William R. Ernst Managing Director at GBQ Partners
Forget the Price – Focus on the ATWAM
What is my business worth? Eventually every business owner asks this question.
Worth, like beauty, is in the eye of the beholder. What your business is worth to you is likely to be a far different number from what your business is worth to a prospective buyer.
In determining a price for a business, it is common practice to look at past profits and multiply them by some capitalization factor. However, a business has value because of what it will produce in the future – period. End of story. A buyer cannot pay tomorrow’s salaries based on prior years’ profits. Historical profits are only important from the perspective that they may be a good predictor of the future. Negotiations should be based on what is anticipated to be coming down the road, not what can be seen in the rearview mirror. What your business was worth yesterday may not be anywhere near what your business will be worth tomorrow.
The price that you will get for your business is mostly dependent on how much risk you are willing to keep. Right now you have all the risks - the normal business risks as well as the global risks of technological change and economic or political uncertainty. If you expect to transfer all the risk to the buyer in exchange for an upfront cash payment - don’t expect to get a great price. If, on the other hand, you are willing to transfer the risk to the buyer over time, the buyer will be more likely to give you a better price.
While price is important, the success of a deal is more dependent on the terms of the agreement than the price at which the deal is struck. $5,000,000 cash up front is more valuable than $500,000 per year for ten years. $1,000,000 with a solid guarantee may be worth more to you than a promise to pay you $2,000,000 from future profits that may or may not come about. $500,000 that is taxed to you as a capital gain is generally worth more than $500,000 of ordinary income.
Most failed deals have little to do with price. Most deals fail because the owners had unrealistic expectations of what the price should be. After all, they worked all their life to get to where they are. Somebody should be willing to pay a lot of money for their business.
Forget the price. Decide what your after-tax-walking-away-money (ATWAM) needs to be to make it worth your while; then let the negotiations begin. If you get your number, walk away happy. If you don’t get it, work on making your business more valuable to the next potential buyer.