An overpriced business opportunity is a major impediment to a successful business sale
An overpriced business is hard to sell. Overpricing business opportunities is problematic and, unfortunately, prevalent. Apart from causing mistrust, overpricing a business can undermine the business selling at all. Considering that many small business opportunities will not sell, with an estimate of 25-75% of unsellable businesses, overpricing is the kiss of death for business opportunities.
Consider a buyer looking to buy a pizzeria and finds 4 comparable options. Let’s say 3 are priced at around $250,000 and the 4th is priced at $600,000. The buyer won’t even look at the 4th option because it’s obviously overpriced.
Why then would a seller market their small business with an overpriced list price? Likely the two most common reasons are unrealistic seller expectations and some business brokers not knowing how to accurately value businesses for sale or want to appease their client by listing the business with an inflated price in the hopes that the seller will come to their senses with prolonged inactivity.
Business brokers who provide accurate feedback on more realistic pricing significantly enhance the business being sold and in a timely manner. Better business brokers know that overpricing a business results in the seller enduring a prolonged and difficult sales process that usually does not result in a sale.
Given the dire consequences for the seller of overpricing their business, and the high percentage of businesses that do not sell, it benefits business owners to manage their expectations and set a realistic sales price relative to their industry and market.
How Are Businesses Valued?
In small business sales, businesses are normally valued on the past 3 years of the seller’s adjusted cashflow multiplied by their industry’s multiple. For example, let’s say the pizzeria’s adjusted cashflow is $125,000 and the multiple in their area for pizzeria’s is 2x cashflow, then the value is $250,000 ($125,000 x 2).
Most small businesses sell at a multiple of 1.0 – 3 times adjusted cashflow. The average is 2.7.
Credible business brokers that have the training and experience to perform business valuations, should be able to show exactly how they arrived at their listing price. The business broker should show the financial records relied upon and comparable sales that clearly shows and justifies the multiple that broker is using.
Most small businesses can usually be valued within a tight range. Overpricing the business above the top end of the range for negotiating purposes is undermines a buyer’s confidence in the business (and seller) and discourages interest. Most qualified and serious buyers will not look at a business when it’s apparently overpriced. Why would they? An overpriced business not only signals inflated seller expectations, but also that the transaction itself may be challenging because the seller is being unrealistic.
What’s The Return on Investment (ROI)?
Another way to ascertain if a business opportunity is overpriced is to consider the buyer’s return on investment (ROI). Roughly speaking, for business opportunities, the buyer wants to see their initial investment, or deposit, returned within 2-3 years. This means that after deducting the buyer’s salary, expenses, and debt service, the buyer should see enough profit to get their initial investment back within 2-3 years.
Beyond 4 years makes the business harder to sell and over 5 years is an overpriced business. Calculations will vary depending on financing and whether commercial property is involved but if a business opportunity pencils out a return on investment of the buyer’s initial investment with 2-3 years, then the buyer is looking at a very good deal.
Right Pricing Makes The Sale
As previously mentioned, overpricing businesses is relatively common in the small business opportunity marketplace and probably explains why a large percentage of small businesses do not sell. Many business owners that originally overpriced their business come to regret it when the business is not sold or they are forced to liquidate their assets and settle for pennies on the dollar. This is an unfortunate result that could have been avoided with a happier ending for the business seller.
While selling a business is not easy, it need not cause undue suffering. Overpricing a business will cause the seller undue suffering. There are checks and balances in business sales, one of which is the lender for the business acquisition loan. The lender will independently determine the business value either by using their valuation technology or have a business valuation completed. When the loan underwriters recognize the sales prices is inflated, they will not loan to the buyer.
Overcoming an overpriced business can be done with market data. Once the adjusted cashflow is determined, then the business broker looks up comparable sales to determine the industry multiplier. This data provides the necessary information for valuing a business and determining whether it is overpriced.
Avoid overpricing your business for sale if you are a business owner. You will waste a lot of time and your business is unlikely to sell. Moreover, you will find yourself drained and frustrated by the process. Working with a knowledgeable business broker with experience valuing businesses like yours is essential for a successful outcome.
If you would like to learn more about right pricing your business for sale, contact our knowledgeable and experienced business brokers to help you get on the path to a successful outcome.