01 April 2024: Selling a Business: The Difference Between “Need” and “Value”?
Selling a business is almost always the most significant financial event in a business owner’s life. As such, the process of selling a business is something an astute owner will understand and adhere to.
That process – to which we devote a six-part series of the most important aspects of selling a business – requires the business owner to ask several questions and, to be successful, demand of himself or herself brutally honest answers. One of these questions is, “What is my business actually worth?”
Sometimes this question is uncomfortable and, if the answer is not provided by a disinterested third party, very often it’s not answered truthfully. This is particularly the case if the owner is the one establishing the business’ value. With the possible exception of the owner’s children, who may have for years been handsomely supported by the business while windsurfing in the Indian Ocean off the coast of Mauritius, a more biased and intently-interested party would be impossible to identify.
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But many business owners feel they can estimate their business’ value either from some reading they’ve done or casual discussions they’ve had with other business owners. They sometimes will even take the opinions of their auto mechanic or orthodontist.
Unfortunately it’s not unusual for us, during our initial conversation with a business owner, to hear that owner state either how much they think their business is worth or how much they need it to sell for. We, of course, ask how this number was arrived at and always learn, immediately, that no one with any knowledge of business valuation has been anywhere near this one.
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As a result, we’re often the bearers of bad news. As a rule, many business owners have an exaggerated opinion of their business’ worth.
Doing some research and applying come basic math, there are ways to determine the approximate value of a business but the research takes time, access to certain data and the knowledge as to how to interpret such data. The math needs… well, not much more than a basic calculator and an understanding of which data results the calculations should be applied to.
But all this, as critical as it is, comes after considering the most important distinction that must be made and understood by the business owner. To wit: what they “need’ or want for the business versus what their business is actually worth. This is question that has seldom been considered by the business owner.
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Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.
When an owner says they “need” a certain amount of money for their business, we automatically think we’re going to have a problem.
First off, some owners have never considered what they really “need”. They pull a number out of their hat because it sounds good.
In the Main Street or “mom and pop” market, a million bucks seems to be a favorite. This number bestows bragging rights as in, “my business is worth a million bucks”, or “when I sell my business, I’ll be a millionaire”.
In the lower Middle Market, owners give less consideration to what’s in their “hat” than what other business owners might suggest. For example, the owners of a business with revenue of $6 million might have heard from someone they respect that such businesses generally are valued at X times revenue or X times annual profit. Though this approach is less senseless than pulling a number out of a hat, it’s still completely meaningless without knowing what the Xs are and what the “real” annual profit is.
But this debate – at least at this point – is a bit premature. The starting point has got to be understanding the relationship of and difference between what an owner wants/needs and what the business is worth.
If you own a business and are beginning the consideration process of selling, Step 1 is to understand what you need. Step 2 is to know the likelihood of your business being worth that number.
Selling a Business: What You Need
Before selling a business, the owner should understand their personal situation. This is where the “brutally honest” answers mentioned above come in. What is you current lifestyle and do you intend to live in a similar style post-closing? Few sellers we’ve dealt with plan to downgrade the way they live after selling. In fact, given the freedom of no longer having to run their business, many sellers ramp up their hobbies, charitable plans, travel plans, etc.
Some business owners, having worked 60-70 hours a week for decades, are looking forward to a quiet retirement. If the owner plans to spend their days tinkering in their workshop or baking chocolate miracles with sourdough discard, adding up all anticipated living costs will come to…well, whatever it comes to. Home paid off? Insurance – life, health, disability, property, etc. – considered? Daily living costs? New chisels in the workshop or an Emile Henry Long Loaf maker for the kitchen? An occasional visit to the grand kids in Tunisia because your daughter and her husband decided that learning Arabic would be useful if their kid ended up translating classified documents for some anally-attentive higher-level bureaucrat in some subsection in the U.S. State Department? All this needs to be considered.
As well, what if the owner has grown a tech start-up from zero to an acquisition by the Evil Empire (Google? Amazon?) in 12 years? Such an seller is unlikely to be planning to “tinker in the workshop” – unless that “workshop” is an enclosed acre where the design and construction of a revolutionary AC37 or AC75 for the next America’s Cup yacht race is taking place. (See competing with the Big Dog.)
These two (perhaps extreme) examples are meant to illustrate the need to understand what the seller will need to live the life they plan after the sale. If the owner plans to compete with Musk or Bezos in establishing a functional colony on the surface of Mars, a completely different bank account will be required than the one needed for the weekly production of sourdough muffins. But understanding this is only the first part of the initial equation.
What’s Your Business Worth?
What an owner needs and what the business in question is actually worth are two totally unrelated issues that must be considered separately – except that the latter dictates whether former can, when the business is sold, be achieved. That is, they’re related only when the desire to sell hits the business owner.
As mentioned at the start of this journalistic tour de force, selling a business will likely result in the largest financial event of any business owner’s life. After debts are satisfied and taxes paid, the owner will need to live off the net proceeds for their remaining days. It is important to confirm there will be sufficient funds for an owner to be able to live life after the deal is done as they’d planned and the only way to do that is to have some idea of what the owner will be walking away with and how/when the sale proceeds will be received.
For sellers, knowing what they need is critical and knowing if they’ll be able to achieve that will be possible ONLY if the value of their business is known. It may be that the value of the business won’t support the owner’s plans, whether those plans involve new chisels for tinkering in the workshop or enough sail canvas to cover Rhode Island. If the business’ value does not provide the horsepower needed for the anticipated post-closing life of the owner, that owner may need to adjust their plans – work longer to increase the value of their business to support the post-closing life or scale back that post-closing vision to fit the likely financial financial results now.
The Bottom Line
Not to be repetitive, but selling a business will likely result in the largest liquidity event of an owner’s life – and part of our job is to make sure our clients know this and factor it into their decision-making. After debts are satisfied and taxes are paid, the owner will need to live off the net proceeds – tinkering in the workshop or building the fastest sailing yachts in the world – for their remaining days. To avoid the possibility of a sudden and potentially catastrophic shock, when considering selling an owner must consider the importance of understanding “need” versus “value”. It’s critical to confirm there will be sufficient funds for an owner to live the post-closing life they plan – or to plan the post-closing life their business will support.
A wise business owner will always have a sense of his or her business’ value. For many significant reasons – insurance, divorce, partnership structuring, succession planning, among others – many owners have their business valued regularly. Over the years we’ve had clients that needed annual valuations done, some for lenders, others for insurance underwriters, etc. Such owners always had a reasonable approximation of what their business was worth. But we’ve found that most owners have very little idea as to what’s probably their most valuable asset is worth.
Proper planning for ALL owners suggests getting their business valued long before they think they’ll sell. Doing so may provide the time necessary to build the business value to meet the “need” number. But you can’t do that unless you know both the “need” and the “value” numbers.
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at jo*@Wo*******************.com.
If you have any questions or comments on this topic – or any topic related to business – I’d like 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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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 600 in the world. He can be reached at jo*@Wo*******************.com