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Valuation Prep

Pricing Your Company Correctly

The buyer's perceived "value" will determine the price. If the buyer thinks the price is too high in relation to the "value" delivered, they won't buy.

That is your challenge when setting the price for your business. The price that you get for your business will depend on how you market the business and to whom you market.

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valuation prep #1

Tips Setting Price

Determining Value of a Business

To get the price that you expect, you need show 2 or more years of upward-trend that supports your market value. This includes:

  • increasing sales from the prior year
  • incurring expenses that directly grow the business
  • building a positive cash-flow stream

    Additionally -

  • get rid of excess inventory
  • pay off short and long-term obligations
  • show a history of collectible receivables
  • maintain a strong credit record with your lender
  • resolve any complaints with business bureaus or other

 

It is critical that you follow these two rules when setting price:

  1. First, substantiate the true market value for your business:
    Picking a number out of the air will be challenged. You can substantiate your price by establishing a "true market" value on your company assets, sales, cash position, and market.
  2. Second, market your "value" to right segment of buyers:
    A buyer who has a clearly defined strategy why they want your business may pay a premium over your asking price. Another buyer who is only interested in your company assets may be less willing to pay anywhere near the asking price.

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valuation prep #2

How to Measure Value

you will need to open up the books

Cash is a good measurement of value

Value can mean different things to different people. The "price" to one buyer may signal low value in the benefits received; to another buyer, the "price" may indicate high value. That is why value can be a different measurement depending on to whom you market your business.

But there is one commonality that exists when measuring value: cash. A dollar-is-a-dollar-is-a-dollar. And the more dollars you have, the greater the value of your business.

So how should you measure a greater value

1: Your Sales Should Be Trending Up

This is a given requirement before any business will sell at its maximum market value. If sales are trending down, it's best to revisit your marketing strategy or exit the business.

The buyer will analyze your sales numbers as follows:

  1. Are your sales from repeat customers
    or are they one-time sales? The more repeat customers you have, the better.
  2. Are your sales from a broad spectrum of customers?
    You have heard of the 80-20 rule, meaning that 80% of your business comes from 20% of your customers. This is typical for most businesses. The concern is when 95% of your sales come from 2-5% of your customers. What happens to sales if one of your major customers leave? Having a broad spectrum of customers increases your business value.
  3. Can your sales be replicated?
    In other words, can you take your product or service and replicate the sales success in a different market or to a different target segment? If yes, your value goes up.
  4. Will sales continue?
    Finally, the buyer will want to know whether the sales will continue when you transfer the business over to them.

    If your business brand, product, customer contacts, etc., are dependent upon YOU BEING THERE, you must prep your business to carve yourself out of the picture. Your business will be more valuable if it is NOT dependent on you.

2: Are Your Expenses Being Managed

Your company will have greater value when expenses incurred support the business operating and marketing strategy. Frivolous expenses or excess employees indicate sloppy management that can decrease the overall value of your business.

Prep your business by removing:

  • expenses that are non-business related:
    pay off company loans made for personal or non-business use
  • expenses that do not produce income:
    analyze individual line items and pay-off or terminate service relationships for expenses that do not generate income

Also, prep your business by documenting:

  • large expenses items that support the business operations or sales strategy
  • expenses items that are part of your marketing strategy

 

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valuation prep #3

Types of Value Buyers

buyers pay at their perceived value ... not yours

The value of a company can be perceived differently depending on the type of buyer. It is critical to market your business sale to the right buyer.

For example:

Buyers Looking for Assets

  • these buyers are only interested in purchasing equipment or assets that can compliment their current operations
  • they will be shopping equipment at bargain prices
  • they may have little or no interest in your markets or goodwill
  • Pricing Formula:
    the price they will pay is the market value of your equipment and assets - which is generally priced at its replacement value
    use this pricing strategy when you want to exit the business
    target the sale of your business to the competition or other-like businesses in your area

Buyers Looking to Buy Location

  • there are buyers who are interested in a particular location such as a retail intersection or logistical handling (i.e., next to the airport).
  • these buyers may or may not be interested in your assets, goodwill, or markets
  • sellers in this situation generally own the building and land
  • these buyers will either tear down or renovate your existing location
  • Pricing Formula:
    the perceived value is dependent on the macro-changes that are happening or expected to happen for that location
    the price they will pay depends on retail price of similar property in the surrounding area
    understand the potential use of your location. If your location is in a prime retail location for example, you may price your business and land at a premium
    you should get an independent land appraisal to substantiate your price

Buyers Looking to Buy Your Established Market or Operation

  • the seller will have established contracts/sales in a geographic location or market to a demographic group where the sales barriers are high
  • the buyer will have interest to move into an established market and ramp up their business quickly
  • Pricing Formula:
    the buyer's perceived value is dependent on the cost and time to establish a similar market or operation
    if the barriers of entry are high, meaning that the cost to setup and capture a similar market relationships are high, then your price could be somewhat high
    if the cost to setup a similar market is not high, then your price will be dependent on the buyer's perceived value of timing - how quickly they want to be in the market.
    understand the cost to setup a similar market. If that cost is high, then the perceived value may be high depending on your projected market position
    if the cost to establish a similar market is not high, then the perceived value is the strength of your documented cash flow position

Buyers Looking to Buy Your Technology

  • the seller will have a specialized or patented technology that cannot be replicated within a reasonable time or cost
  • the buyer will be an established operation that can benefit from this technology
  • Pricing Formula:
    in most cases, the buyer would seek to license the technology and may not be interested in buying your operations
    the buyer's perceived value is the opportunity cost of not having the technology
    price the business and technology together with the technology piece the greater portion of the overall value
    the buyer may perceive the value as a great buy where they can take ownership of the technology and discontinue you as a potential hostage holder or competitor

Buyers Looking to Buy Your Goodwill

  • the seller will have a strong brand name in a defined market.
  • the buyer will want to capitalize on the brand name to expand their marketing operations
  • Pricing Formula:
    the perceived value is dependent on strength of the brand name and the current operations or product line
    the value will depend on the brand - which can be subject to different opinions - and the value of your assets and earnings
    if you are in a position of strength - meaning that your cash flow position and brand recognition are strong - you can bump the price up.

Buyers Looking to Own Their Business

  • the seller has a business that is performing well with potential growth opportunities
  • the buyer will be an individual who left the corporate ranks to look for an independent business opportunity
  • Pricing Formula:
    the buyer's perceived value is the cost to finance the business, set an annual salary for the themselves or another business manager, and maintain required capital expenditures
    the higher your cash flow position, the greater your market value
    price will be based on your cash flow position which can be 2-3 times over cash flow

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Krayton M Davis
Executive Director, CFOne Business Advisory Services
Serving Richmond and Northern VA
1-571-306-3590

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