Setting Reasonable Price Expectations

Many business owners believe they should be able to sell their businesses for a higher price than many buyers will be interested in paying. A buyer may feel their business is worth more for a variety of reasons. While part of successful deal making is identifying a business’s unique value-added attributes and attracting the buyers best positioned to deploy them, another important part is establishing reasonable expectations of what buyers will think your business is worth.

A good approach for owner-operated companies is to evaluate the income to the buyer after debt service if they buy your company for the price you want. Even with this streamlined perspective, there is no perfect science for evaluating the decision rules of buyers. But the examples below are designed to provide a basic structure you can apply to the deal you expect to make, to see how it would look from the buyer’s side.

The approach is simple. A buyer financing with a traditional SBA loan can expect to make a 10-15% down payment (we will assume the minimum 10% for our examples) and finance the remainder, typically at Prime plus 275 basis points. We’ll ignore loan closing costs, and use a financial calculator or spreadsheet to compute monthly debt service (interest plus principal) on a 10-year, fully amortizing loan. We then annualize the debt service, and subtract it from the company’s annual earnings, assuming it performs similarly to the way it did under the seller’s ownership, to determine what the buyer would pocket each of the next ten years.

Example 1

This small income replacement example below with $110k of SDE assumes no significant net working capital adjustment is needed to purchase price (i.e., working capital items at close are at normal, long-term levels). It demonstrates the buyer’s earnings after debt service are considerably lower under the higher multiple purchase price scenario.

Example 2

The example below takes the numbers up a notch. The buyer pockets more under all scenarios, but the price tag is higher as well. A buyer that can afford a down payment of this magnitude can expect to pocket more each year relative to other career opportunities, but the purchase price makes a considerable difference. The twist this example illustrates is the use of a smoothed earnings measure. If the business model is solid, but the evidence suggests the most recent 12 months are not an accurate reflection of the business’s earning power, the parties may agree that a longer business cycle is a more appropriate period on which to base valuation.

Example 3

This example illustrates yet another variant that can have a significant impact on the the economics for the buyer. Our earlier examples ignored working capital adjustments. But consider for a moment a situation in which the buyer must, in order to achieve the level of historical earnings reported by the seller, make a considerable additional investment in the business. This could be precipitated by depleted inventory stores, or fixed assets nearing the end of their useful lives. In cases like this, whether a particular purchase price makes sense for a buyer also depends on the additional investment in working capital or fixed capital the buyer must make. The business illustrated below can be expected to produce $183k of earnings, but only if the buyer makes an additional $460k investment in inventory, over and above the purchase price of the business. Under the low, medium, and high deal price scenarios, the seller would get 3.27x, 2.73x, and 1.91x SDE, respectively, as shown in the table below. But to the from the buyer’s perspective, the alternative scenarios represent 5.79x, 5.24x, and 4.42x SDE, respectively. Under the cheapest of these alternatives, the buyer’s annual net would be only $138k–and the buyer’s annual payout would be 27% lower if they pay the high-end price.

If your business isn’t currently performing at levels that will lead to the deal you want, there are things you can do to make the company more attractive to buyers. The more flexible you are on your exit timing, the more effectively you can make purposeful changes that will move the needle in the right direction. Advanced planning with your transaction advisor is always a more effective means of getting the best price for your business than setting your desired price and expecting to hit it through willpower and negotiation. At Ravelin Pointe, we help you set realistic price expectations, talk to you about your options, and work with you to determine what steps they can take to position your company for the outcome you are looking for. Contact us today for a free consultation.