Thinking about Selling Your Business? Part One: The Price is Right
From 2008 until 2012, the door was closed for almost all small closely held business exits. Especially in ’08, ’09 and ’10, very few people (and no lenders) were willing to take on the risk of a business purchase.
Beginning in 2012, the market began to show signs of life. In 2013, the number of sales in Central Florida increased, and the market continues to recover.
Because of the five-year stoppage, a lot of owners are looking to sell. They hung on through the downturn and are ready to move on.
A sale transaction is a critical point in the life of a small business. Things can go wrong, resulting in loss of business value and income.
I’ll show you how to address these big risks and issues to help you make your sale successful so you can get the most for your business in the least amount of time.
Price Is Right
The first and, in my opinion, most important issue to get right is the offering price of your business. An underpriced business means you are leaving money on the table and not getting the best return on your years of hard work. An overpriced business may not sell at all. Even if you do get a chance to adjust the selling price and try again, potential buyers may be weary of a business that has stayed on the market for too long and might steer clear entirely. Not to mention the nasty psychological effects that the protracted process can have on a seller’s morale.
Sally and Bob’s One Stop Shoppe
Sally and Bob (not their real names) operated their small One Stop Shoppe (not its real name) for ten years. Then, they decided it was time for retirement and contacted a broker to sell their business.
The Broker asked what they wanted for their business. Sally and Bob heard from a friend that businesses like theirs should sell for 1.5 to 2 times total sales. So, they answered $700,000, right in the middle.
The broker scanned their tax returns and financial statements for a few minutes, then proclaimed the business worth $500,000. Sally and Bob signed a one-year exclusive listing agreement with the broker, and he listed the business for $550,000 (so they’d “have room to negotiate,” he said).
A few weeks went by, but nothing happened. Then a couple of months had passed. After 6 months with no traffic, Sally and Bob contacted the broker. He suggested a $50,000 price decrease to get the market going. So, they dropped the price to $500,000.
After 3 more months, Sally and Bob again contacted the broker. He said the market is always slow around the holidays and suggested another price decrease. So, again, they dropped the price by $50,000 to $450,000.
Much to Sally and Bob’s dismay, still nothing happened.
Eventually, the listing agreement expired. Shortly after that, they met with me on a separate legal issue and mentioned the situation with their business sale. They told me that for the first few months they wondered what the problem was. After 7 or 8 months, that wonder turned to fear that they’d never be able to sell.
So, I put them in touch with a reputable broker. He prepared a written and objective analysis of the value of their business, and, unfortunately, had to inform them that there was no way they were going to sell the business for $500,000, $450,000, or even $400,000. The most it was worth was $300,000.
He went over the valuation process and showed Sally and Bob how he had arrived at the opinion of value that was much lower than their original asking price.
Even though they were unhappy that they’d wasted a year trying to sell at the higher price, Sally and Bob were actually relieved. Finally, they understood.
It still took several months to find a buyer and complete a sale, but with the accurate price they began to get traffic and even a couple of offers fairly soon.
Fly Too High and You’ll Get Burned
Interestingly, of these two potential mistakes, setting the price too high is more common. That’s because arriving at an objective estimate of the value of your business is difficult. By definition, you aren’t an objective party here; the business is near and dear to you.
Similarly, a fear of foolishly losing money by pricing the business too low causes owners to hypercorrect and swing the pendulum too far in the other direction.
Overpricing a business is also a worse problem than underpricing. To the average person, it might seem obvious that you’d rather overestimate than underestimate, err on the side of caution, as it were. But without realizing it, these business owners have become Icarus. They are going to fly too near to the sun, with disastrous results.
A Perfect Storm
First, an overpriced business cuts out the real buyers.
Our culture in the United States doesn’t haggle. For the most part, we view a price as the price, and we won’t bargain if it’s too high. We simply move on to the next deal.
Consider whether most people are comfortable buying a car. Do they like visiting the dealer to negotiate over price and terms? Do they feel comfortable sitting with the dealer’s finance manager? No and no.
In fact, Americans are so much against bargaining that some auto dealers have developed ‘no haggle’ pricing as a point of differentiation.
Second, most buyers are first-time buyers, and they’re terrified. If you combine the first-timer’s apprehension with the cultural fixed-price mindset, you wind up with a buyer who will outright avoid any business with the slightest hint of being overpriced. It’s a perfect storm. They’re looking for any reason not to take the risk of buying a business, and you’ve just supplied it.
People won’t even say they’re not interested. They’ll make excuses—“the price is the price, there’s no point in trying to negotiate”—or just walk off into the sunset doing nothing. This means you won’t even know that the price of your business is scaring off potential buyers!
Bottom line: You’re not getting many offers.
Sharks in the Water
Finally, there will be a few bold buyers (read: sharks) who do make an offer. But these buyers are looking for super deals. They know you’re overpriced, so they’ll toss a low-ball offer to you, just to see what you say. They figure they’ve got nothing to lose. They’re preying on your psyche, hoping that—like Sally’s and Bob’s—you’re business has sat untouched for too long and you’re starting to get anxious.
And this is a good bet. As the weeks and months come and go without any real offers (and often without any showings) the owner becomes very concerned. He might even begin to panic.
To put yourself in their shoes, imagine that one day your phone stops ringing, and customers stop coming in. This goes on for a couple of days. Then a week. Then a month. What would go through your mind? What would you do?
The owner’s panic is amplified because she’s trying to sell her biggest financial asset. So, when a low-ball offer comes in, the desperate and panicked business owner is more likely to take it. Now she’s really leaving money on the table.
So, What’s the Good News?
How do you avoid underpricing your business and losing money in the sale or, even worse, overpricing your business and never selling or impulsively taking an even lower offer?
You’ve already made one big step. You are educating yourself on the process so you can anticipate and preempt costly mistakes. As G.I. Joe used to say, “Knowing is half the battle.”
You also do this by calculating the estimated value of your business as objectively as possible with accepted valuation methods. Unfortunately, valuation estimates are just that, estimates, and to a certain extent a business’ value can’t be firmly established until a buyer actually pays a certain price. But, there are good, well-educated estimates and then there are, let’s call them, out-of-the-‘hat’ estimates. You definitely want the former!
In “Part Two: Business (E)valuation Methods,” I will cover the various ways that you can estimate the value of your business without a PhD in mathematics!
How Can We Help You?
Here at Alexander Abramson, we focus exclusively on business-related legal matters. We have advised closely held businesses and business professionals for years on everything from raising startup equity to selling a business.
Ed Alexander is also a Florida licensed business broker and a shareholder of Fitzgibbon Alexander, Inc., a Central Florida consulting, business valuation, and business brokerage firm.
We would love to speak with you directly about how we can help you sell your business.
Call us 407-649-7777 to set up an initial consultation.