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Valuation, overvaluation and the sales process

Interview with...

Andrew Rogerson, owner and MD of Sacramento Murphy Business and Financial Corporation office
Topics covered:
Business valuation, dangers of overvaluation, how deals break down, building trust with buyers
Owned five businesses, selling first at x 2.5 original purchase price. Chair of Sacramento Chapter, California Association of Business Brokers, highest business broker accreditation in California
business valuations, transaction analysis, consulting for sellers and buyers & for aspirant franchisees, machinery and equipment appraisals, range of sectors, US and international business
Sacramento, California
andrewrogerson How often do sellers overvalue their business, given the obvious difficulty in being subjective about something you've built up yourself?

Andrew Rogerson: It's probably one of the biggest mistakes sellers make. A lot of the work I do is business valuation and I can give you example after example of overvaluations.

I did an appraisal two weeks ago. It took him about three months of the process before he got me to do the valuation, and he thought the business was worth $1m. But by the time I got his tax returns and did the analysis I had to deliver the unfortunate news that it was only worth about $110,000, so he was a bit shocked.

Another seller thought the business was worth about $8m, but I did the appraisal and it was worth just over $1m.

So it's very common that sellers have this expectation - especially if they've been working in the business over a long period of time. People think "I've been working on this for 20 years so it must be worth a lot of money", but it's really about the cash flow of the business.

That comes as a shock to many business owners; they put their heart and soul into the business and think it's worth a lot of money.

I've never come across a business owner who has undervalued their business; it's always overvalued, often quite considerably

BFS: Presumably it's a rare instance when vendors undervalue their business...

AR: I've never come across a business owner who has undervalued their business; it's always overvalued, often quite considerably.

BFS: How long does the sale process tend to last?

AR: It was taking about six and a half months to sell a business before the financial crisis hit, now it's taking about eight and a half months.

But here's a reality check: only about 20% of businesses actually sell. That comes as a surprise to a lot of business owners, who presume it's like a piece of furniture, that the business will eventually sell.

I dealt with a transaction recently where a young lady had a good business. She was pregnant and wanted to sell the business before the baby was due.

I advised her on what price to sell it for and she decided that she wanted to sell it for a higher price. But here baby arrived before she could sell the business so she just ended up just closing it down because we couldn't find a buyer for her.

So life interferes with selling a business, so if that is something you want to do then you need to get focused on it.

BFS: Many businesses fail to sell, but you can sell any business, surely, as long as you're prepared to drop your price low enough...

AR: Yes, that's the critical thing: if the business isn't selling, then the only route you have is to drop the price to attract some more buyers. Price is a critical component sometimes.

BFS: What other factors commonly cause deals breaking down?

AR: Lots of reasons, and it really isn't just one reason sometimes. I've got one guy who wants to sell a sandwich shop and he's been promising documents for the past three months but he's just not it's difficult. I've got a buyer for him but he's just not organised.

This is a bit unusual, but feelings can get hurt in the transaction - and that's a good reason to have a business broker there, to manage the feelings and emotions in the transaction.

I've got a couple of attorneys and one managed to buy the other. They can be difficult to deal with sometimes.

The buying attorney wants to take his time but the selling attorney wants to keep the process going and is getting frustrated. He wants to get the ball moving but the buying attorney wants to slow things down because he sees it as a negotiating strategy.

And finance: one of the reasons transactions don't happen is that they just can't get finance. That's a critical thing I'm finding right now.

One of the first things to do right now is to find out if the buyer needs to borrow, get the banks involved and make sure they qualify for finance.

BFS: Has seller financing been able to bridge the gap in that regard?

AR: In the States it's been very difficult, the banks have been very reluctant to lend. They're starting to improve now; the president signed a bill late September, which I think will get things moving again.

BFS: How can a vendor decide if a prospective buyer is trustworthy?

AR: That's a really tough question. I don't think you really can. Trust is built over time and it really comes through experience.

That's the point of having a broker involved - because we know which things to disclose at which point in the transaction. So if a buyer asks for tax returns up front, one of my processes is to make sure the buyer is qualified to buy the business. I go through a set of questions and responses from the buyer, and I'll reveal information if appropriate, while some things won't be disclosed until later in the transaction.

BFS: How can a vendor build trust with potential buyers?

AR: Trust is earned, so you do what you say you will do. If you offer to have a meeting make sure you arrive on time, and be prepared if you offer to give a certain set of documents. Whatever you offer to do, make sure you follow through and do it, so you build the trust.

Both parties are nervous of each other and they don't want to give away too much when they're negotiating things, so trust is very hard thing to build until you actually close the deal and everyone seems to relax a little bit more.

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