Would you expect to buy a new Lexus for $ 10,000? Now, a house on 3 acres of land with 9,000 square feet of living space in a new section of town for $ 75,000? How about a gallon of gasoline for $ 1.85?

It doesn’t seem like a long time ago that fuel sold for $ 1.85, but today you couldn’t dream of getting it for that price. Why? There is not enough incentive for the owner of the fuel to give it to you for that price when you have others who would pay much more. It probably cost you over $ 1.85 to purchase the fuel and refine it! So how much is enough? When you are about to make an offer to buy a business, the million dollar (or more) question becomes “Will you guess the correct purchase price?”

Many people struggle with this question. And guess what, it’s not just you who fight. Even the best people in businesses who buy and sell other businesses try to figure it out. The truth is that value, like beauty, is in the eyes of the beholder. There is no scientific justification why a company is worth 8 times its annual EBITDA a year and then 5 times a month.

Yes, market conditions and attitude play an important role in determining the value of a going concern. But how much is it really worth? Nobody really knows. The price of a business is determined solely by what you pay. Under normal circumstances, companies are bought in an arm’s length transaction. As the definition states, the fair market value of a company is what a seller and a buyer, both in possession of all the relevant facts and conditions, and not under duress, agree as a price.

But since you are the buyer, what price should you offer? We get that question a lot. Be careful here. As a buyer, make sure you have objective advice when and if you want to determine a bid price for a business. Remember, most brokers and intermediaries are really agents of the Seller and, as such, they should ethically advise you not to ask them for price advice. They cannot be objective on your behalf.

They can help to discuss the issues with you, but in the end it is you and ONLY you who make the final decision on what to offer. Your paid advisers are usually hired to highlight the flaws and risks of a decision you want or need to make. The actual level of risk that you accept and are willing to take is something you must take. No one will do it for you.

When YOU want to make an offer on business ownership, YOU are the only one who can take that leap of faith as to how much is enough. That winning PRICE is something that tips the balance in your favor. It is something that makes the business owner stop and think about the value to them. In a word, it is a price (and terms) that INCREASE them.

A buyer should only make an offer based on the value of a business. But that offer should incentivize the business owner to accept the sale. Many buyers, unaware of the process to use to determine the value of a business or determine the price of an offer, become confused and make unrealistic offers, both high and low.

An offer price that encourages a seller to sell, but is not representative of market value, is a bad offer. Offering a high price to guarantee success could be disastrous. The company’s cash flow may not support the debt service incurred or provide a competitive return on investment to shareholders. An informed salesperson may be afraid that you might not pay the money owed to them, and then be forced to get the business back, something they probably don’t want to happen.

Unfortunately, the reverse is also true in many cases. Buyers make offers for businesses every day that don’t work out. Why, because the buyer did not offer the business owner a sufficient incentive to sell. This article is not intended to help you price a business, but with this in mind, it will help you understand the psychology of a sale. TO good business that is profitable, has strong positive cash flow and has an excellent outlook for continued operations, has definable value. As a buyer, you must determine how to assign a value to the business that appeals to you and meets your needs.

You probably never know exactly what will incentivize the Seller. However, during your discussions with the Seller and other research, you should try to determine what would incentivize them. I’ve seen companies sell for 10% of their value because a salesperson wanted to retire and just make sure their clients continue to receive services. But, as you probably guessed, that happens one in 10,000 times.

When determining what price to offer, first determine a price range that makes sense to you. Ask yourself how much you need to earn. What are the chances of increasing cash flow? What are the risks? Find comfort with the range. It’s not unusual to be nervous about that amount, especially on the higher end. However, it should still be viable for you.

Now, try to determine what the seller would consider reasonable and it would encourage them to give you their kidneys. Consider the following items when attempting to make this determination:

  1. What is the multiple of the cash flow? Is it within current industry standards or not? If it is too low, the probability of a better offer from someone else is very high.
  2. Are the combination or the price and terms reasonable? There is a big difference when a price actually ends with loan payments or earnings. Remember this formula that a salesperson will consider:
    • Price = Cash Now + (Cash in the future * Collection risks).
  3. How long would it take for a landlord to EARN the money you are paying? at closing and is not at risk of collection? If it takes 2 to 2½ years or LESS, most Sellers would prefer to stay in business, keep what they earn in that time, and then simply go out of business. They will not have closing costs, aggravation of a sale or have to deal with a third party making the decisions during the transition period.
  4. If your transaction allocation results in a high tax consequence for the Seller, you may not pay for the sale. Ask your broker or tax accountant the true implications of an allowance for you and (not directly obvious without considering your personal tax situation), the Seller.
  5. An offer can be seen as an insult (in dollars or in terms) and does not indicate to the owner what the value of their efforts has been. This could lead to you being disqualified from receiving a counter offer or even negotiating a new offer!
  6. You are not doing the seller a favor by buying their business. They are likely proud of what they have built, and would not sell it cheaply or on more terms than they would give away a prized painting they own because they have owned it for too long.
  7. Offers must be unemotionally priced. However, that does not mean that in all cases the Seller will evaluate it without emotion. If you, as a buyer, believe that a seller will place too much emphasis on emotion versus value, you may be wasting your time. You should evaluate the Seller and the business to make sure you are using your time, money, and resources effectively.

When you finally get a business owner to agree to a bargain price, chances are that both you and the Seller have not gotten exactly what you wanted. You will think you paid too much, or maybe you made the terms more in favor of the seller, and they will think you got a bargain price and are being too harsh on your terms and payment requirements. That does not mean that there was a disagreement. It is simply the nature of the negotiations. Nobody thinks they really won.

To be prepared! Understand the psychology of what prompts a salesperson. Be careful to only offer what a business is really worth. Understand that you may have paid more than you wanted, but if you have faith in the business, as well as your experience and skill set, hopefully your investment will pay financial and psychological dividends for years to come.

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