Listing prices can seem like they are all over the map, and to be honest, sometimes they are. Some businesses are listed for far too much – where a seller is unsuccessfully trying to recuperate every dollar they’ve ever invested. Some businesses are listed for so little it seems like they’re trying to hide some kind of massive fault. While the wide scope of prices might make all listing prices look like just an arbitrary number – for the vast majority of businesses for sale they aren’t. Sellers who are motivated to sell and who have the right help from a decent business broker will have their business listed for an appropriate price.
As a buyer it might initially seem difficult to determine if what you’re looking at is indeed worth what a seller says it is – especially with things like depreciation, add-backs and multiples clouding the waters. While there are many factors that can add or subtract some value from a business, the most important marker to consider is cash flow.
Cash flow is king because that’s what a business is.
It is a money-generating enterprise. The money a business makes it what gives it value. This is very different than say, a house. It is the features and aesthetics of a house that will determine it’s worth.
Here’s the problem. Some buyers get hung up on the aesthetics of a business, like the condition of the furniture or the color of the walls – and base their own perceived value on these physical things while completely missing the point. You need to be looking at cash flow. And you need to understand that how things currently look and the way things are currently done is what is producing that cash flow.
Getting hung up on aesthetics can cause other issues as well. It can make a buyer believe that a business price should be discounted based on a difference of opinion. Let’s go back to the house example.
If you walk into a house and you hate the design of the brand-new kitchen you can’t go to the seller of the home and say “I’m decreasing my offer by $50,000 because that’s how much it’s going to take to redo the kitchen.” That would be ridiculous, right? When you buy a house, you are buying it as-is. The same goes for businesses. If you don’t like the way a current owner is doing things or the truck they just bought for the business – you don’t get to discount the price because it isn’t something you would have chosen or isn’t a procedure you would have implemented. Again, you need to remember that the way the current owner is doing things is what is generating the cash flow that you’re buying.
From the outside looking in, especially with only a cursory glance, you can’t possibly understand the nuances of why a business is generating the cash flow that it does. It can be difficult to look past the aesthetics – but it is critical that you do. You need to look deeper and try to understand what it is about the way the seller does things that works.
It’s also a great idea to keep from insulting a seller to the point of no return by trying to get a deep discount on a business for something that is essentially a difference of opinion. Talk to your business broker about any concerns you might have, and they can help you come up with a fair offer that will (hopefully) keep the deal moving forward.
Are you in the market to buy a business and have more questions about the importance of cash flow? Would you like to know more about how other factors may play into business pricing? Ask us! Leave any questions or comments and we would be happy to help.
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