How to Price a Business, Part 2
In my first blog on this topic, I covered the basics of how you price a business. When you look at actual sales of businesses, you see a large variation in the multiples at which businesses sell. In this blog, I want to discuss the reasons for the variation in the sale prices of businesses.
One of the first expenses that needs to be factored into the cash flow that is available to the owner are capital expenditures. Depreciation is an add-back in computing EBITDA or SDE. Be sure to include in expenses the normal equipment replacement that is necessary in most businesses. This brings us to another question, how old is the equipment, how soon will it need to be replaced, and how much will this cost? Keep in mind that replacing older equipment that may also be less efficient and replacing with new, more efficient equipment, may reduce costs, making the payback faster.
Another factor that affects the price of a business is the personnel situation. Are the key people good and are they likely to stay on for several years? That makes a business worth more than one in which a buyer needs to hire new people. The real estate can affect the price of the business in more than one way. How good is the location? How good is the physical layout of the property for doing the business? How good is the lease?
Pricing a business that does B to B (business to business) sales has some unique factors to consider. Is the business dependent on one, or a few, customers? Does the business sell through brokers, or distributors? If so, there is the dual risk of losing one of these customers as well as the risk of their losing one, or more, of their customers. A business that does B to B sales frequently has accounts receivable. How well do the customers pay? How dependent is the business on its vendors? How vulnerable is the business to technological obsolescence or Internet sales?
Sales involve people. The motivation behind someone buying or selling a business affects how important price is in the sale. Not everyone is seeking the highest price for their business. Some sellers have other priorities, such as a fast sale, or a buyer who will preserve the business best, or pay cash, for example. People vary considerably on how skilled and patient they are as negotiators.
All of these issues affect the price of a business, but don’t show up on the income statement. Keep them in mind when you are pricing a business – as a buyer or a seller.