Selling a business is a difficult process, but not for lack of buyers. One thing that is certain in a free market, is when there is distinct value in a business, buyers will emerge. Buyers must be able to distinguish the value quickly when looking at a business, otherwise they’ll never approach the transaction.
The biggest asset of a small business is goodwill:
“those elements of a business that cause customers to return in sufficient volume to generate profit in excess of a reasonable return on other assets”.
Goodwill is not only an intangible asset, it is also a walking asset. If one of the many elements that cause customers to return in sufficient numbers is disturbed, any goodwill is lost. There is also no reliable way to identify and value each component that contributes to the overall goodwill of the business.
One of the biggest challenges in a small business sale is the preservation and transfer of goodwill. The buyer will need to be sure that they will receive this loyal client base, should they purchase the business.
Personal to business goodwill transition
If a business’s goodwill revolves around the business owner, then the business cannot be sold without a substantial transition period. This period is to allow personal goodwill to be transformed into business goodwill.
The business system
Buyers are also looking for a proven business system, one that works. If this system only exists in the seller’s head and can only function with the seller at the helm, then buyers will walk away.
Buyers need to be convinced that they will be able to successfully run the business long after the seller has received their cheque and gone fishing.
So then, if we can convince the buyers that a business does indeed have goodwill, if that goodwill can be transferred and if that business can function without the current owner, then maybe, just maybe, the sale becomes possible.
Three extremely big IFs and we haven’t yet touched on negotiating a price ...
Small business sales isn’t about standardisation
A few years ago I was selling a pure goodwill business. Its only asset was its client list.
My customer’s business focussed on putting together beautiful packages of wine and spirits. The business was taking over £350 000 in sales, resulting in almost £60 000 in cash flow.
I’d targeted wine producers and in speaking to one producer in particular, I’d spent 2 hours over the phone and in person just to convince him that client relationships could be successfully transferred from the seller to the buyer.
We hadn’t event discussed the price of the business!
More recently, I’d taken on the franchise sale of a retail chocolate store. The store was selling a standardised product defined by the master franchise owner and had a turnover of £60 000 with a cash flow of £20 000.
This was in the depth of the Greek economic crisis, so to find a business this profitable was somewhat of a rarity. Regardless of this, I had potential buyers walk away because they didn’t feel they could offer the same level of pampering the current owner offered to her clients.
They believed that goodwill could not be transferred.
On paper, small business sales revolve around standardisation and limiting risk. However in reality, small businesses are unique and beautiful and in most cases are affected by nuances from the owner.
And this uniqueness is the crucial factor between its success or its demise. But when it comes to selling the business the uniqueness must be tamed and harnessed.
Making a business sale easier
How can a seller make the sale of his small business easier? Preparation, preparation, preparation! It only takes 2 Cs and 2 Ds:
Clean-up the business and its books, clarify and document all its processes and start delegating, fast. Remember, if the owner is the business then the business is unsellable.
When the business is ready for sale, you must address the buyers’ healthy suspicion. Buyers are skeptical, if not outright afraid. They are potentially putting their life savings in something they can not touch, or even measure, goodwill. Goodwill that the seller has created and there is no guarantee that it will be transferred to them. No wonder they are afraid. And their fear can only be addressed in an environment of mutual trust. I strongly suggest that you hire a professional business broker to do that.
And now that we have negotiated the difficult part, let’s talk about price. Easy ...
Setting the price
Buyers are looking for a business that makes money and can prove it.
The fact that the seller has enjoyed a good standard of living from the business, has little or no influence to the buyers’ thinking unless it can be proven from the businesses records. This refers to the official records, the ones that are submitted to HMRC, not the additional shoe box of invoices (or nowadays a flash drive that’s hidden away) that show additional earnings.
How is the price determined? This is one of the most difficult questions in finance and no short-cut answer exists. Those of you interested in a comprehensive answer can read my book titled “How much is a business worth?”, but here are two of the main components.
a) The price must make sense for the buyer
b) The price is neither determined by the buyer nor by the seller, it is determined by the market through negotiations.
A buyer will only consider a purchase if the business is likely to provide an adequate return on the investment, in relation to the amount of risk involved. A buyer will never take the personal effort of the suffering of the seller into account when assessing the viability of buying a business.
But who decides what an adequate return is? The market of course! If someone can invest their money and earn a 2% return on a 10-year (almost) risk-free Government bond doing nothing, don’t expect to find a buyer that will be happy with a 5% return on your coffee shop.
Calculating the return on investment
Under certain assumptions the ratio of price/cash flow is the inverse of the required return. If the business is valued at 5 times the cash flow, then the return would be 20%. If the business is worth 3 times the cash flow, then the return would be 33%.
Where can you find these multiples? No prizes for guessing, BusinessesForSale listings of course! Just check the asking price against the cash flow of the business.
Selling a small business is so difficult because we are dealing with the intangible and sometimes elusive goodwill. Add to the mix high emotions – letting go of the achievements of a lifetime on the sellers’ part and fear on the buyers’ part – and it does not get any easier.
All of these difficulties can be overcome with sufficient preparation, creating an environment of trust between seller and buyer and setting the price within the limits of the market.
Don’t forget that although there’s never a right price, you can choose the right initial price that brings buyers to the negotiating table.
Feeling better prepared to buy a business? You can check out our listings here.