The value of a business is based upon it’s future expected cash flows, however the price is based upon the buyers perception of the expected cash flows. This is known as the credibility gap. It is through reducing this gap that the business seller obtains maximum value for his business.
The buyer initially uses the statements of the seller as a starting point for valuing the business and making an offer.
The buyer of the business does not believe the seller’s statements pertaining to the sales income and expenses. The buyer comes into the process believing that the seller is inflating the sales and reducing the income to show a higher profit.
Part of the buyer selection process is based on the question “How much time energy and money should I invest performing due diligence? (investigation the seller’s claims about the business performance) The more time the buyer needs to invest in this project the more likely he will not want to take the risk and move on to the next seller. For example: Two business are selling for the same price. “Business A” said that in was earning $100,000 dollars per year. The proof of sales and income is organized, detailed and only takes a few minutes to review for accuracy. “Business B” also said that it is earning $100,000 dollars per year. However “business B” does not have complete record or enough evidence to prove this, therefore you would have to spend 2 weeks in the store and 80 yours of piecing together his income from his incomplete receipts. Even after you spent this investment you would still have doubts that maybe the business performs better at different times during the year. Which business would you choose?
The buyer, often times, starts the process of due diligence and inspection and discovers missing receipts and inaccurate records. The buyer requests the missing information from the seller and in many instances, the seller does not comply or partially complies or inaccurately replies. The buyer becomes frustrated and feels that the owner is hiding facts and being untruthful. Animosity flares between the two parties and the sale is in jeopardy. The longer the time period to complete the due diligence process, the higher the probability of the deal falling apart.
The buyer puts a huge discount on the price of the business based upon the risk that the business is not performing as profitably as the seller claims.
In the small mom and pop venue, the seller is usually totally disorganized and not prepared to present the necessary evidence to the sell the business for its true market value.
The business owner is usually focuses on the day to day operations of his business and making money, not keeping good records or organizing the bills and receipts and inputting all of these into a computerized accounting system.
Small business owners believe they know what’s going in their business and they do not see the value in accounting systems.
Professional services; accountants, bookkeepers and programs to set up a point of sale system are expensive and may not be cost effective. Depending upon the sales volume and number of employees this may or may not be true. The owner knows the time and cost of the accounting expenses but often he is not aware of the money that is stolen by his employees.
Many times when a business is profitable, and I there is a wide gap between the selling price of a businesses and its true value base upon the cash flow, this is usually because the owner the owner could not properly demonstrate to the pool of buyers the actual income of the business. The buyer are now put in a position where they must take on the risk of the owners statements not being accurate and therefore discount the price they offer.
When the business broker conducts an interview with the small business owner and asks him about the sales, expenses and profit of the business, the owners reply with relatively extremely vague answers. Usually they categorize the sales and income by the week and the expenses by the month.
A business Sales System
This system would go back 3 years or as far back as you opened or have proper accounting records.
It consists of a computerized bookkeeping system such as quickbooks and a file cabinet.
The systems also acknowledges the value of intangible knowledge and as such creates a detailed list of vendors, recipes, polices and procedures, advertisements and marketing results, mailing and email lists, introduction to community contacts. You want the person to feel that they are not just buying the assets but a money making system just like the successful franchises do.
The computerized bookkeeping system would be able to to pull up he income statement for any time. The file cabinet would be organized so that the potential buyer could quickly and easily cross check any item in the computerized bookkeeping system with the actual paper supporting receipts. For example on the income statement, which was given to the buyer, it states that for the previous year, the seller had $300,000 worth of food sales and $100,000 worth of food purchases. The buyer can open the screen on the computerized bookkeeping system and see the total of all the purchases and the receipt entered for day they were purchased. The buyer could then open sellers filing cabinet and easily find the receipt from the company.
This would reduce the risk that the seller is misrepresenting the business income. Thus giving the buyer more confidence in the investment and thus making it much more valuable.
Further this would decrease the time and the burden for the owner to prove to the buyer that the business has the income the owner stated. Thus cost effectively allowing more bidders to verify the sales.
A Business Seller’s Promotional Book
Items that might be contained in this book:
Pictures of the business.
Annual income statement for last several years
A chart of the income increasing
List of Assets/ equipment included in the sale
List of Assets/equipment
Details about the age and condition and any warranties on the equipment
Pictures of the equipment included in the sales
Appraised value of the equipment. (A letter from a second hand dealer)
A discussion of the cost to build the business and the time it would take to bring the sales and income to the current level
A discussion about the intangible knowledge you will provide such as a detailed list of vendors, reciepes, advertisements and marketing results, mailing and email lists, introduction to community contacts
(A letter from a contractor or the receipt from the contractor to build out the business could be included in the appendix)
A business valuation section discussing why the business is worth more to the buyer than the amount hat you are asking for.
A business payback section discussing the terms and demonstrating the ability of the business to give the owner an income during the payback period.
If you have any questions or you need any of the above service performed call me at 929 366 0211.
Thomas McGovern, MBA, CVA
Certified Business Appraiser / Valuator (CVA)
Masters Degree in Accounting and Business Adminstration
Bachelor s degree in Sales and Marketing
Contact Thomas McGovern, MBA, CVA
16403 89th Ave., Suite 1C
Jamaica, NY 11432
Located in Queens County, New York City, NYC