I have always tried to avoid generalities and instead draw conclusions based upon facts and data. So I am always conflicted by trends - are they really quantifiable, or just a recent turn of events? However, I am going to stray a bit from my usual rules to discuss a situation I see happening more frequently of late in the business for sale arena which is the incredibly creative posturing and thought process that some sellers are using to justify their asking prices.
While buyers certainly want to be confident that the business has growth potential, their bigger crieria is to be certain the business can sustain a change of ownership.
In large businesses, where there is a broad infrastructure in place, there is far greater assurances that the business shall stay on course after an acquisition and therefore, it is justifiable to weigh future earnings into the valuation.
However, as a result of the recent downturn where many businesses are experiencing declining sales and profits, we are seeing an usually high number of scenarios where the sellers are basing their valuations on some very aggressive assumptions about the future, and pitching buyers on a lot of "blue sky" theory. While this is certainly an interesting and creative strategy, it's nonsense.
As an example, for a seller to believe they should be paid a premium on the business by telling a buyer they only need to hire more salespeople, or attend trade shows, or add new products and services, etc., is a completely illogical argument to attempt to bolster the present-day value of the business. After all, if these initiatives are so simple, why hasn't the seller done them? I reviewed one situation recently where the seller inflated/adjusted his Gross Margins and bolstered the asking price based upon his theory that "a new buyer can get the costs down"...oh yeah, how? And why hasn't the seller been able to do so in the five years he has owned the business?
Another recent example was a seller of an events marketing company making $150,000 in Owner Benefits who priced his business at $600,000. For years, the company has staged four large events each year with similar profits. The seller believed that any buyer could easily double the number of venues and would then make $300,000 and so the $600,000 was a "very reasonable price" according to the seller. That is complete craziness! To reiterate, I hate generalities, but I have seen at least a dozen similar cases of this ass-backwards strategy for arriving at an asking price over the last month or so.
I guess it's simply a case of when they going gets tough, some sellers get ridiculous.
Now, I do not want to confuse earnouts or performance based deal structures with this delusional valuation ideology. Earnouts are for specific circumstances I have discussed before (i.e. declining business where the buyer needs protection, programs the seller has implemented which will only produce results post-sale, the recent addition or loss of a major customer or supplier, etc) and they have their place, and they are based upon rational thinking.
When you come across a seller who may be taking this tactic, if you are unable to convince them of their polluted thought process, suggest that they put these so-called "no-brainer" initiatives into place over the next year and if they lead to the results they claim, then they can justify a purchase price inclusive of those results.
Buyers have to be wary of being suckered into this type of pricing model. Remember, it is profit not promises that pay the bills. It is easy to visualize all the wonderful things you can do to the business after you take it over. But keep in mind that if these strategies were so simple, the seller would likely have them in place already (besides, they probably tried some of them and they didn't work). Forget about all the wonderful things a seller tells you that can be done with the business. Instead, focus upon your ability to takeover the business, sustain the present levels, learn it until the business is in your gut, and then put plans into place for growth. With that strategy in mind, clearly,
I welcome your comments and appreciate your feedback. Please feel free to provide your input on this blog. As always, please visit our website if you have any questions about buying a business.
Have a great week.
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