Welcome back to Becoming a Better Business Broker in 30 Days!
This concise series title describes exactly what we hope you get out it - becoming a broker that can close more deals with less work.
If you missed yesterday, check out The Top 5 Mistakes Business Brokers Make.
Today, we will explore the world of business valuation. But don't worry, we're leaving the spreadsheets at home for this article, instead focusing on the art of setting the right listing price.
Hot Take: Business Brokers Don't Determine Valuations 🌶
Before you leave a rude comment on this article - hear us out.
Business brokers can't decide how much a business is going to sell for (aka it's market valuation). Because if that were true - every business would sell for $10M dollars and every broker would drive a Ferrari.
We checked with a few brokers and this is unfortunately true.
So who sets the valuation? Well, Milton Friedman would say the market sets the price. In this case, we'd probably agree with Milty - buyers and sellers ultimately determine the price.
If brokers don't determine value - then what use are they? Where brokers provide massive value is providing price transparency for each party, unlocking market liquidity.
You're probably thinking, "Okay, Mr. Fancy Words, what does that statement even mean?" Well, allow us to elaborate.
How Brokers Provide Price Transparency 🔍
Brokers can provide price transparency in the following ways:
- Giving Buyers + Sellers access to comparable transactions within their industry.
- Educating Sellers on Saleability vs. Value and the buyer persona most likely to buy their business and how that impacts the pricing strategy.
- Educate buyers on the return profile of a particular deal using ROIC, IRR, and/or other financial return metrics.
Let's break each of these down 👇
Giving Buyer + Seller Access To Comparable Market Data
This one is pretty straightforward:
- Obtain your Seller client's financial statements and/or tax returns
- Recast or normalize the financial statements to calculate Seller's Discretionary Earnings (SDE) and/or EBITDA
- Using your client's revenue, SDE, and EBITDA, compare businesses of the same size and industry to find the suitable asking price multiple.
Where do you obtain the transaction data? We're big fans of DealStats from BVR (shameless plug: DealBuilder clients automatically receive a license to DealStats and unlimited valuation reports - demo here) another popular tool is PeerComps.
Finally, every broker should have a copy of the Business Reference Guide on their bookshelf. While it doesn't provide specific transactions, it's an excellent tool for rule-of-thumb valuations and for obscure business industries without much transaction data.
Educating Sellers on Saleability vs. Value
What’s the difference between saleability and value? While it is counterintuitive, a valuable business is not always saleable. How? Well, let's use an example:
The One-Person Show
This is very common among owner-operated businesses. It is not uncommon for a baker to make all the baked goods at 5 AM while managing the front counter until noon. While this business may have recurring customers, a brand, and even profits – it is very difficult to sell.
The reason is that your buyer needs to possess the same skillset as the operator. This means selling to another baker or finding someone who wants to become a baker.
This becomes even more difficult the more skilled the baker is. For example, if the baker is world-renowned for intricate cake designs. Then the new owner, if they wish to take over your business as is, must find someone who can achieve the same standard of outcome.
This is the same reason that a YouTube star who makes millions of dollars per year - obviously this is a valuable business - can never sell their business. Because they are the business.
Using Saleability to Create Market Liquidity 🤝
So how do we use saleability to our advantage? Understanding the saleability factors of a given business allows us to build our buyer persona. The key personas:
- Lifestyle Buyer: seeking to transition from the corporate life and buy + operate a business. These buyers are less concerned about owner dependency, as they plan to operate the business.
- Financial buyer: these buyers are interested in the cash flow, return on invested capital, IRR, and/or other metrics. They are often very concerned with owner dependency, client concentration, competition, and/or other 'risks' that may reduce or eliminate your return. These buyers (often private equity firms or Search Funds) typically want the owner to stick around on a longer-term transition or will require an 'earn-out' as a part of the purchase price.
- Entrepreneurial buyer: these buyers are often a mix between a lifestyle buyer and a financial buyer. Typically a previously successful entrepreneur these buyers are well capitalized (with their own money) and are looking to purchase their second, third, or maybe 10th business. Writers note: these buyers are often my favorite to work with as they understand the deal process, have been business owners themselves, and often know how to connect well with a seller. They are no slouch, however, and will still have high standards for financial returns, cash flow, and mitigating deal risk.
- Strategic buyer: a buyer within the industry of the selling company that has a unique strategic advantage by buying the business (classic example: Facebook buying Instagram). For Main Street deals, this is often a slightly larger local or regional competitor. Usually (exceptions are made) this option is only available to owners open to sticking around in transition post-sale.
If you listen to your client's goals during your initial meetings you will pretty quickly refine your buyer persona to 1 or 2 buckets. This allows you to develop a marketing strategy for your client's business (you can learn more about marketing to these buyer personas in this article).
So how does this relate to business valuation? Well, there are different strategies for selling a business to each group:
- Lifestyle Buyer: show them, in simple terms, how much money they can bring home each month. Set your asking price for the business so that it can adequately service any SBA or bank debt the buyer will incur by buying the business (you can calculate this using DealBuilder's built-in financing calculator).
- Financial Buyer: Again, focus on the ROIC and debt service calculations. Does a 5x EBITDA multiple actually finance? Are you confident you can generate multiple interested parties and LOIs? If so, listing without an asking price is a great strategy to maximize the purchase price. Caution: this only works with sophisticated buyers who understand business valuation + the multiples of the industry you are working in (this strategy does not work well with first-time buyers).
- Entrepreneurial Buyer: short-list your list of entrepreneurial buyers and approach them with the deal. Start with an asking price that is slightly above the market-based multiples. Next, ask the buyer how they feel about the price point - like most entrepreneurs - they will want a deal. As such, see if deal structuring (via earn-out) would make them feel more comfortable. Since these people love creative problem-solving, this will both be intellectually stimulating but also get them invested in the deal. It also gives you a buffer to reach your client's desired amount of cash at closing (the remaining asking price premium being covered by an earn-out or seller financing).
- Strategic Buyer: always approach a strategic buyer without an asking price, as it is impossible to understand their cost structure and what synergies they will get from the business (your calculated $500K EBITDA may be a $1M+ EBITDA in their eyes). Before approaching the strategy always brief your client about this strategy and the typical multiples for their industry.
Wrapping Up: Mastering the Art of Business Valuation for Every Buyer Type
In conclusion, the journey through the art of business valuation is not just about the numbers; it's getting into the psyche of each buyer persona. As it's important to remember, the buyer and seller are ultimately who decide the purchase price, not you.
Enjoyed this article? Join us tomorrow where we cover How To Filter Sell-Side Leads.
If you want to learn more about automating your business brokerage with DealBuilder, please visit our site or book a demo here.
