The sale of your business may be the largest transaction you will ever do. Because the stakes are so high, nobody wants to get it wrong. When it comes time to price your business, it’s ok to aim high, but setting your expectations too lofty can ruin your chances of finding a buyer quickly - or at all.
So what’s the right price for your business? "It’s both a science and art," says Jon Franz, founder of Franchise Clearly, a firm that specializes in selling franchise businesses. When determining a sales price, Franz looks at the total owner benefit and compares that to other similar businesses that have sold recently. To complete the business value picture, Franz looks at dozens of details that affect saleability. He and his team have a process. He looks for expense items that contribute to owner benefit. The higher this number, the greater the potential sales price. This is called an add-back because it’s recategorized as part of discretionary earnings. Another less desirable pricing strategy is based on a percentage of sales (revenue). However, doing this presents an incomplete picture that buyers see right through.
The Danger of Pricing Too High
Business intermediaries use a database to share information similar to the Multiple Listing Service in residential real estate. Unlike the MLS, buyers cannot see how long a business has been on the market. So is it ok to price a business at the top of the market and wait for a buyer with deep pockets to come along? Franz cautions against this strategy. "Even though a buyer cannot see on the listing how long the business has been on the market, they always ask, and it’s among their first questions. If it’s too long, it immediately raises suspicion and makes the buyer think there is something "wrong" with the business."
Let’s say you have a verbal agreement with a buyer that is ok paying an above-market price. That’s great right? While that sounds like a wonderful scenario, the deal may never get to the closing table. It’s because most small business transactions like these go through the Small Business Administration. The federal government-backed loan products are used by banks to help buyers get funded. However, the bank will do their own analysis and determine a loan-to-value ratio they are comfortable with. Among other factors, the bank wants to see that the business provides a "reasonable" salary for the new owner and cash flows enough to service the debt. The lender is required to order a business appraisal. If that comes back too low, that’s a problem. If the numbers don’t check out, the buyer won’t get the loan they need. The only remaining options are to ask the buyer to come to the closing table with more cash or be willing to hold the difference in a seller note. "That rarely happens," says Franz.
The Sellers Reality
Most sellers have an idea of what they think their business is worth. It may be based on what an accountant tells them or from conversations with other franchise owners. "Owners seem to formulate their own number, and round up from there," says Franz. Unfortunately, many times that number is not grounded in reality. The news can be tough to hear, but an honest conversation early on will help the business get sold as soon as possible, and on the best terms. Franz says, "I’d rather not have the listing than give false hope."
The 2020 Wildcard
When the business lockdown of 2020 occurred, it caused a major shockwave through the business world. Some sectors saw revenues drop to zero overnight such as in the case of gyms and hair salons. Even during the worst economic slowdowns in history, that’s never happened before. Yet other sectors saw a business boom. UPS franchises had a banner year because of the online shopping trends and lack of travel. People had to visit their local shipping store to return unwanted items and send Christmas gifts to family members because they wouldn’t be with them in person. With clear winners and losers in the short term, lenders weren’t quite sure how to value businesses. The uncertainty killed most business sale transactions for 6 months.
However, now that the worst has passed, business is returning to normal. But the question about accurate valuations persists. Was business value destroyed due to last year’s dismal financial performance, or is it overvalued due to the relatively short-term phenomenon?
Franz explains "We are seeing banks accepting explanations about 2020. They understand it was an unprecedented time in history and they need to be flexible. If a business can show how they have rebounded and returned to normal, we can explain away a short-term drop in revenues. It’s not hurting business value. However, if a business struggles to return to pre-pandemic levels, the extended revenue drop becomes harder to explain to buyers."
Franz and his associates have been through this exercise before. They put together an information packet that tells the story of the business and the financial health. It helps the buyer understand where the business was and where it’s headed.
It’s not all about price
It’s important to note that the sales price is only one (albeit important) detail in the deal. A business intermediary that specializes in franchise sales can help you identify and negotiate other factors that affect how much money you put in your pocket. For example:
These and other factors can be just as important as the sales price. However, Franz says the biggest factor in selling your business for as much as possible is competition.
If a business is priced properly, it will attract more than one buyer. If multiple buyers know they are competing with each other, they will put their best offer on the table. And in some cases, pay more than the asking price.
Franz’s best advice is to seek the help of a professional advisor or intermediary that understands franchise models well. Have them use the commonly accepted method of evaluating owner discretionary earnings and assign a multiple supported by comparable sales. Encourage multiple offers by appealing to the widest pool of buyers. Doing these things will ensure you get top dollar for your business.