Valuations for Selling A Business - Risk
There are many factors that influence valuations for selling a business. Risk is a major factor in business acquisitions and risk can greatly influence the value of a business.
One of the best things that a business owner can do when they are getting ready to sell their business is to take a moment and try to "see" their business through the eyes of a potential buyer. This sounds like common sense, but it is quite difficult to do this for some business owners. After all, they have been working in the business for years, building it up, rolling with the ups and downs and, over time, they get comfortable in their role as owner.
This is not the case for buyers. Buyers may have experience in the industry, they may have even owned businesses before, but they have not owned this business before. It is foreign to them and, in their eyes, things may not work out. For some buyers the investment they put towards the business may represent their life savings, their children's future and so on. Even for larger strategic or institutional buyers there are shareholders or investors to answer to.
It is said, the greater the risk the greater the reward. This is very true is business sales. There is also, however, what I call competition for capital. I will give you an example. Let's say that a potential buyer has $100,000 cash to invest. They could invest these funds in a number of ways: stocks, bonds, real estate, they could start up a company or they do nothing. What am I getting at? A business must be priced so that the return to the buyer is greater than they could get elsewhere. If, after servicing the debt on the business, the return on the $100,000 is only $10,000 - $20,000, many buyers will take their money elsewhere where they can get a similar return for less risk.
The specific risk that a business presents to the buyer also influences the price.
When you read about SDE and cash flow multiples, ( more information on Valuations for Selling A Business )
you know that many businesses command a price of 1 to 7 times SDE. Risk or the lack of risk can increase or decrease the price. An example: If a business is well established, has steady revenue and has a product or service that is in demand, then it is less risky then a business that does not have these things. In terms of valuations for selling a business, the well established business will command a higher price.
Some factors that influence risk:
Size of the business: Larger businesses are less risky. They have more influence in the marketplace and usually have a diversified product or service line.
A business that is highly dependent on the owner: This is when the owner "is" the business. An example would be a highly specialized construction company where the owner's knowledge makes or breaks the project.
Years in business: Start-ups are risky.
Reputation: A company well-respected in it's industry will command a higher price than a unknown one.
In demand product or service: We all need gas, groceries, and our cafe lattes. We may not need a electric shaver that plugs into a USB port on our computer. (This product really exists)
Diversified customer or client base: Do you think that a firm that has only one customer that accounts for 90% of its revenue (Not on a contract) would present a risk to the buyer?
Obsolete product or service: Does anyone sell VHS tapes anymore?
Very little or no profit: Speaks for itself.
Revenue and/or profit trending downward: This tends to alarm buyers.
Location: Population changes, crime, or poor location can present a risk.
Poor or non-existant financial records: There is a saying in our industry: If it is not on the books it doesn't exist! Valuations for Selling A Business usually cannot even be done with out some financial records.
Please do not misunderstand. The factors that I listed do not mean that a business is not marketable. Quite to the contrary, most businesses fall into one of the categories above and sometimes these factors are out of the owner's control. We have successfully represented many businesses that were influenced by some of factors listed above. I am simply stating that for a business to be priced correctly, and note that correctly pricing a business is one of the first steps in the successful sale of the business, the price must take into account the risk that the business presents to a buyer.
More good news! If you are a business owner and you believe that your business may present more risk than it should, often times you can make some changes and lessen the risk.
Click here to go learn about how to prepare you business for sale.
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Would you like more information regarding Valuations for Selling A Business ? Are youa Southern California Business Owner? If so contact me. I would be happy to give you my opinion regarding the marketability of your business.
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