How To Determine The Sale Price For Your Company ?
Many entrepreneurs dream of retiring early. We all want a break, at some point, to enjoy the fruits of our hard work. Some dream of catching up with family and spending more time with loved ones. Others want to pursue their travel dreams and see the world. There are even some, who consider retiring, so they can help save humanity. It is however, rather difficult, the exit process.
For most, a business is a baby, almost in the literal sense. In fact, many are the entrepreneurs who have given more time to their companies than to their actual kids. There is thus, often, a lot of sentimental value invested. This makes it extremely difficult to consider an exit strategy.
Desperate times, however, call for desperate measures. In the wake of the Coronavirus for example, many have come to realize they would rather sell their businesses, than deal with un-ending economic turmoils. Two recessions within twelve years, it's a lot to take in.
It‘s then, only fair, having spent so much time and effort on your company, to value it appropriately when you decide to sell. How then, can one determine the right price to sell a business ?
Traditional Valuing Methods
One traditional method of valuing businesses uses three factors:
the nature of the business
the generated annual revenues
the seller’s discretionary earnings, SDE or Adjusted Net
Seller’s discretionary earnings refer to the earnings and benefits for the owner of the business. It usually encompasses profit or loss of the business adjusted with add backs in the form of amortization, depreciation, owner compensation, and any other benefits for the owner such as health insurance, a car payment, cell phone payments, etc.
Important to note, most traditional methods are deeply rooted in using past performance as an indicator of the market price of a business.
In fact, many brokers are stuck in the 1970s paradigm of EBIT multiple, the most conventional way of pricing a business, which makes adjustments to a company’s historic profit and applies a multiple to it to determine market value.
Less conventional methods of pricing a business focus on future potential rather than past performance. They argue the price of a business should have nothing to do with past performance but must only be evaluated based on its potential from time of sale and onwards, under new ownership.
Indeed, a new owner might, in most cases, have more resources, more vision, drive, ambition and energy to exploit the business to its full potential. In addition, the business to sell might add synergetic and complementary value to the buyer’s pre-owned companies.
What is even more, the market is always changing, thus past performances might not reflect future potential.
Others, more grounded brokers suggest the price of a business should only be determined by how much buyers are willing to pay for it. In a more theoretical sense, price is determined by the dynamics of supply and demand.
The goal of a broker is then, in this case, to bring in as many buyers as possible. Interestingly, there is usually a huge discrepancy between the proposed prices from different buyers for many reasons. For instance, one buyer might only be interested in the Intellectual Property of a company. Another might only want the amazing talent of the employees of the business . Ergo, we can rationally justify the drastically different prices proposed by various prospective buyers as each derives value in acquiring the business from a different perspective.
WHO IS RIGHT ?
I believe that evaluating the value of a business only on the basis of future potential is dangerous. We are never certain of the future potential of a company. Our estimation of the future is completely based on assumptions, which can later prove to be erroneous. Still, future potential should be an undeniable determinant of the sale price of a company. In the absence of certitude, past performance is not to be undermined, assuming the market is not likely to drastically change.
Still, bringing on the table the best prospective buyers, as many of them as possible, who can fully benefit from the business and exploit the most its potential should be the primary goal of a business broker. It ‘s only when you have enough buyers that can greatly benefit from acquiring the business, that you bring out the full value of its potential.
Get Help Selling Your Business
Moussa Sarr is a business broker, software engineer and entrepreneur. He has helped numerous startups launch their technology and satisfy their application development needs. Nowadays, he is helping sell businesses and license Intellectual Property. Get in touch now to discuss selling your business or buying a new business: firstname.lastname@example.org
Software Engineer and Entrepreneur