Setting the Price of a Business
Seller: My business is worth a million dollars.
Buyer: I think his business is worth $250,000.
Who is right? The seller or the buyer?
They both are. Right? Maybe? Possibly? Is this a trick question?
The business owner has a bias to the value of their business. All the work they have put into it, the time it took to grow, the building purchased 20 years ago, the equipment they invested in, the inventory sitting on the shelves, and the retirement they are trying to fund. All these reasons support a big price tag in the eyes of the seller.
The buyer has a bias too: the age of the equipment, the condition of the facilities, the unused inventory, and all the work that needs to be done for the continuation of the business.
So, what is the business worth and how is that determined?
Buying or selling a business? There is not much difference in the work that has to be done for either to happen. Just remember, you have to keep the horse before the cart.
Here is what I mean. Buyer and seller each have to do their due diligence for a successful sale.
Seller, you need to have accurate financials of the business to help justify your asking price
Buyer, you need to see the financials of the business to justify your offer…if you decide to make one.
At the very least, three years of taxes, current P and L, and balance sheet is where everything starts. Incidentally, this information will be required by any lender that will be involved with the sale.
What do taxes and accounting reports show? They show:
- Whether or not the business is making money.
- The business is able to handle debt.
- If there has been growth over the last three years.
- Financial information can also be compared to other businesses in the industry and how they are doing in the market.
Seller, keeping the horse before the cart means having accurate and up to date financial records before considering an asking price on your business.
Buyer, keeping the horse before the cart means not making an offer until you have the financials to base your offer on. You are going to need the financial information for the same above reasons as the seller along with producing projections on what you think the business is capable of doing over the next three to five years. Be sure to include the additional debt you will be acquiring in those projections.
So, that’s all there is to determine the price of a business?
I put the cart before the horse. Financials are the most important part of getting the business sold, not setting the price.