We know, we know -- outsiders never understand the true value of your business, do they? Which is why you price it at 15 times earnings and end up owning it for life
Honestly, you'd think the word would have gotten around by now. You'd think that company owners trying to sell their business would have heard from potential buyers, from their brokers -- from this magazine -- that when you overprice the darn thing, it's going to have your name on it for a long time.
We thought the same thing back in August 1992, when we did a retrospective on the companies that had been featured on our "Business for Sale" page. Our story, titled "Why You Won't Sell Your Business" ( [Article link]), revealed that of the 15 businesses we'd put on the back page up to that point, only 2 had been sold.
At first we figured we'd done a pitiful job of picking attractive businesses to write about. (Hey, we're not perfect.) Or perhaps the market that year was in the tank. (It was.) Or maybe the pricing was off. Way, way off. (Bull's-eye.) Asking the experts to help us pick through the wreckage, we heard time and time again that sellers were overestimating the value of their charming country inns, colorful fishing piers, and gutsy small-town newspapers.
Cut to 1994. This time around, we've got 28 businesses to sift through, and, hey! -- our hit rate is up! Ten of them have sold. Are we picking them right these days? (Who said we're not perfect?) Is the U.S. market in better shape? (It is.) Or can it be that owners are finally putting sensible sticker prices on the businesses they're selling? (Read on.)
But first, a confession: As much as we'd like to, we cannot pretend that our batch of highly selective (if not downright funky) businesses is representative of the U.S. market as a whole. "You happened to select more businesses that were fairly priced," one expert told us. However, our list does give us an opportunity to examine some broader trends and to show how some sellers go about off-loading their businesses all wrong.
Sellers' pricing gaffes notwithstanding, there is more activity in the low-capitalization end of the market, according to most brokers. Actually, says Duncan Haile, managing director of C.D. Peterson Associates, a brokerage firm in Danbury, Conn., "there's more money chasing deals than there are good deals to be had." The difference today: only the good deals are getting done.
Put it down in part to the demise of the cute-country-store lifestyle play that marked the end of the Greed Decade. "Those investment bankers who made their money in the mid-1980s and then decided to quit the rat race by buying a quaint business in a small community -- typically for all or mostly cash -- are no longer around," says Susan Pravda, a managing partner at Epstein, Becker & Green, in Boston. That's not to say that noneconomic factors -- the picture-postcard location, the dreamy hobbyist business -- aren't, well, factors anymore, just that they're less influential than they were, say, four or five years ago.
Link it, too, to the collapse of inflated valuations spurred on by the merger fever of the '80s; more business owners are tackling the process of selling with a tad (we said a tad) more realism. "Gone are the days of overpaying," says Darrell Fouts, president of Colorado Business Consultants, in Denver. He says earnings multiples (against which sale prices are often measured) have dropped. A handy example of a modern multiple that makes much more sense: the one used by the North Carolina motorcycle dealership, which sold for 2.7 times earnings -- near dead center compared with national averages compiled by Bizcomps. (See table, page 3.) One observer went as far as to say, "If I could find them, I could sell 100 businesses like this a year."
Plus, the banks are starting to lend again. The relative vigor of the U.S. economy puts buyers in a more expansive mood. And there's a little more willingness on the part of buyers to think about terms other than all cash, such as sellers' notes, earn-out agreements, and purchase of controlling interest. That's certainly what helped clinch a deal for the owner of the Nevada casino, who still holds 20% of the business, and for the proprietor of the New England rowing-equipment manufacturer, whose sale terms included an earn-out -- and a nice flexible arrangement in which the new owner rents living space to the seller. We're guessing that the Virginia French bakery might have been sold if the seller had been able to finance the deal. As it was, at least one buyer was interested -- despite the need to get up before daybreak to fire up those ovens -- but couldn't get financing. (Then again, maybe financing would have been easier to get if the price had been lower. But we digress. . . . )
But let's not go overboard about how smart the sellers have suddenly become. Even our limited sampling shows that they're still just not realistic enough when it comes to pricing. Of the 28 businesses we profiled, 9 are still on the market, and half of those haven't seen a price drop -- or a big-enough price drop, at least. Of those businesses whose asking price exceeded 3.5 times the earnings base, 22.2% were sold, compared with 35.7% overall. (Of those businesses with asking prices higher than 100% of annual sales, 25% were sold, but they all involved real estate.) According to David Bishop, president of American Business Appraisers, a business-valuation firm in Lake Oswego, Oreg., "Even the sexy lifestyle businesses don't sell when you get up to 4 times earnings, unless there's real estate. With the more mundane businesses, when you start getting much beyond 3 times earnings or 50% of annual revenues, they simply don't move."
Of course, price is not the only factor that sellers screw up, as you'll see from the table on the next few pages. But it's definitely the cardinal sin. According to Ian MacLachlan, president of the Business Team, in San Jose, Calif., "The real problem is with the seller who won't listen to reason when pricing the business." Warped valuation methods abound: You can perhaps convince us of the arcane merits of the "discounted future-earnings method." But when we hear about maneuvers like "six times your zip code" -- a great method if you happen to live in California -- we really have to wonder what that seller's been smoking.
It gets weirder. While attending a business-valuation seminar not long ago, I was asked why I was there. I said that since I wrote a monthly column on the subject, it was important for me to get a sense of what went into putting a price tag on a business. The guy laughed, took out a laminated card, and said, "Here's all you need to know." On the card was this formula:
(1/2 gross sales + (5 x earnings) + book value)/3 = price
"Does this work for all businesses?" I asked. Sure does, came the reply. But, how did he know? "It just does."
Would that it were that simple. As much as people would like One Universal Rule, it simply does not exist. Not that folks haven't tried to find one. Here are some fairly stunning examples of the, um, inventiveness of the U.S. businessperson when it comes to pricing a business.
"You know, I've always wanted to go to Madagascar."
Sellers often base their asking price on the amount of money they need for what they are planning to do next. Maybe they've figured out that they need $600,000 to retire. Or they need $100,000 in seed capital for their next venture. Or maybe they're just planning a trip around the world. According to business-valuation expert David Bishop, those rationales have nothing to do with the current earnings stream, which is really what the buyer is buying. "Say I want to buy a new car, and I need $50,000 to get a new Infinity Q45. Well, that's great, but that has nothing to do with the value of my 1978 Dodge Dart."
"I've put a lot of money into this business over the years. Now I want it back."
So the buyer should care? Says Susan Pravda: "Sellers often make the mistake of equating market value with cost. But there is only one test of value: the cash-generating ability of the business." Pravda's opinion: had the owners of businesses such as the Wyoming hot-springs water park and the Michigan airplane brokerage grasped that fully, those businesses might have been sold.
"I owe. I owe. So on the block I go."
Some sellers want to use the sale as an opportunity to get them out of the red, either commercially or personally. But the buyer would have every right to ask, "Why should I pay for your bad business decisions?"
"Because I want a million dollars, OK?!"
Bishop calls this the WIFL method: Whatever I Feel Like. Sometimes setting a price is pure caprice on the part of sellers. And no amount of smooth talking will persuade them otherwise.
"It would cost me half a million to start it from scratch."
This oft-spouted ploy is usually called "replacement value." And sometimes it is germane to value. However, if it would cost $500,000 to re-create an existing business, but the market price for that business is $200,000, then the "replacement value" needs to be replaced with a better valuation method.
"Earthquake? What earthquake?"
Subtitle this one "Well, we meant for there to be revenues." If the Southern short-line railroad didn't use diesels, we could add a lame line about how it ran out of steam. But it's hard to know what the railroad's purveyors were thinking, knowing that if their single, solitary customer uncoupled its business, revenues would be history. It did, and they were.
"OK, here's my price. Now I'll just add fixtures and equipment and . . . "
If you set a price based on an earnings stream, the buyer is buying not only that earnings stream but the means by which to achieve it. So tacking on an extra charge for fixtures and equipment is like selling someone a car and then charging for the key.
"Fred said he'd give me $500,000 for my business. Let's see, that was nineteen seventy . . . three?"
Sellers often fixate on an offer they may have gotten a long time ago in a totally different marketplace. National and local economic factors have more than likely changed considerably since then, but the owners get that magic number in their heads, and there's no dissuading them.
One last look over our list. Ah yes, the Florida travel agency. It was priced to sell, and it was pleasantly profitable. But it came with something that really warms up buyers: financial records -- lots and lots of them. (The seller was an accountant, you see.) Duncan Haile explains that you may need to spoon-feed the buyer. "You want to help the sale go forward, so you need to give the buyer what he or she will need to do the due diligence: equipment lists, customer lists, supplier information, and the like." Bottom line: make it easy for a buyer to understand the business completely -- where it's been and where it's headed.
And if you can combine the right price with financials that have been audited by a reputable firm -- with none of those discretionary expenses (you know, the country club, the tennis lessons) hanging on -- you'll be fighting off the bids from qualified, cash-rich buyers.
WHAT AM I REALLY BID?
These averages give a rough (very rough) sense of what businesses are selling for these days
|Selling price as a % of asking price||Selling price as a % of gross revenues||Selling price as a multiple of earnings|
|Businesses sold for less than $500,000||85.8%||56%||2.5|
|Businessessold for $500,000-$1 million||81.6%||60%||2.7|
|Businesses sold for more than $1 million||93.3%||63%||3.6|
|Wholesalers and distributors||82.7%||48%||2.7|
Source: "Bizcomps '94, the Second Annual Study of Recent Small Business Sales," Asset Business Appraisal, San Diego.* * *
AMERICAN DREAMS: WHERE ARE THEY NOW?
|Company / Issue it appeared in / Status||Asking price||Selling price||Real estate included?||Asking price as a multiple of earnings||Asking price as a % of sales||# of inquiries|
|NORTH CAROLINA RACQUET CLUB / February 1992 / Pulled off market||$2.6 million||Yes||18||417%||6- 12|
|HAWAIIAN CHARTER YACHTS / March 1992 / Unknown||$2.9 million||No||15||242%||Unknown|
|CALIFORNIA ANTIQUES AND CRAFTS SHOP / April 1992 / Still for sale||$230,000||No||2.7||119%||"Good response"|
|WASHINGTON SKI MOUNTAIN / May 1992 / Sold||Best offer||Unknown||Yes||NA||NA||6|
|NEW ENGLAND DINER / June 1992 / Pulled off market||$175,000||No||4.5||58%||120|
|TEXAS DRAG STRIP / July 1992 / Sold||$500,000||Unknown||Yes||3.5||161%||24|
|IDAHO MOVIE THEATER / August 1992 / Sold||$135,000||Unknown||Yes||7.3||180%||About 12|
|NORTHERN CALIFORNIA BIKE SHOP / September 1992 / Out of business||$80,000||No||2.3||37%||70- 100|
|NORTH CAROLINA GOLF RESORT / October 1992 / Still for sale||$5 million||Yes||11||260%||25|
|ROCKY MOUNTAIN WATER-SKI SHOP / November 1992 / Pulled off market||$550,000||No||3.7||34%||50+|
|TAHOE INN AND MARINA / December 1992 / Pulled off market||$4 million||Yes||11.9||296%||25-30|
|ISLAND CRAFTS CATALOGER / January 1993 / Sold||$150,000||$127,500||No||1.9||52%||250+|
|WYOMING DUDE RANCH / February 1993 / Pulled off market||$2 million||Yes||8.7||242%||500+|
|FLORIDA BILLIARDS ROOM / March 1993 / Sold||$190,000||$60,000||No||3.5||74%||100+|
|NORTH CAROLINA MOTORCYCLE DEALERSHIP / April 1993 / Sold||$1.1 million||$900,000||No||3.7||41%||4|
|SOUTH CAROLINA MINIATURE GOLF COURSE / May 1993 / Still for sale||$595,000||No||16||405%||8-10|
|ARIZONA BOWLING CENTER / June 1993 / Sold||$3.6 million||$1.25 million||Yes||7.5||279%||15-20|
|FLORIDA TRAVEL AGENCY / July 1993 / Sold||$150,000||$105,000||No||1.2||9%||15- 20|
|NEW ENGLAND ROWING-EQUIPMENT MANUFACTURER / August 1993 / Sold||$550,000||Close to $550,000*||No||NA||65%||200|
|WYOMING HOT-SPRINGS WATER PARK / September 1993 / Pulled off market||$1.35 million||No||10||370%||50|
|MICHIGAN AIRPLANE BROKERAGE / October 1993 / Still for sale||$110,000||No||7.8||30%||25+|
|NEVADA CASINO / November 1993 / Sold||$2,261,000||$1.45 million**||Yes||6.4||126%||35- 40|
|MIDWEST RECORD-STORE CHAIN / December 1993 / Still for sale||$1.5 million||No||3.8||41%||10- 15|
|SOUTHERN SHORT-LINE RAILROAD / January 1994 / Pulled off market||$1 million||No||5||303%||75- 100|
|VIRGINIA FRENCH BAKERY / February 1994 / Still for sale||$275,000||No||3.4||122%||33|
|LAS VEGAS COMMUTER AIRLINE / March 1994 / Still for sale||$2 million- $3 million||No||18- 27||74%- 111%||10|
|ILLINOIS ART GALLERY / April 1994 / Still for sale||$91,000||No||1.2||31%||12|
|NEW YORK CITY THEATRICAL- PRODUCTION COMPANY / May 1994 / Still for sale||$30 million||No||4.8||114%||20|
Rocky Mountain Water-Ski Shop
"Uh, could you come back when we're really for sale?"
One shudders to think how this business's owners cope at supermarket checkouts when they're forced to choose between paper and plastic. But there are some owners who can't quite make up their minds about what to do with their businesses. This one's been on the market, then off; now it may be on again. Who knows?
Island Crafts Cataloger
Priced properly from the beginning. The buyer -- from the next island over -- saw a great business opportunity. The flood of other callers saw a great lifestyle purchase.
Las Vegas Commuter Airline
"Love my business, love me"
And then there are the sellers who don't realize that they are their businesses. Not only is this business overpriced (way overpriced), but it's owned by a very hands-on kind of guy. "Buyers think, 'If he goes, there goes the business," says one broker.
(This just in from our experts: Sellers who have a death grip on the business will give prospective buyers more confidence if they make themselves less indispensable. Tip number one: Establish a strong nonshareholder management team or an active board of directors.
Tip number two: Groom an employee who can do what you do.)
Wyoming Dude Ranch
"For sale? Them's fightin' words, pilgrim"
It's not quite the shoot-out at the OK Corral, but as far as the hundreds (and hundreds) of interested parties are concerned, it might as well be. Turns out the majority of the owners wanted to sell, but the minority owner/operator/gaucho didn't. The result? Big-time litigation, pardner.
Illinois Art Gallery
Don't hate the buyer
A prospective buyer was going to employ one of the owners after the sale, but the relationships went awry. Personalities clashed, and the sellers began to think that the business wouldn't be in the best hands. "Goodwill just fell apart," says the broker.
Arizona Bowling Center
They put the "real" in real estate
"If you back out the real estate value here, the price was about right," says broker Darrell Fouts. "You should get a 10% to 11% return on real estate and at least 20% on the business, and you did here. These guys understood that you have to have both to make it work."