 businesses that had sold in the previous five years and 10 of these were extremely similar to the subject business giving the broker a respectable data set on which to base his conclusions. His preliminary work suggested that the business would be valued lower than he originally thought and he began to expect that the final numbers would disappoint the sellers. After finishing up his work, he was sure of it.
What Drive a Business’ Value?
A business has to do three things for an owner and buyer, a point that I explained in detail in a previous post. We refer to these as The Three Essentials.
- The business must generate enough profit to pay the buyers (or their hired managers) reasonable salaries – salaries that are competitive with what is paid to the owners of similar businesses –.
Once a broker or advisor calculates the business’ Discretionary Earnings, it becomes pretty evident whether the business generates enough cash to provide the Three Essentials. And once the financial results illustrated in the data set are applied to the Discretionary Earnings (“DE”) of the subject business, a range of numbers are calculated that form the basis of what we refer to as the Most Probable Selling Price, a number that is based on the transaction data of the previously recorded “sold” businesses and the subject business’ comparative DE. This is how the numbers tell us the “market” – buyers and sellers of similar businesses – is likely to value the subject business.
In many cases, small business owners are disappointed in this number but if the valuation work done by the broker is presented in a professional and comprehensive document, the business’ owners may express their disappointment but they are almost never able to find flaws in the analysis. But reality may take some time to be accepted and the danger at this point is that the relationship between the broker and the owners runs the risk of becoming adversarial, a condition that helps no one. So, how does the broker handle this?
The Importance of Language
Many times the business owner will become defensive at this point. He or she may possibly take offense at what the broker presents. In such cases, it’s important that the broker work to make sure that the owner understands the source numbers (the numbers; not the source OF the numbers) because you want to get any argument about the source numbers and the subsequent calculations off the table. This is math, after all, not philosophy or the righteousness – or lack thereof – of the Spanish Inquisition.
Once the owner grasps the math, profound disappointment may ensue as the owner realizes that the business’ value appears to be lower than he or she had hoped and that their plans for the future – possibly retirement – are no longer possible, at least immediately.
We have seen instances where the owner becomes defensive to the point of irrationally blaming the broker for the low number; essentially blaming the messenger. If you find your self in this situation, language becomes extremely important.You may not be able to salvage a listing (which is why you should charge for your valuation work) but you definitely want to try to salvage the relationship. The owners may not sell at this time but eventually – and hopefully after increasing the value of their business – they will. And you want them to call you.
The Conversation
Language and how you structure your responses will determine how the relationship will evolve. Here’s a little role-playing scenario to illustrate the point.
The owner blames you: “So, you’re saying that my business is worth only X?”
You: “No. I’m saying that this is what similar business in your geographic region have sold for in the past five years. I am not putting a value on your business. I’m reporting what has happened when similar businesses have come up for sale. Essentially, this is what the market suggests your business might be worth. If you intend to bring your business to the market – with or without the involvement of our firm – this is information you need to have.”
Owner: “But what if I want/need more than that?”
You: You can ask any amount you want for your business. The purpose of the valuation is to guide you in determining a reasonable price.” (Our valuations specifically state at the conclusion that “This report offers our opinion of the Most Probable Selling Price which may or may not have any relationship with the asking price of the business or the actual selling price.)
“The numbers in our report illustrate what the market suggests the value may be X. You can certainly put any price on the business that you would like but as you’re considering what number would be appropriate, keep these three things in mind:
a.) A business’ bottom line must provide The Three Essentials.
b.) The time a business stays on the market is directly related to how it is priced relative to its value.
c.) A professional business broker generally will not take a selling assignment for businesses he or she does not believe will sell.”
I have written previously about the P.T. Barnum theory of life and how it obtains in our industry as in any other industry. And I have also written about how businesses losing money may have value and can be sold. But the job of the business broker/advisor is to provide the client with the information pertinent to selling the client’s business. Misleading the client about value does not serve the client well. It also risks wasting a lot of time and money on marketing a business that is over-priced as well as risking damage to the reputation of the broker for not being able to find a buyer.
Knowing how to value a business and defend the results is one of the most important aspects of business brokering. It allows you to discuss the results dispassionately with the business owner, reduce the level of emotion in that discussion and base your position on facts. It may take the owners a while to come to grips with what is in your valuation report – and if it is crafted properly and presented professionally, it will be difficult for most owners to reject it – but it will be hard for them to argue with your conclusions.
Learn the secrets of brokering small businesses…
The Bottom Line
Small businesses are generally bought by buyers that want to be in business for themselves and, as such, may pay a premium to gain that freedom. But the Three Essential do not change. Larger businesses, ones that may be the target of a strategic acquisition, are often bought at a premium because the acquiring company might be looking for something other than the target business’ demonstrated ability to generate X number of dollars in earnings. Access to a customer list, a specific needed technology and a proprietary distribution method are three of the attributes I discuss in this post that have nothing to do with the targeted business’ bottom line. But that is generally not the case with smaller firms.
So, know if you’re valuing a small business, do your research, know your numbers and draft a report that essentially eliminates doubt and argument. (If you’d like some help, let me know in the comments box below.)Do whatever you can to get ahold of the Tom Friedman column on the blogosphere. I’d provide a link but my local newspaper where I found the column in the July 3 edition didn’t include this column on its website.
Friedman tells about an encounter with a woman while waiting in line. She butted in front of him and they got into a confrontation. But now he says, he would never confront her. He would just let her in and apologize. Why this change of behavior? The blogosphere.
“Because I’d be thinking there is some chance this woman has a blog or a camera in her cell phone and could, if she so chose, tell the whole world about our encounter–entirely from her perspective–and my utterly rude, boorish, arrogant, thinks-he-can-butt-in-line behavior. Yikes!”
Friedman then shares insights by a new book by Dov Seidman called “How.” The point is in this age of extreme transparency, of digital memory that never dies, of instant transfer of information, how you live your life and how you conduct your business is more important than ever. “For young people, writes Seidman, this means understanding that your reputation in life is going to get set in stone so much earlier…For this generation, much of what they say, do or write will be preserved forever online. Before employers even read their resumes, they’ll Google them.”
And when it comes to business: “Companies that get their hows wrong won’t be able to just hire a PR firm to clean up the mess by taking a couple of reporters to lunch–not when everyone is a reporter and can talk back and be heard locally.”
But Thomas, that’s what at least some of us in this industry have been saying for some time. It is all about trust and trust depends on doing the right things (the “hows”) and telling your story well.
Friedman and Seidman also make the point about the opportunity this represents. Those who do their “hows” right, in other words conform to the public’s view of right behavior, have the opportunity to create trust and distinguish themselves from their competition on that basis. “…it represents a rare opportunity: the opportunity to outbehave your competition.”
Great stuff, Mr. Friedman. This is the age of transparency and we’ll put Mr. Friedman in that growing group of thought leaders we like to call the “apostles of authenticity.”For the first time, the UEFA Champions League Final, to be held on June 3 at Principality Stadium in Cardiff, Wales, will be broadcast in 360 VR through BT Sport and MTG.
MTV's announced today of its intention to relaunch Cribs and Girl Code, series which originally aired on MTV's