By Jeffrey D. Jones, ASA, CBA, CBI
There are many reasons why business owners decide to sell their business such as retirement, ill health, divorce, or partnership issues. However, if the only motivation to sell is price, it is unlikely that buyers will pay a price that will be sufficient to get a deal done. Often, business owners have price expectations based on personal reasons such as the amount needed for another investment, the need for lifelong retirement funds, or replacement of income for less work. None of these reasons are motivations for buyers to buy. The price must be supported by earnings derived from the business. Due to the risk of small to midsize businesses, there are economic limits as to the price buyers are willing to pay. However, that price may be insufficient to motivate sellers to sell.
The following is a list of reasons why Fair Market Value (FMV) is not enough to entice a business owner to sell:
- A business owner could make the equivalent of FMV by keeping the business and its earnings for about two years to three years and still own the business.
- FMV is usually inadequate for a seller to retire permanently.
- The business owner has heard that a close competitor received millions for his or her business and expects the same price for their business even though the earnings are not the same.
- The business owner could not make the same income elsewhere.
- FMV rarely will fully compensate an owner for the time and expenses of starting and building a profitable business.
- The business owner frequently underestimates the systematic and non-systematic risk factors that impact the business and differentiates the small closely held business from the public company counterparts.
- A more viable option may be to allow a family member to take over the business.
- The idea of selling is motivated by a short-term problem that is later resolved.
Understanding why a business owner wants to sell a profitable business can be the key as to expectation of price and reasonable terms of sale. Profitable businesses do sell at reasonable prices wherein the earnings support the Fair Market Value of the business and the sellers are motivated to sell for reasons other than price. This does not mean that motivated sellers must expect to sell at some liquidated value. FMV is not liquidation value; it is the value which can be supported by the earnings of the business given the risk expectation of those earnings continuing to materialize in the future.
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Jeff Jones is the President of Certified Appraisers, Inc. and Advanced Business Brokers, Inc. located at 10500 Northwest Frwy., Suite 200, Houston, TX 77092. He can be contacted by phone at 713-680-3290 or by email at [email protected].
