THE GOLDEN RULE
Oct 23rd, 2009 | By admin | Category: Pricing Businesses for SaleHe who has the gold makes the rules. Unless the seller can attract multiple buyers and create an auction, the buyer determines the purchase price and terms of sale. The seller may or may not accept the buyer’s offer.
The above is true up to a point. Seller’s know what they want and see in the WSJ how big companies sell for 10X EBITDA and think they can also get that. A big part of the process is education and that’s where statistics on done deals come in handy. They give a range of generally accepted values for an industry.
Using databases of completed transactions is a great way to bring in what the market is actually paying. However, a little interpretation is necessary by the broker/appraiser. Many of the transactions in the database are older, some 10 or 15 years old, so that item needs to be kept in mind. Another common mistake that I see with these databases is a person looks at the median and uses that multiple. Once you get the multiple, you have to determine if the company that you are appraising/pricing is better than the average or worse than the average. Then you have to be able to support why this is so.
Any good business decision requires doing your homework and knowing where to get advice to avoid making a mistake. Buyers and sellers get along and complete transactions if they use actual sales data from a reliable source. A good advisor will keep the relationship on track by making sure that both sides are relying on accurate information.
Larry raises a good point. I had a long discussion with someone a couple years ago because he kept focusing on the average multiple of the done deals. He thought the price should be at the average. I kept asking if the business was better than average (it was) or worse than average.
For one other deal we looked at ratios, multiples and more. One example of what we did was consider that the business had seller’s discretionary earnings (SDE) about 20% above industry averages. We realized this was a better than average business (again, this was only one comparison factor we used). When other pricing/valuation methods gave a number higher than a multiple based on the average of done deals we knew it made sense. This business was better than average.
And, there are many businesses worse than the average. They would love to sell at the industry average multiple of profit or SDE.
My strategy has always been to create other phantom buyers interested in the business to scare my one real buyer into action. I don’t really see anything ethically wrong with it. Competition real or imagined is still competition. No buyer would pay; more than he’s willing to pay, either way.
Sorry, Alex, I can see a LOT ethically wrong with lying to a ‘real’ buyer to scare him into action. Imagined competition is only that – in your imagination – then I guess they could just imagine they were going to pay your commission, no?
Alex. I guess straw buyers placing low ball offers ahead of the real buyer is just part of the game. No?
The Seller has ultimate power. To price. Accept or reject offers. Finance or not. Even to agree to meet!
Buyers need to enlist the Sellers in their pursuit; to agree on the value, how it will be financed, and to “be there” when necessary (for benefit obviously).
If a business has an above average SDE, it would seem that using a multiple of SDE takes into account its above average performance. It certainly is a more attractive business than an average or below average one, but the multiple makes that adjustment for pricing purposes. It would seem that John Martinka is suggesting a premium on top of that.