Buying a business? Determine if the asking price is realistic

You are considering acquiring a business and are in talks with the seller. It will not be long before the asking price comes up. It is important to know exactly how the seller reached their number. But it is just as important to determine if it is an acceptable price for you. Here are some key considerations to help you assess whether the asking price is realistic.

Valuation

The seller will look at many different factors when setting an asking price. For example, as the value of the company’s inventory, assets, premises and customer base, as well as its patents or dealer agreements. These elements make up an important part of the total asking price. So, their value must be described and justified properly.

Goodwill

The seller may also include goodwill in the asking price. Goodwill reflects the intangible value of a company and cannot be found on the balance sheet. Goodwill is determined based on an assumption of future profit and factors that contribute to it, such as a good reputation, specific recipes or skilled personnel.

There are two types of goodwill.

• Corporate goodwill derives from the company’s name, reputation, or past performance, which you will continue to benefit from after the acquisition.
• Personal goodwill derives from the seller and boils down to the value of the owner's skills and attributes, which means this type of goodwill is lost when the business is sold.

Goodwill is always a tricky subject when agreeing on an acquisition price. It can be an emotional topic for the seller, which makes negotiations (in Dutch) more difficult.

Remember that it is often difficult to finance goodwill, because the bank gets no collateral in return.

Request a memorandum of sale

In a memorandum of sale, you will find a total description of the business for sale, including the asking price and the method for determining that price. Ask yourself if you think that the company is worth that amount.

The asking price serves as the starting point for your financial review (in Dutch), in which you normalise the company’s current figures based on your own situation to assess what the company will look like when you own it. This process will help you figure out whether the company is sufficiently profitable, in the sense that you will make money from it and be able to recoup the goodwill you paid.

The importance of an acquisition consultant

It is usually a good idea to enlist the help of an acquisition consultant during the valuation process. You can also choose to bring in a legal or financial expert. These specialists (in Dutch) are not free, but they will give you valuable advice that can help you make the right choice. In other words, they are a worthwhile investment.