The typical business sale is one in which a buyer continues to operate the business as a standalone business. But, there can be other situations where a business sale will generate more value to the seller and the buyer when it is sold as a book of business. A book of business is the customer base of a business that sells to other businesses. These are the customers who buy from the business on an ongoing basis. In the sale of a book of business, it is typical for the buyer to merge the purchased business into their business. They are likely to keep key employees, particularly those with the customer relationships. On the other hand, they are not likely to want to buy most of the equipment because it would duplicate equipment the buyer already owns.
Buyers and sellers have trouble arriving at a price for the book of business, particularly if the business being sold is not generating much income to the owner. If the business isn’t making much money, the owner may think that the book of business has little value and sell the business for the value of the equipment. A buyer recognizes that additional income will be generated by merging the business with his business and, thinks he shouldn’t pay the seller a price based on this increased income. What the buyer and seller are both doing wrong is confusing the value of the business with the selling price.
When a business owner has a valuation done on their business, the valuation is normally based on valuing the business as a standalone business. Let’s assume we have a business with $1,000,000 in sales and $100,000 in owner’s cash flow/seller's discretionary earnings. Let’s assume that an independent valuation arrives at a value of $250,000. What will the business sell for? That depends on how much a buyer is willing to pay. Perhaps, $250,000 if sold as a standalone business.
Let’s assume the buyer is another business with the same sales and owner income. By buying this business and merging it with his own business, he will eliminate many duplicate expenses such as rent, payroll, utilities, and other expenses. It is possible that the additional sales will add $200,000 in income to the acquiring business resulting in a business with $2,000,000 in sales and $300,000 in owner’s income. If a buyer would pay 2.5X cash flow, an average selling price for a business, the buyer should be willing to pay up to $500,000 for the book of business.
In this sale, the selling price of the book of business should be between $250,000 and $500,000. There are two factors that affect the eventual selling price: the desirability of the customer base and how much competition there is for the business. Some factors that affect the desirability of the customer base are:
- How profitable the sales are – leaving out the fixed expenses of the selling business.
- How desirable the customers are, which could depend on the buyer’s target market.
- How quickly the customers pay their accounts.
- How concentrated the customer base is in a few customers.
- How likely it is that the customers will switch to another supplier.
The second factor is how much competition there is for the business of business. If you are a buyer, you would like to be the only potential buyer dealing with a seller who is not knowledgeable about his options and who is unwilling to test the market for their business. If you are a seller, you would like to expose your business to as many potential buyers as possible so the price is bid up. The difference between the potential selling prices can be enormous. In one sale that I did, the selling price was four times the offer from the largest industry buyer who was buying many of the other businesses in the industry.
A business broker can help you buy or sell a business. But, in the case of the sale of a book of business, the use of a business broker, who can expose the business to many buyers, can pay off much more than the cost of the business broker’s commission.