Tuesday, 29 November 2011

The wrong price can be a big mistake

Too high is bad; too low is bad.

If the price is too high, buyers don’t think you are serious and won’t investigate the opportunity.  The offering can become inactive or worn-out, and has to be taken off the market or dumped below the market.

If it is too low you will leave something on the table.

Most sellers do not know the market value of their business. 

Unfortunately, the explanation isn’t always an easy one.  The truth is if you ask 10 people you probably will get 10 different answers on the valuation of a business.  There are a number of methods:
·         Book Value
·         Liquidation Value
·         Price to Earnings Ratio
·         Discounted Cash Flows
·         Etc.

The easy answer is, “Your business is only worth what someone is willing to pay you and what you’re willing to accept.”  The long answer is a lot more complicated.

The basic criterion of most buyers is return on investment (ROI).  This number will vary depending on risk, perceived inflation and other subjective and objective perceptions about the business and related market conditions.

One of the most effective valuation methods is known as “cash flow” since it considers the cash flow ‘return’ and selling price ‘investment’ in the equation.  Buyers typically are comfortable with this method because, at the end of the day, although they are buying a company, what they really are buying is its cash flow.

With an understanding of a business’ actual cash flow, different multipliers can be applied to determine a fair market range of value for the business.  Multipliers vary depending upon the type of business.  Of course many other factors can affect the multiplier.  For example, new products in the pipeline, strong market share and a diversified customer base positively affect the multiplier.

Conversely, out-dated inventory, declining market share and the risk that key personnel could leave the business and disrupt operations could have a negative impact.  Why?  Because they relate to risk, the higher the risk the more likely the buyer will insist on a higher ROI and lower multiple.

You’ll notice that this method contains no mention of the ‘terms’ of the transaction.  This is an incredibly important factor and needs to be considered in order to ‘prudently’ position your business to sell.   And one to be discussed in a future blog. 

Do you have small business questions you would like answered about this article or others?  Please visit www.VRWindsor.com or call 519-903-7807. 
William Sivell is a sales representative of VR Windsor Inc., Business Brokerage; his blog appears every Tuesday.

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