Buying a business at the right price is the first critical decision a business owner will face when making the investment. If you pay too much for a business then it is unlikely the profits you generate will justify the investment. Or more importantly:
Will the profits you make from the business be sufficient to cover the price and the risk of the business?
We have found a number of clients have come to us to help them answer this question, and invariably the asking price of the business is more than the profits can justify.
In a recent example the client had worked in a health professionals practice and wanted to purchase the business from the owner.
Is the asking price of the business I wish to buy fair and reasonable?
What We Did:
We looked at the historical performance of the business and identified the earnings the buyer would get if they purchased the business. We showed what investment would give this cash flow, given the minimum rate of return the buyer wanted to achieve.
Developed a cash flow projection for the future under a worst case scenario (loss of customers) and an expansion scenario.
Identified the net present value of starting up a similar business from scratch.
Documented the value of each of the scenarios to the buyer.
Developed a negotiation strategy based on rigorous analysis.
The key in this case was to establish at what price the buyer should walk away from the deal and seek an alternative investment or strategy. In negotiating the value of the business, the buyer focused on what the likely cash flow would be that end up in the new owner's pocket, and what this cash flow was worth.
We also highlighted the potential risks and uncertainty of the future cash flows of the business and how this risk was influencing the price the buyer was prepared to pay.
Naturally the vendor of the business had their own strategy and the initial asking price was an ambit claim. Our strategy was to justify why we offered the price we did, based on likely cash flows in the future.
The client settled on a purchase price that was more than half the original asking price. Whilst any negotiation will involve some "to and fro", offering a price that can be justified is always hard to argue against.
How Can We Help Your Business?
If you are about to buy a business there are two critical pieces of information you must determine:
The walk away price - the maximum price that you can justify paying based on expected performance.
The starting price - the lowest price the vendor is willing to accept.
If the business you are about to purchase will form part of your existing business, then you also need to know what range of values the new business will add to your existing operation. This can influence your negotiation strategy.
Paying too much for any business is a sure-fire way to lose money!