Frequently, the price expectation for the sale of a business in Washington D.C. is dramatically “off the mark” – and interestingly enough though, these off-estimates happen in both directions – under as well as over. In less than 10% of scenarios are the expectations consistent with what that of a Fair Market Business Valuation in Washington D.C., which in turn determines, or with what an investor is in fact willing to pay for a business. Why is this so?
“One of the key reasons for a consistent ‘overvaluation’ is the seller’s expectation for the business buyer in Washington D.C. to pay for later improvements in business performance – either due to changes in the general economic or specific market niche conditions or due to a future owner’s changes in the business structure”, says Mr. Achim Neumann, President of Neumann and Associates, a merger & acquisition and business brokerage firm in Washington D.C.
Bluntly speaking, business investors in Washington D.C. are not willing to pay for expected future improvements simply because the business investor argues that if he / she needs to implement the changes, then a credit should not go to the previous owner. On the opposite side, if the potential for an improved business structure is indeed available, then the (current) business owner in DC should make the changes first and then sell the business in Washington D.C.
“There are exceptions, though,” says Michael Gersten, Managing Director, Northern New Jersey & Southern NY State for Neumann Associates. “If there is a justified expectation of a market improvement, then both parties can come to terms on a deal structure that takes such improvements into account. We have successfully put many such deal structures into place, however, such business improvement must be due to external events, and not a result of the (new) owner’s readiness to make substantial changes to the business.”
The challenge for a large segment of business owners then is accepting a more realistic asking price. Indeed, after performing a Fair Market Valuation in Washington D.C. by an accredited 3rd party business valuation firm, an “outsider’s view” will often move expectations to a more realistic value, specifically, with respect to two factors: goodwill and deal structure.
Goodwill, often perceived as a nebulous concept, is actually a factor that can be fairly easy determined, by comparing the existing cash flow and the market based company value with its asset base. “We have provided over 500 business valuations in Washington D.C. and around the country over the past 10 years, and every one had a fair market determination of the goodwill, ’” says Gary Herviou, Managing Director Central NJ & Lehigh Valley for A. Neumann & Associates, LLC.
More difficult is the actual deal structure, which frequently contributes to unrealistic price expectations. As stated above, if there are expectations for a substantial improvement in the business climate, then the deal structure must take all of this into account.
Beyond this, however, there are other factors that will come into play. For example, the lack of a seller note will typically drive down the FMV of the transaction by 10% to 30%, even though, in many business transactions the seller note will ultimately never be used.
A second factor, such as the current low interest rates available from the SBA, will allow for a higher ROI for the investor and therefore for a higher transaction price. As recently reported, “Small-business lending activity is on the rise, but the size of loans is shrinking, new data shows. The total number of small-business loans jumped up 10.4% last year, according to a report released Wednesday by the U.S. Small Business Administration’s Office of Advocacy.” [The Wall Street Journal, July 15, 2013]
Such an increase in lending is often the outcome of low interest rates, which in return provides for a much more favorable deal structure, and subsequently, more deal flow.
“All in all, there are many factors that contribute to the determination of a Fair Market Value of a business in Washington D.C.,” says Neumann, “and it is truly unrealistic to expect a busy business owner to sort out all these factors. Choosing to use an accredited third party professional’s opinion andrelying on M&A advisors in Washington D.C. who are active in the field on a daily basis, is certainly the more prudent way to go.”