What buyers buy when they buy a small business:
It has been my experience of the years of business broking that buyers follow a natural path of progression in their search for the ideal business opportunity. Grasping the content of this article in the early phase of the search can assist buyers to formulate their thinking and prioritise what really matters. It could however also assist sellers to understand how buyers look at their businesses and improve some aspects to make the proposition more attractive.
- Buyers buy an income stream:
This is basically the cash flows generated by the business and is most of the time the first level interest buyers has in acquiring a business. They would evaluate a number of businesses on the market based on the price to profit ratio and pick some very attractive options and discard the rest. In doing so they may actually already have rejected some of the most attractive options. Investors would look at the return on investment after management costs has been factored in. Business entrepreneurs who intend assuming management from the seller would consider cash flows before all salaries, benefits and lifestyle expenses drawn by the seller. Such an entrepreneur would however deduct his opportunity cost (salary and benefits earned at his current employ) before the return on investment can be established.
Consultants such as accountants, brokers, bankers etc. often create expectations with both buyers and sellers around the selling price “norm” by using formulae. These formulae very seldom takes risks into consideration. At Tri Source consulting we strive to achieve more realistic valuations for our clients by using a dynamic triangular approach between the prices to earning and risk ratio present at the business.
Investors investing on the stock exchange would look at dividends declared by companies as the potential income stream generated by the company.
- Buyers acquire an Asset:
For the purpose of this writing an asset in this context is the market value of the business for sale. The market value can only be established at the point where a buyer and seller agree on the price and terms of the transaction and not the price at which a business is advertised for sale. The scalability or potential to increase the market value of the business is an extremely important consideration when selecting your business. Smart buyers often consider businesses that appear expensive or even some that are making a loss as they have the knowledge and skills to turn such a business around. Such a business can eventually be sold at many times the price it was originally acquired at. The returns earned from such growth could easily outperform cash flows earned from the business and should always be an important consideration for buyers.
Investors investing on the stock exchange heavily depend on the growth in the price of the stock in order to justify the decision to invest in it. Many listed companies do not declare dividends and many other pay 2% or 3% per annum which is clearly less than the inflation rate of 5% – 6% per annum. Buyers of unlisted businesses should similarly consider the potential growth in the market value of the business in their buying decision.
Unlocking synergies between what you already have and/or know and/or are networked with often becomes the most important ingredient in successful transactions.
- Buyer acquire a Lifestyle.
Less so for investors but certainly entrepreneurs who buy a business to manage the acquired business will become what they buy. With many hours at work physically running the business and many more thinking about it the entrepreneur will become one with the products, people surrounding him, customers, place and all and everything associated with it. From the front gate through reception and ultimate meeting place will become the most important first impression of the business. If you are already a successful engineer you may find it very difficult to successfully ad value at the corner café even if it makes an outstanding return on investment and great growth opportunities.
In the process of optimising your business value you may also consider your exit strategy by improving lifestyle attraction to potential buyer. This would increase the pool of buyers when you want to sell which would in turn have a direct influence on the value.