says. For the buyer, keeping a grasp on reality means not coming in with an initial offer that’s too low. Although you will want to begin negotiations with a lower price than what the seller is asking, avoid dropping more than 25 percent off the original price. Otherwise, the seller may not take you seriously.
Step 9: Take Your Time
It may be worth taking the time to make some adjustments to your business before selling. Robertson recalls one seller who wanted more money for his business than his broker thought was realistic. Instead of lowering the price, the business owner took close to a year to introduce some new products, then put his business back on the market, netting about $1 million more than he could have the previous year. Buyers also need to be patient, Robertson says. If the business owner is truly motivated to sell, they will provide all the information the buyer needs, which should include the business’s books, any pending laws that may affect the business as well as any bad debts. That takes time, but it’s worth slogging through. “I’ve had people tell me the owner won’t give that information without a down payment, in which case I say, 'Don’t walk away -- run,'" Robertson says.
Step 10: Take Transition into Account
There are multiple transition issues that could affect the sale price: whether or not the seller will stay on to help with transition, any in-progress inventory or customer work, how and when contact with customers will be handled, the status of current employees, contracts with vendors and dealing with any “hidden” liabilities that may show up after the sale closes.
Step 11: Know Thy Covenants
Covenants are the promises each party makes to each other, and they are important details to include in negotiations. In a business sale, it’s typical for covenants to include a noncompete agreement with the new owner and the seller’s promise to keep the business running as usual without altering inventory levels and continuing the same level of customer service.