A potential buyer looks at a business to see what he can do with a combination of money (resources), motivation (goals) and management (skills). Once he estimates how profitable he thinks it could be under his ownership, the buyer can determine what he thinks the business is worth.
The idea that the value of a business lies in the future as seen by the buyer can be difficult for business owners to embrace. They know their company’s background and important milestones, and may have a hard time accepting that future return on investment is the foremost question on the potential buyer’s mind. While the bottom line, and past and present performance are certainly important, it is the buyer’s perception of the future that carries the most weight.
That’s why, when business intermediaries (people who are trained in facilitating the sale of a business) assess a company, a great deal of effort is put into determining what the business’s future is likely to be. An intermediary working on behalf of the seller will look at broad economic trends and the marketplace for that company, including the current and potential competition. The relevant history and performance of the business is then “re-cast” to provide a reasonable estimation of the future, thus determining the value of the company from the seller’s perspective.
Meanwhile, the potential buyer estimates his or her return on investment by looking at such things as the cost of borrowing money, the degree of risk involved in the transaction, his personal need for income and liquidity and the future expectations of profit.
For instance, if sales are down, profits have dropped, competition is high and capital expenditures are needed, this combination of factors will likely result in a lower purchase price being presented.
The type of business also affects how a company’s value is estimated. For instance, purchasing an insurance agency is considered a lower risk investment because most insurance policies renew yearly; whereas, a construction firm is a higher risk because its activity depends on being the successful bidder in contracts – the business is only as successful as its most recent contract.
How a business measures up to similar operations in the same industry can also affect the value a buyer will put on a business. In the printing industry, a buyer will want to know if customers have chosen a particular business due to loyalty, location, service, capability, capacity, timeliness, pricing, payment terms, or other more personal reasons.
When it comes to buyer motivation, lifestyle goals are also a contributing factor. Buyers may be interested in purchasing a business primarily because of its location, e.g. in a resort or vacation area. Family interests can also play a part – a buyer may be interested in a particular company because it provides employment opportunities for sons or daughters. Nevertheless, if the perceived future for the business isn’t bright, no buyer will hand over the money regardless of how well it matches individual goals.
When a business is sold, the seller’s and buyer’s goal are naturally opposite – the seller wants the highest purchase price possible and the buyer wants the highest return on investment – and a lower purchase price means less risk to the buyer in achieving a strong return on his investment.
These two very different perspectives set up a process that is inherently confrontational. This is where a business intermediary can help who is not personally involved. The process is similar to using a real estate agent to sell your house, a lawyer to manage a lawsuit or an accountant to handle an income tax reassessment. Putting specialists between two opposing sides can help make the transaction a smooth one, and will ensure that the necessary regulatory issues are appropriately managed.