Determining the amount that you are prepared to pay for the company is probably one of the most difficult decisions to make. No one wants to pay a cent more than the lowest possible price at the best terms that the seller is prepared to sell the business for.
There are two pieces of information that you require in order to determine what you can pay for the business. How much can you afford to spend to buy this business? – which is a combination of how much cash you have and how much debt the business can afford to service. Remember that the money that you will have to pay out at closing includes professional costs such as legal and accounting fees and closing costs that are adjustments in valuations to items such as inventory, receivables and deposits. Depending on the terms that you have negotiated these closing costs and adjustments can be substantial.
The other item to take into account is whether or not you will require an instant income from the business in order to maintain your current lifestyle and handle current commitments such as house mortgage payments, car payments and living expenses.
I strongly recommend that when you calculate your available cash plus debt service burden that you maintain 10% in reserve for emergency use. If you have $400K cash and the business can afford $600K in debt payments that would indicate that you can afford to pay a maximum of $1M for the business and all of the closing costs combined. My recommendation is that you do not commit to buy the business for anymore than $900K this will provide you with a 10% reserve. This does not mean you should actually pay $900K nor that the business is worth $900K what it means is that the maximum you can afford to pay for the business and the associated closing costs is $900K.
Just because the seller has set a price and terms, does not mean that it is a fair valuation for the company. Many owners of small businesses will list there business with a Business Broker (there is no cost involved) on the basis that if I can get my price I will sell it, otherwise I am just as happy to operate the business myself. The price that this seller wants to sell his business may really be way out of line against industry norms or what the business is actually worth.
If a seller has what you consider to be an unrealistically high selling price on the business and there is no driving force such as poor health or other business interests that are motivating him to sell it is unlikely that you will be able to buy the business at a much lower price. If however there is some driving force behind selling and you can determine what that is, you may be able to set a price and terms that are realistic to the businesses value in the market place.
In all cases price and terms go hand in hand. If someone wanted $1M for his business and you offered to pay twice that, $2M, but wanted to pay it out interest free over the next 50 years in equal annual installments the seller would probably reject the offer. On the other hand, cash talks! I have seen some deals consummated at as much as 30% less than the seller was asking because the buyer delivered the Letter of Intent with a certified check for the total purchase price being offered (still subject to due diligence). Most individuals find it difficult to refuse cash and at the very least the temptation to accept the check is enormous. To send back a check with a counter offer goes against most people’s basic instincts. Grab the check and run! In actual fact it is no different than offering cash at closing as that is when the seller will actually get to put the check in his bank account, but psychologically it makes an enormous difference.
In order for you to acquire the company that you are interested in, at the lowest price and with the best possible terms, it is generally necessary to understand what items are motivating the seller to divest himself from his business.
There can be many very good and valid reasons why someone wants to sell their current business.
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