The final price of anything that sells in a market is the equality of the value the buyer is willing to pay and the value the seller is willing to accept. It is a transaction. But two things are almost always true: some buyers will make low-ball offers, and some sellers set sky-high prices.
Those two extremes aside, as a seller, what is probably going through your mind is what price is high enough so I don’t leave any money on the table, but not too high such that prospective buyers are not deterred from making offers. I can tell you from a buyer’s point of view that buying a business is an investment decision, and as such the price will be based on my desired rate of return. The higher the perceived risk in the business, the higher the rate of return needs to be.
For example, say your business nets you $200,000 (after deducting expenses, which includes your salary and health benefits). My rate of return is going to be around 35% if there is a full time manager/operator after the sale, and closer to 50% if I have to go out and hire a general manager. So $200,000 ÷ 35% = $571,428.57. That will be my investment amount, and to the seller that is my offer. At a higher risk, asking for a 50% return, the investment is $200,000 ÷ 50% = $400,000. Unless the seller demonstrates a compelling reason to adjust my rate of return downward, I will probably not offer more than that.
This gives you the buyer’s perspective on the price. Another broader perspective is what the market is willing to accept in terms of risk tolerance for your business in your industry. The higher demand there is for your business type, and the greater the availability of general managers or even just skilled employees in that industry, the more risk prospective buyers will take, and thus the lower the acceptable rate of return.
A shorthand way of coming up with a price based on the market is to try to find a valuation multiple. There are actually websites that have this information. There are also business broker websites that list the transaction size per industry for the year, from which you can infer the valuation multiple. The way this works is the higher the risk tolerance (i.e. the lower the acceptable rate of return), then the higher the valuation multiple.
To get a price based on the valuation multiple, multiply your pre-tax earnings EBITDA by the valuation multiple. Continuing from the above example, if the multiple is 2.75 for your business type and size, and your EBITDA is $200,000, then the valuation is $550,000. This number falls in line with the investment perspective. Say you use instead 3.0 as the multiple, then your price would be $600,000. That is still not too far from the higher investment price, so a buyer would find it reasonable to make an offer.
Bigger businesses are often less risky because they tend to have a management team as well as more defined systems in place. So a business in the same industry as the above example but with an EBITDA of $500,0000 may have a valuation multiple of 3.5, hence its asking price can be set at $1,750,000.
That’s it for a quick overview of business pricing from a couple of different perspectives. To start exploring your price, start with some research on what has sold for your industry and business size, and go from there.
