Most people would agree that there’s almost always a difference between the price a vendor would like to achieve and the price a buyer would like to pay.

In the case of a business sale the spread of what somebody might want to pay for a business and what, ultimately, the business sells for can be enormous.

Why is that? What factors cause that “value gap”?

Here are two key reasons:

1.   Vendor price aspirations are unrealistic and rather than being based on a detailed professional valuation are often based on nothing more than what the vendor would like or might need to achieve.

2.  The risk profile in the transaction is too high in the eyes of the buyer. The higher the risk (even perceived risk in the early stages) the less they will want to pay, either up front or at all!

Of course, it is important for a vendor to have a price in mind that they would wish to achieve from the sale. But that has to then be qualified by understanding what will make that price achievable.

It helps to look at this from a buyer’s perspective; whilst this can be difficult to do this objectively, it will help to identify what aspects of the business might increase or reduce the desired price.

Every business owner knows the good points of their business – great workforce, great products, customer service, great customer base. But what if the staff turnover rates are rising? What if the sale of one of your key product lines is dropping off? How do you evidence the quality of customer service? And what if your top ten clients represent the majority of your revenues?

All these factors equal risk to a buyer.

To unpack that a little, let’s look at some other factors that might constitute risk to a buyer.

At a top level, buyers are looking at the future cash generation ability of your business. What has your business got that will provide that? What does it have that will make a buyer pay more and what will raise the risk profile too high?

On the plus side:

Growth Potential – Acquirers will typically pay a premium for businesses that can evidence strong potential to grow. In some circumstances this might be the over-riding attribute as the buyer may be able to leverage some of their own assets to deliver that growth.

Some of the most common ways acquirers use to evaluate a company’s future prospects are revenues and earnings, the price to earnings ratio (P/E), price to earnings to growth ratio (PEG) and return on equity (ROE).

As advisers, when we present a client’s business to a potential acquirer, the growth story is at the heart of the Information Memorandum – the Sale Prospectus. Understanding how our Clients’ will achieve the growth they forecast is one of the key areas we focus on during the initial phases of engagement.

Recurring and/or Repeat Revenues – Contracted Recurring Revenues are the ‘holy grail’ for a buyer as they pretty much guarantee the future cash generation ability of a business. However, not all businesses operate in industries where Contracted Revenues are normal or even possible. But there is still enormous value in recurring revenues that can be substantiated by a long-term customer base. Being able to demonstrate stable and predictable revenues will help to swing the risk pendulum to the vendor’s favour.

Barriers to Entry –acquisitions can provide a faster, more cost-effective way to access a new market, especially if there are regulatory restraints. However, often it will be long term contracts, intellectual property or products that are hard to copy. Such competitive advantages will make a business more valuable to a buyer.

On the minus side:

Poor financial performance –  given that acquirers are buying the future cash generation ability of the business, what will make a buyer more confident that your business will deliver what you say it will? Do you have good financial reporting processes in place and can you put forward a robust financial argument that underpins your company’s growth potential?

Owner reliance – You must be able to prove that the business has a future without you at the helm. Acquirers expect your company to be able to function successfully and, just as important, grow under their ownership. It is very difficult for an acquirer to consider a high value for your business if you are the main decision maker in the company and the business depends largely on you. That doesn’t make it impossible, but it does mean that the price will be tagged to the length of time you will need to remain in the business.

Customer reliance – Would you buy a business where a high percentage of revenue comes from just a few customers? Again – unless your business has a particularly unique “something” – you can reduce transactional risk by building a more diverse customer base where there is less than 20% dependence on the revenue of any particular customer.

Experienced buyers will always have a price in mind, calculated on a range of factors of which financial performance is probably the most obvious but not always the most important. Whilst sellers also will have a price in mind, in my experience most business owners arrive at a value based mainly on personal desire.

For a buyer, trade acquisitions carry considerable risk so, when considering what would make an acquirer pay more, it helps to look at this from those two different perspectives.

Summary

That “value gap” can be bridged; sellers can, with time and careful preparation, increase the worth of the business and also take steps to reduce a buyer’s transactional risk – something that benefits both parties.

Bear in mind that it is the vendor that holds most of the information, so the risk is higher for the acquirer. Which is why they will want to understand as much as possible about a company’s financials, customers, key staff, contracts, and future potential.

As with everything, the better you plan the more successful you are likely to achieve the results you want.

To discuss how to prepare for a future business sale, please email us at info@evolutioncbs.co.uk