Lance Hood: Now let's get into the power tactics to a successful negotiation. You know Richard it's easy for a person to think that negotiating to buy a business is pretty straightforward. Personally I'd think that you just look at the numbers and it either works or it doesn't, but I'm guessing it might not be so cut and dry to price a business or structure a deal.
Richard Parker: And you're correct. One would think it would be fairly simple. And generally speaking people draw upon past experience with buying a home as their barometer. Unfortunately buying a business and buying property are two completely different entities and very few similarities. Let me take you through some of the overriding issues to give you a clearer picture.
First of the all the seller is almost always emotionally tied to the business. I'm sure Lance you've heard the expression "buyer's remorse" have you not?
Lance Hood: Yes.
Richard Parker: Well it's a very common phrase but interestingly enough sellers get remorse actually more often than buyers do in this equation because you're dealing with them on a highly emotional level. And while the buyer's going to have some emotion tied to transaction, sellers are clearly emotional. This is their legacy. This is their blood. This is their sweat. This is their tears and beers. Right? And this is all the time that they've put in the business and suddenly, especially if they're selling it for reasons like health or retirement; they're suddenly looking at their own mortality. So it's very much an emotional issue for them.
So what I like to tell people is what a seller thinks their business is worth generally has nothing to do with the value and because every business is different. A business is a living entity. There are problems and good points about one business that are entirely different from another business and they both may be in similar businesses.
You can have issues like customer concentration issue where 30 or 40% of the business is done with one customer. That's something that the seller has been very comfortable with over the years because of their relationship with them, but it's very hard for someone outside to become comfortable with that. Or there could be looming threats within the industry. Or looming threats - for example if someone owns a coin laundry and it's in a particular shopping center and a looming threat is that the anchor tenant, the big grocery store is potential going to not renew their lease in three years from now. Well that's a looming threat. Or someone who's looking to buy for example a gas station and there's legislation in place where you have to redo all the tanks by the year - I believe it's 2009 - double wall tanks. So those are some of the looming threats. So those things are issues that you have to take into consideration that impact valuation.
Two businesses can have the same sales and profits but if one is increasing and one is declining then clearly those businesses are not worth the same thing. Whereas you look at the bottom-line, you see they're both making X profit. They both got Y amount of sales, and they're Z type of business so they should be valued around the same thing. But if one is let's say they're making $100,000 a year, and one made $60 two years ago, then $80 then $100. Viruses the other one made $180, $160, and now $100; clearly the business that's showing to be trending upward is worth more than the business that's declining. People have to keep in mind that valuation is an art. It's clearly not a science.
Another thing that people need to consider is they over emphasize assets, and assets are really a means to generate revenue. Because the truth is if you're looking at a business that has a lot of assets, machinery and equipment for example, that machinery and equipment is a vehicle to drive the revenues of the business. And while there may be a book value to those assets, the truth be told if you have to liquidate those assets in a very short period of time you could rest assured that those assets are not going to fetch anywhere near the dollar amount that they may be indicated on the balance sheet for example.
So assets are important but they're a vehicle to drive the revenue of the business, and so people need to focus on what is the bottom-line profit and tie that to what the business is worth as opposed to saying, "Well they've got X amount in assets so it has to be worth Y dollars." And people get too hung up on that. Oftentimes you see professionals like accountants who get really hung up on this but the truth is they don't really know how to value a small business because it's profit that you take to the bank to pay your mortgage. You don't pay with machinery and equipment.
Different people have different needs when you talk specifically about a seller. One seller may want to cash out and run like a thief into the sunset to his retirement. Another may want to hang around for awhile even though their wife says, "We're going to spend our time traveling." There's another seller who may not have the same level of motivation to sell. Another situation where again, they really don't have any idea what their business is worth and may have to sell it for health reasons, but there may be higher degree of motivation on their part, and so you can put together a better transaction.
So you have really a whole host of moving parts that vary once again, from one business to the other. So valuations are not cut and dry and putting together deals are not cut and dry. Especially we talked about that situation earlier, 40% customer concentration, you'll want a mechanism to make sure that is protected and that customer's going to continue.
So you have to structure the deal and the valuation for the particular situation. And it's exactly the type of thing that we do in all our materials and our ongoing consulting is we take all those individual unique aspects to any particular situation on both the buy and the sell side and factor that into a valuation and deal structure.
