How many times have you told a prospective customer the price of a product, only to have them wince from sticker shock? The problem is you haven't conveyed the value. Our business valuation guru Douglas Craig maintains, it's the same when selling your business. Price doesn't matter when there is great perceived value by the purchaser.
There can be a difference between the 'value' and 'price' of a business. Value typically refers to the return on investment to the owner of the company in its current state. This is referred to as the company's "stand-alone value". The stand-alone value can include goodwill value if the goodwill is commercial or transferrable in nature.
The price of a business refers to the amount paid by a potential acquirer of the company. A potential acquirer may pay a premium over the stand-alone value of a company if it perceives that synergies can be obtained in combining or merging the two companies together. Synergies come from the whole being greater than two or more parts identified separately. A potential acquirer can obtain synergies from:
- Utilization of excess capacity
- Entry into new or existing markets
- Combined overhead costs
- Technological improvements
The price paid by a potential acquirer of a company can also be influenced by the terms and/or financing of a deal. Generally speaking, the higher the amount of cash required by the vendor upfront or on closing, the lower the price paid by the purchaser. The reasoning is that there is more risk associated with paying for a company in cash. A vendor may be able to realize a higher price by:
- Agreeing to vendor take-back loan. In this type of deal, the vendor is providing a source of financing to the acquirer. However, there is risk to the vendor of realizing the cash from the loan in the future.
- Agreeing to an earn-out provision. An earn-out is an amount paid by the acquirer based on future performance of the business. This type of deal is often used where there is perceived risk in transitioning goodwill from the current owner to the acquirer. Again, there is risk to the vendor in realizing full value of the business due to unforeseen circumstances in the future.
Share exchange. In this type of deal, the vendor receives shares of the acquirer as payment for the company. This is often used by public companies, where there is liquidity for the shares of the acquiring company. There is risk to the vendor if the stock market conditions deteriorate in the future and the vendor is not able to realize full value for its sale of the business.