14 November 2016
Business sale price has and always be an integral player in the supply and demand curve.
Put simply, the higher the business sale price, the lower the demand and the more difficult it is to sell the business.
Conversely, the lower the price, the higher the demand and the easier it is to sell your business.
All things being equal that is.
However, there are two distortions in the market:
Firstly, there are some really good businesses (for reasons explained in the other criteria) that are in short supply and can demand above market prices. Because these businesses are rarer and perceived by buyers to be better, they can fetch prices that are more resilient to downward pressure.
The only problem is most business owners see their business through tainted lenses and almost all think that their business falls in this group. And they will price their business unrealistically high that will never meet the market.
A particular seller wanted to sell his good cafe in Sydney CBD for $1.2 million when the business sale price for comparable business in the CBD was only $500-800K.
The second distortion relates to businesses on the market that are mediocre, ill prepared and not making much profit, or making a loss. A low asking price alone is insufficient to determine whether a business could be sold off quickly or not.
For example, due to a break-down of his marriage, a business owner wanted to sell his cafe at a Westfield Shopping Town for next-to-nothing prices. He had no financials, no verifiable documents and was unwilling or unable to prove the business turnover.
He would refuse the buyer a two (2) weeks trial in the cafe as a condition of sale. The owner was insistent on a WIWO (Walk-In, Walk-Out) sale, colloquially to mean that the buyer will need to buy the business without much due diligence.
In this instance, the business sale price was very low but the business would not sell any quicker. The buyer can't be forced to buy a perceived bad business.
So when do business sale price matters with regards to the time needed to exit? If you have a genuinely good business, then the asking price matters and you can use price as a mechanism to time your exit.
If the sale is urgent, you merely have to lower the price to attract more buyers and chances are you will get it sold faster.
Unfortunately, most business owners have their own ideas how much their business should fetch without consideration for meeting the market.
However, many business owners often have unrealistic expectations of what the market will pay and most of the time, they over-value their business. Their rationale may include:
a. Putting a monetary value on the hard work they have put into the business (e.g. ‘I have worked 70 hours per week for the last 5 years, so that I should at least sell for $x to compensate for my effort’)
b. Paying too much for the business initially and unwilling to sell for less at exit (e.g. 'I paid $500,000 for the business 3 years ago so there is no way I can sell for anything less than that')
c. Pricing the business in a way that does not reflect the market sentiment (e.g. using a price valuation from an accountant or using a method of valuation that did not have the market sentiment in mind)
d. Pricing the business based on the perceived (or sometimes inflated) value of the equipment or fixtures
e. Pricing the business to match the loan still owing to the bank (e.g. 'I borrowed $400,000 to buy the business so I can't sell for anything less)
The fact is the market (the collective buyers) determines the price, not the business owner.
Nearly all business owners believe that their business is a good business that buyers want. But that cannot be all true. The 80/20 rule applies here. 8 businesses are not that great. Only 2 are good.
What is the definition of a 'good business' then?
The ultimate litmus test of a good business is one that attract buyers and offers. What a business owner might consider to be a good business is not relevant to the buyer.
A 'good business' should address the nine (9) top problems that repel buyers, which is an article I will post at a later date. The takeaway is that if you are serious about selling, you should have a honest discussion with your broker agent about the market and be prepared to accept a business sale price the market will meet.
If you have a business that is clearly not ready for sale or has problems (e.g. no verifiables, no financials, legal troubles, ATO troubles, powerful new competitors etc), then the business sale price is less accurate as a predictor of the time needed to exit your business. Luck and an element of randomness will play a part.
I would advise that you re-read the Three (3) Pillars To Exit formula and take action plans to ready your business for sale.
The above applies largely to SME (small medium enterprise) firms and businesses where the owner is fused to the business and the prosperity of the business is reliant on the owner. Large businesses may be valued differently.
Most SME businesses are called 'moms & pops' businesses. Moms & pops because the owners are largely scattered individuals who are working in the business for a cashflow or an income.
These buyers of these businesses don't see themselves as investors. Truth is they are buying a job.
How would this have an impact on price?
For these buyers, their abilities to purchase is dependent on how much they can borrow from their banks or lenders. Rarely would they have the entire sums available.
Banks and lenders see SME businesses as higher risk and so will ask for real estate as collateral over the loan. Hence the business sale price is correlated to real estate prices.
The average price of residential dwelling in Sydney, NSW is approximately $1 million. Given that most banks will only lend 50% on the asking price of the business and up to 80% on the value of the real estate property, then not surprisingly, most SME businesses are priced below $1 million.
For business sale price exceeding the $1 million price tag, the mom & pop buyer pool shrinks significantly, even if the business is very profitable.
The next tier of buyers have different source of funding. Perhaps they are successful business owners looking to buy out their competitors, or overseas buyers.
In any event, mom & pops buyers may be intimidated by the complexity and the learning curve required of higher priced businesses.
Regardless of the size of the business, owners may be required to re-shape and transform their business if their asking price is higher than what the market is willing to pay.
Last updated: 20 December 2018