Justifying an Asking Price for Your Business

When most people think about selling something, especially something as significant as a business, they typically picture a heated negotiation back and forth between a buyer and seller in order to come to a final deal that perhaps both are unhappy about.  That is the last thing we want to take place.

Most businesses have some complexity, and it is important for a buyer to understand these complexities during the early stages of ownership to avoid costly mistakes with customers, suppliers, and, of course, employees.  Not all of these complexities can be identified and discussed in advance, so a transition process is generally required to allow the business to change ownership without “missing a beat.”  The transition requires the old and new owners to cooperate, working closely together as the new owner learns the unique aspects of the business.

So how do you arrive at a selling price?

The key is to set the asking price at true market value and stick to it.  But “sticking to it” isn’t about stubbornness, it’s about being able to justify that price.

Arriving at a justifiable asking price – and therefore sales price – is the purpose of conducting an independent market valuation.  Such a valuation is always the first step in our process.  There are three distinct attributes of such a valuation, and they all provide for justification of the asking price.

First, the fact that the valuation has been conducted by an independent 3rd party, not the seller’s CPA or brother-in-law or broker, gives a buyer confidence that it has been performed in an objective manner.  In our case, the seller must pay for the valuation up front, meaning that the valuation firm is paid before they calculate the fair market value, not afterwards.  These firms don’t get paid to produce a number that the seller likes; instead, they are paid to produce the most accurate value estimate they possible can.  

The second attribute is the valuation process itself.  The process of doing a valuation is complex, and our partners look at the business from seven different perspectives: two asset-based, two income-based, and three market-based viewpoints.  Plus, the valuation process incorporates seven years of financial information for the business. Our valuation firm partners are accredited, and they subscribe to the financial databases that help them establish risk premiums and comparable market sale prices for similar firms.  These data help the appraiser make key decisions upon which the market value is calculated.

Third, all of our valuation partners’ reports include a calculation of the return on investment (ROI) to the buyer, given the asking price, suggested deal structure, and expected cash flow based on historical (not pie-in-the-sky projected) results.  The report details how the expected cash flow was projected, what the debt service will be on financing obtained by the buyer, and what capital expenditures are required to keep the business operating smoothly.  The result is the net cash flow to the buyer, which is divided by the buyer’s down payment to arrive at a first-year cash-on-cash ROI.  This ROI is used as a check to make sure that the return to the buyer is sufficient to justify investing in the business being sold.

So finally, when we get to the final part of the negotiation process and, let’s say, that the asking price is $5 million, we expect the buyer to agree.  If the buyer says the business is only worth, say, $4 million, we say, “OK, you could be right.  But in order for it to be worth only $4 million, you need to tell us what we did wrong in the valuation.  Were the revenues not correct?  Were the cash flows calculated incorrectly?  Were the discount rates and market value multiples incorrect?”  Most often, the buyer can’t point to a flaw in the assumptions or the logic of the valuation.  So finally, we ask why the buyer feels justified to ask for a higher ROI than the one calculated in the valuation.  Generally, they wind up agreeing to a sale price that is at – or very near – the asking price (and the valuation price).  

That’s the purpose of our process and why we always start with an independent, 3rd party valuation.  We want to sell businesses for our clients at the highest market value achievable – professionally, confidentially, and successfully.