As a business owner, deciding to sell your business is one of the most significant decisions you will make — I would venture to say that it is THE MOST important financial transaction in your life. While it might be tempting to set a high price with the hopes of achieving a substantial financial return, this strategy can often backfire. In this article, we will discuss Price, but from the perspective of the Buyer.
Why From the Buyer's perspective?
Because, to effectively negotiate, everything needs to be seen from their perspective — it's a universal law in Marketing and one that helps you anticipate likely objections. Doesn't seem fair, right? Don't worry, when I represent Buyers, I ask them to do the same — to see things from the perspective of the Seller.
This empathetic approach is critical when buying or selling a business. By doing so, you put yourself in the other party's shoes which allows you to address likely objections before they are presented.
What Do Buyers Care About?
The good news is that most Buyers behave very consistently, making potential objections fairly easy to see in advance. Buyers care about:
Not paying too much - they will analyze the numbers and most will know the value of the business within a reasonably small margin of error.
Feeling like they "got a good deal" - every Buyer will negotiate some part of the deal.
Knowing that there is a high probability that they can take the business to the next level, thus creating even more upside for themselves.
Cash Flow - "Cash is King!"
Key Reasons Why Setting Your Price Too High Can be Detrimental:
1. Reduced Buyer Interest
Pricing your business too high can significantly reduce the pool of potential Buyers. Many prospective purchasers may be turned off by an inflated price tag and may not even consider inspecting the details further. This decreased interest can leave your business on the market for an extended period, making it less appealing over time.
2. Misalignment with Market Value
A price set too high usually means it is above the market value, leading Buyers to question the validity of the price. This misalignment can make your business appear less transparent and more risky, negatively impacting buyer trust and reducing the likelihood of offers.
3. Prolonged Market Presence
Businesses that stay on the market for too long due to high pricing often gain a negative reputation. Potential Buyers may wonder why the business hasn’t sold and speculate that there might be underlying problems. This prolonged exposure can make the eventual sale harder and may force you to lower the price significantly to attract interest.
4. Attracting Wrong Buyers
Most serious buyers who understand the market will easily discern an overpriced business and might skip over your offer entirely. Instead, you might attract opportunistic Buyers looking to negotiate drastic price reductions, which can be a waste of time and resources. These negotiations can be frustrating and often do not lead to successful sales.
5. Potential for Deal Failures
Overpricing your business can lead to extended negotiations, during which time Buyers may become discouraged or lose enthusiasm. This increased complexity can cause deals to fall through, ultimately sabotaging the sale. In addition, most deals will have some form of bank financing — an over-inflated price makes it much harder to get through underwriting.
6. Perceived Value and Buyer Psychology
Interestingly, a higher price can sometimes convey higher value; however, this generally applies when the pricing is just above market norms and is accompanied by evident value enhancements. An excessively high price, on the other hand, can lead buyers to believe they are not getting a fair deal, thereby affecting their perceived value of the business .
One Approach to Valuation that Every Buyer Will Calculate
One valuation method that is critical to develop is the Debt Coverage Approach. This approach is the ultimate measure of whether or not your price is too high. It answers the question, "Can the business pay the debt service and still compensate the owner for his or her risk?"
Let's use a fictitious example...
Imagine that you are buying a business listed at a $1,000,000. Let's assume that your bank will require 25% down and will finance the balance ($750,000) at 7%. To recap:
$1,000,000 - Purchase price
$250,000 - Buyer cash
$750,000 - Amount financed
Interest Rate - 7%
The annual debt service (principal + interest) is $104,497. To assess whether or not this level of debt service will be tenable to you, it is necessary to look at the Discretionary Earnings (DE) of the business.
We'll keep this example simple and compare three levels of Discretionary Earnings:
Example # 1: DE = $350,000
Example # 2: DE = $200,000
Example # 3: DE = $100,000
Remember, Discretionary Earnings represent the total financial benefit to the owner of the business. In Example # 1, DE is equal to $350,000. So, there is plenty of room to play ($350,000 - $104,497 = $245,503).
In Example # 2, DE is equal to $200,000 which still leaves some room for the business to cash flow, but significantly less ($200,000 = $104,497 = $95,503). There still may be room enough for your purchase to be made, but it's not quite as sweet of a deal as before.
Finally, In Example # 3, DE is equal to $100,000. This obviously poses a significant problem because now the business is Cash Flow negative ($100,000 - $104,497 = -$4,497).
An important item to note is the presence of the Seller's salary in this overall equation. If the Seller was acting as the onsite Manager and you needed to hire a Manager to fill the Seller's place, this would have another negative impact on the overall financial picture — it would bring Net Operating Income downward and along with it, Discretionary Earnings would fall as well.
This exercise is critical to conduct from the Seller's perspective. You can set your price wherever you desire, but if the business isn't profitable, if it can't service the debt, and if it can't pay the new owner, it's likely not going to sell.
Conclusion
Determining the correct price for your business is crucial for attracting genuine buyers and ensuring a successful sale. While it's natural to aim for a beneficial return, an overly high price can deter interest and create several barriers to sale.
It's important to conduct a proper valuation and market analysis to set a price that reflects the true value of your business, ensuring a smooth and timely sale process that meets your financial goals. At Collaborative Commercial, we specialize in guiding business owners through this intricate journey, helping you strike the balance between a competitive price and a profitable sale.
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