Pricing a BusinessLast week’s post about valuing a business generated a number of questions about pricing a business. Most of those questions related to how price is determined for the marketing of that business. Different people have different approaches to pricing a business. Some business owners want to price their business at a number they “need” or “want”. Some brokers – and almost all real estate agents that we’ve run into – say, “sure!” and bring the business to market at whatever price the seller wants. This path, of course, is pretty much a guarantee that the business won’t sell. Why? Well, the vast majority of owners – especially owners of small businesses – have an exaggerated opinion of the value of their business. And the ONLY reason something – anything; be it a business, a house or a pound of tomatoes – doesn’t sell is that the price is too high.
Other sellers – and business brokers – look at the valuation report the broker put together and resign themselves to the report’s conclusion. If the valuation comes in at $2.4 million, that’s the number it’s sporting when it comes to market.
Back to the Goldilocks PriceTo finish up on the Goldilocks price – one that is not too high and not too low… We know that almost every buyer for pretty much any large purchase from any private seller – a car, boat, house, business – looks at the “ask” or “list” price as little more than a “suggestion”. If you’ve ever sold a car or boat and put a sign stating “For Sale: $10,000” on the windshield, I suspect you were anticipating receiving “offers” for your car or boat, some of which might be ridiculously low but none of which would be $10,000. If you’ve sold a house, the same scenario existed. The Competitive Market Analysis provided by your agent – she DID provide a CMA, right? – suggested that the market value was $365,000. As is often the case, you were hoping for something north of $400,000 but, as the current en vogue saying goes, “it is what it is” and you agree to list your house for $365,000. But to a buyer, this price is just a suggestion. You get offers of $345,000, $322,000 and a old Volkswagon bus, $351,000 but you have to take back the financing and so on. You end up negotiating the first offer up to $354,500 and the deal is done. But wait a minute! The deal is done at $10,500 below the house’s value as suggested by the CMA. A business valuation is tantamount to a CMA albeit FAR more complex and detailed. It tells us what “the market” suggests a business is worth. That becomes our target. But we know that buyers of businesses – as with buyers of houses, cars, boats and countless other things – look at any “asking” or “listed” price as a suggestion; a number that is unlikely to represent, in the buyer’s mind, what the seller will actually accept. An experienced, professional business broker will suggest to their selling client adding what we refer to as a “negotiating premium” to the target price. What kind of premium? Well, as you’ll see in a moment, it depends. When pricing a business, we always suggest to our selling clients that we add a negotiating premium to the target price and that premium is always expressed as a percentage. The resulting “ask” or “list” price reflects a padding that assumes a buyer is going to expect a discount of a certain percentage to that ask. We know offers will come in that will be lower than the “ask” price. But remember, our objective is the target price. The discount we’ll expect – and will calculate for – depends on several factors such as industry, marketability of the business, the necessity of specialized talent required to manage the business and several other factors. (This topic is discussed in greater detail in our course.)
The Bottom Line
When pricing a business we have to keep in mind our target price – as determined by the valuation – as well as our client’s ultimate objective and level of motivation.
We’ve had clients that became just plain “don’t-wanters” if their business didn’t sell quickly or some personal setback occurred during our engagement. In some cases, they just wanted out and would agree to an offer that was below the target price just to be rid of what, to them, had become an enormous headache. But in most cases, when we explain why we want to add a premium to the value, our clients generally greatly appreciate the concept and reasoning behind our recommendation. If you have any questions, comments or feedback on this topic – or any topic related to business – I want to hear from you. Put them in the Comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast. I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week! Joe
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