Selling a business is a complicated process, but not for lack of buyers. One thing that is certain in a free market is when there is distinct value in business; buyers will emerge. Buyers must be able to distinguish the value quickly when looking at a business. Otherwise, they will never approach the transaction.
The biggest asset of a small business is goodwill. Goodwill can be defined as those elements of a business that cause customers to return in sufficient volume to generate profit more than a reasonable return on other assets.
Goodwill is not only an intangible asset, but it is also a walking asset. If one of the many elements that cause customers to return in sufficient numbers is disturbed, any goodwill is lost. There is also no reliable way to identify and value each component that contributes to the overall goodwill of the business.One of the biggest challenges in a small business sale is the preservation and transfer of goodwill. The buyer will need to be sure that they will receive this loyal client base, should they purchase the business.
Personal to business goodwill transition
If a company’s goodwill revolves around the business owner, then the business cannot be sold without a substantial transition period. This period is to allow personal goodwill to be transformed into business goodwill.
The business system
Buyers are also looking for a proven business system, one that works. If this system only exists in the seller’s head and can only function with the seller at the helm, then buyers will walk away. Buyers need to be convinced that they will be able to successfully run the business long after the seller has received their cheque and gone fishing.
So then, if we can convince the buyers that a business does indeed have goodwill, if that goodwill can be transferred and if that business can function without the current owner, then maybe, just maybe, the sale becomes possible. Three extremely big IFs and we haven’t yet touched on negotiating a price.
Making a business sale easier
How can a seller make the sale of his small business easier? Preparation, preparation, preparation! It only takes 2 Cs and 2 Ds: clean-up the business and its books, clarify and document all its processes and start delegating, fast. Remember, if the owner is the business, then the business is unsellable.
When the business is ready for sale, you must address the buyers’ healthy suspicion. Buyers are skeptical, if not outright afraid. They are potentially putting their life savings in something they can not touch, or even measure, goodwill. If the goodwill is created by the seller, then there is no guarantee that it will be transferred to them. No wonder they are afraid. And their fear can only be addressed in an environment of mutual trust. I strongly suggest that you hire a professional business broker to do that. And now that we have negotiated the difficult part, let’s talk about price.
Setting the price
Buyers are looking for a business that makes money and can prove it. The fact that the seller has enjoyed a good standard of living from the business has little or no influence on the buyers’ thinking unless it can be proven from the businesses records. This refers to the official records, not the additional shoe box of invoices (or nowadays a flash drive that’s hidden away) that show additional earnings.
How is the price determined? This is one of the most difficult questions in finance and no short-cut answer exists. Those of you interested in a comprehensive answer can read my book titled “How much is a business worth?”, but here are two of the main components.
- a) The price must make sense for the buyer
- b) The price is neither determined by the buyer nor by the seller; it is determined by the market through negotiations
A buyer will only consider a purchase if the business is likely to provide an adequate return on the investment, about the amount of risk involved. A buyer will never take the personal effort of the suffering of the seller into account when assessing the viability of buying a business. But who decides what an adequate return is? The market of course! If someone can invest his/her money and earn a 2% return on a 10-year (almost) risk-free Government bond doing nothing, don’t expect to find a buyer that will be happy with a 5% return on your coffee shop.
Calculating the return on investment
Under certain assumptions, the ratio of price/cash flow is the inverse of the required return. If the business is valued at five times the cash flow, then the return would be 20%. If the business is worth three times the cash flow, then the return would be 33%. Where can you find these multiples? No prizes for guessing, BusinessesForSale listings of course! Just check the asking price against the cash flow of the business.
Selling a small business is so difficult because we are dealing with the intangible and sometimes elusive goodwill. Add to the mix high emotions – letting go of the achievements of a lifetime on the sellers’ part and fear on the buyers’ part – and it does not get any easier.
All of these difficulties can be overcome with sufficient preparation, creating an environment of trust between seller and buyer and setting the price within the limits of the market.