The problem of value is what causes both buyers and sellers to be anxious about pricing small business for sale by privately-held businesses. Both parties are anxious about the question of the selling price. A seller does not want to overprice their business nor “lose money” by underpricing it either. Business buyers are always concerned that they will pay too much for the worst possible deal.
What then are the best practices for pricing a small business for sale?
Pricing v. Value
When pricing a small business for sale, first, let us consider what is pricing and what is value. Price is simply the amount for which the parties are willing to exchange the business. Value is the perceived benefit.
As business brokers, the most frequent mistake we see is that business sellers overprice their small business. They overestimate the perceived value of their business. This is quite understandable, especially if the company was started from scratch. It is a normal reaction to letting the business go that a business seller will project a greater value on the business through their attachment to the company through both financial and emotional filters.
The Problem of Overpricing
Overpricing a small business may have serious consequences. An expensive business will be difficult to market and sell. Business brokers will find it hard to recommend an overpriced business to their clients. They will not waste their time trying to sell a business that they do not anticipate will be sold
Moreover, business buyers are savvy. Many have looked at several businesses and learned rudimentary valuation. They usually know how much a business in their preferred niche should cost depending on the features they desire. An overpriced business will make it difficult for buyers to seriously consider it as a viable option. A business priced too high is a bad way to market since it discourages buyers, will likely require price reductions and basically stay listed for sale for a prolonged period of time.
Although the valuation of small businesses is not an exact science, there are guidelines that stakeholders use to determine reasonable pricing. These guidelines are based on the Small Business Administration (SBA) valuation approach for small business sales. The methods used are known as the Sellers Discretionary Earnings and Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA).
For most business sales, it is a good idea to have a business valuation before pricing a small business for sale. There are varying degrees of valuing a business depending on the size of the business. For most small business sales, a business valuation by a business broker or accountant is sufficient. Business valuations take the guesswork out from business sales.
Asset sales are the most common type of small business transfer. The buyer buys the assets, which usually include furniture, fixtures and equipment as well as inventory. Goodwill is also included. All financial encumbrances are removed from these assets at the closing. The cash on hand, and accounts receivable are generally not part of an asset sale. The seller usually keeps these two items.
A corporate stock sale is the opposite to an asset sale. The purchaser purchases all outstanding stock shares in the corporation and takes control of all assets and liabilities of the company. These are less common as most buyers do not want to buy the potential liabilities of the seller.
A basic understanding of business value in pricing a small business for sale is that profit is more valuable than its tangible assets. An income stream is what is being sold to buy a business. The business appraiser will value that stream of income. This leads to two types of business appraisal guidelines.
First, and easiest to follow is that businesses should be sold for at least a percentage of their annual revenues. Second, is the formula that is based on discretionary cash flow. All furniture, fixtures, and equipment required to run a business are included in these guidelines. The guideline results include inventory value at cost. They do not include cash and accounts receivable in their sale. These guidelines assume the business is in a lease location with a reasonable rate of rent. Commercial property sales are not assumed in these pricing guidelines as they are typically priced separately from the business sale.
These guidelines are not applicable if the business, in its worst case, is losing money or breaking even. The best possible price for a business owner is the value of inventory, furniture and fixtures.
(1) The Value of an Annual Revenue as a Percentage
First, most profitable private businesses that have annual revenues below $5 million can be sold for between 20% and 80%. The type of business determines where the business’s selling price falls within the range of 20 to 80 percent of its revenue. For example, convenience stores are on the lower end while dry cleaners fall at the top.
(2) Valuation as a multiple of cash flow
Another set of guidelines aims to estimate the business’ value by adding a multiplier to its discretionary cash flow. The second guideline says that businesses can sell for anywhere from one to six times the owner’s discretionary income. The type of business will determine exactly where a business is located within this range.
Price To Sell
The market determines the price. Saavy buyers will be informed and compare price points in their niche. They will be advised by their brokers on typical pricing ranges.
When pricing a small business for sale, work with a business broker to sell your business will significantly help. Brokers will use their skill and experience to right price your business and smartly market it for an efficient sale and successful outcome.