Why the right asking price is critical when trying to sell your small business - David C Barnett

Think you can just ask whatever you want and hope for the best?  You may be scaring off the exact buyer you need to meet.  Watch: https://youtu.be/CuiJUenzEzc

Hi, Everyone it’s David Barnett here from www.InvestLocalBook.com and my new exit planning course:www.Howtogetoutofmybusiness.com. I’ve got a question here today, it’s sort of a topic of discussion but it’s for business owners, when you sell you need to get the price right you’re asking price. Let me give an example. When I was a business broker for over three years I would get people all the time come in and they would say ‘’Hey want to sell my business’’ and I would say great the first thing I have to do is an evaluation and I would do what was called the most probable selling price evaluation. I still do them today for consulting clients. I would then come back with that business owner and would say look here are all the factors considered and this is here some examples of other people who’ve recently bought businesses like yours and this is what your business is going to sell for. Let’s say it was $275 000 and then the business owner would say no, my financial planner says that I need $500 000. Never thinking that what they need has actually nothing to do with what the business is worth. So then I would explain to them you know what you need has got nothing to do with what it’s worth. If you need more money then maybe you can’t afford to retire right now maybe you need to keep operating the business.

Now here’s the problem, some business brokers would say to the person ok you want $500 000 let’s ask $550. Now it’s a business worth $275 and it has an asking price of $550 I wouldn’t take those listings when I was operating my brokerage I would tell them, you know what you can list it for $325 or I don’t want the listing. Here’s why when you over-price a business and you try to get way more than what the business is actually worth. What the cash flow will support, what happens is you miss out on what I call the reasonable buyers. The reasonable buyers are people who are thinking people, who’ve educated themselves maybe they’ve even taken my www.businessbuyeradvantage.com program and they know what a business should be worth. And if they see a business that’s worth $275 000 with an asking price of $310 they know that’s there’s a negotiation going to take place. They know the seller has left the room for a back and forth negotiation. That’s fine.

The reasonable buyer is going to make an offer; discuss with the seller they’re going to pursue that opportunity. When a reasonable buyer sees someone with a $275 000 business who’s asking $550 000. What they think is that person who’s selling has no idea what they’re doing and they would be right. And they believe that the seller is not unreasonable person. And they know that it’s difficult to negotiate or have any kind of reasonable relationship with an unreasonable person. And so what they end up doing is he might watch the business or wait for the price to come down but they don’t engage with the seller. And so what ends up happening is that seller who’s got the crazy over inflated price never gets to meet the reasonable buyers but you know who he does get to meet?

The unreasonable buyers and what I mean by unreasonable are the people out there who are just low balling everyone trying to get a fish to bite the hook to take the bait, so to speak. so unreasonable buyer is someone who goes into the market and simply bids way low on everything hoping to find a desperate seller, who is willing to talk to anybody so the unreasonable buyers if they see you know a business that might be worth $275 with an asking price of $310. They may come in an offer of $150 or $200 but that’s okay, because that seller is also talking to reasonable buyer’s so they don’t need to take the bait.

The unreasonable seller who’s asking $550 that unreasonable buyers still going to come in and low ball at $150 or $200 and that’s the only kind of buyer the unreasonable seller is going to meet and he’s going to spend all this time talking with these guys and some of them have money and some of them don’t. Some of them are just tire kickers and some of them are just wasting your time. The reasonable buyer is the personal with money and purpose and motivation and drive and they have sound thinking.  And they’ve educated themselves. They’re not going to pay double of what a business is worth. They just won’t, that’s why as a seller it’s important to get proper advice on what your business is actually worth, before you put asking price on it.

I do most probable selling price evaluations today for my clients around the world and be more than happy to do it for you. So if you’re thinking about selling a business you need at the price right and you need to work with someone who can help you set the proper price and show you why your business is worth what it’s worth so that you can have that intelligent conversation with a potential buyer that comes along, and hopefully it’s reasonable buyer with money and purpose and motivation and desire.

Anyway thanks a lot and we’ll talk to you later. Don’t forget to go to my website www.InvestLocalBook.com. sign up for my email list everyone on my email as guests to enjoy my videos before everyone else. Thank and we’ll talk to you next time. You made it to the end of the video. That’s great. Don’t forget visitwww.InvestLocalBook.com, sign up for my email list it’s right down here under the welcome video. Thanks and we’ll see you next time.

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[VIEWER QUESTION] How do you know if the asking price on a small business is reasonable?

This week's question is a frequent one. How do we know if an asking price is reasonable?



Transcript:

Hey everyone it's David Barnett from the investlocalbook.com blog site. This week our question of the week comes from Phil who asked how can I determine if the asking price of a business is reasonable or not. And it's a very difficult question for me to answer because there are so many different ways that I can say ‘it depends.’ Or there are certain circumstances that we have to look at. But let me try to address it with some simple sort of guidelines that can help you determine if the asking price is anywhere within some sort of ball park or not. 

The first thing you have to determine is what are they selling. Because if you are dealing with an unsophisticated seller or someone who is using an intermediary that doesn't know what they are doing, you could end up looking at something for sale which is not purely a business. This would be what we call a recasting exercise. So for example, is it a business but it also includes real estate. Operating businesses and real estate are two very different types of assets. So somebody could have a business with a free cash flow in your pocket of a $100,000 a year, and they might be asking a million dollars for that business. And on the surface that would seem very unreasonable but if you look under the hood and realize that there is a seven hundred and fifty thousand dollars piece of real estate included in that package, then of course that changes everything. And it could in fact be a reasonable asking price. But you then need to try to determine what's the building’s worth and what's the business is now worth based on the business standing alone.

So you have to do so recasting or normalization and look at that business outside of the real estate with all of the direct cost that it would normally bear if it was operating as a tenant. In general what you want to look for is, I'm I going to be reasonably compensated for the risk that I'm taking in getting into this business. So there are two different measures of cash flow that are often looked at when people are evaluating businesses. And one of them is EBITDA, the earnings before interest taxes depreciation and amortization. In the world of professional business appraisal practice, the EBITDA figure or multiplier is only used when we are talking about businesses within EBITDA of half a million or more. But you find that a lot of the times people will use that type of measure for a much smaller business. And what's interesting about the EBITDA figure is that, it's the cash flow after the professional full-time manager has been paid.

So you need to make sure that, that cash flow figure actually includes a salary for a manager and that the manager is being paid a reasonable market rate. So for example if the owner is paying himself $40,000 but a competent manager in that business should earn 70, then you are going to have to adjust that EBITDA figure. And when you look EBITDAs as a general across the board rule of thumb across all industries which means this is a dangerous thing to look at in a specific instance. But you're generally are going to be between maybe 3 up to 5 times that EBITDA figure, is going to be somewhere in that realm of reasonable.

The other way to look at small businesses is what we call sellers discretionary earnings, which is the EBITDA figure with the owners salary added back. So if the EBITDA was $200,000 and a fair market wage of an owner manager is 70,000, then the sellers discretionary earning will be 270,000. This is the figure that is more often used in evaluating smaller businesses. Because small business buyers tend to look at a business acquisition as a mixture between an investment and buying themselves a job. So that cash flow that goes into their pocket, they look at the whole thing as the return on both their invested capital and their labour together. So when we start looking at sellers discretionary earnings, that multiplier could range anywhere from as low as one times to as high as 3 times, maybe a tad bit more with most industries being around the 2, 2.3 area. But again these are general rules of thumb. If you have a seller's discretionary earnings figure of a hundred grand, and somebody is asking for 500,000 for the business, what it simply says is that a combination of your labour and capital; you are going to take five years to get that back.

And the problem with small businesses is that it's very difficult to say with any degree of certainty what the conditions of the business are going to be in five years; the market, the environment, the economy etc. And so that's why when you are looking at investing your money and your labour, most business buyers want to make sure that they can recoup that investment entirely back to themselves within about two years for example. Now that doesn't mean they are going to pay off the business in two years but it means that they need to get that value back out within that two year period. So I hope that gives you some ideas. It can be really dangerous to apply these rules of thumb in a specific instance. So for example if you went you and you valued a restaurant at the 2.2 times discretionary cash flow, you would actually end up over paying for the restaurant. It's a very competitive industry and people in that industry end up paying far less because of the risks involved.

So I hope that gives you an answer. If you want to really get in and understand how to do this, then I suggest you take my course which is available at businessbuyeravantage.com where we actually work through a step by step example with a sample company. We look at the initial financials, we do normalization. We then do an evaluation of the business and I explain why the multipliers that are put in place in that example are used and how they make sense. So thanks and we'll see you next time.

Hey you made it to the end of the video. That’s great. Don’t forget to visit www.investlocalbook.com and sign up for my e-mail list. Thanks and we’ll see you next time.

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