[M171]Making An Offer House

It does not seem that long ago that fuel was selling for $1.85, but you could not dream of getting it for that price today. Why? There is not enough incentive for the owner of the fuel to give it to you for that price when he has others who would pay much more. It probably cost him more than $1.85 to acquire the fuel and refine it! So, just how much is enough? When you are about to make an offer on the purchase of a business, the million dollar (or more) question becomes - Will you guess the right purchase price?

Many people struggle with this question. And guess what, it is not just you who struggles. Even the best people in business who buy and sell other businesses try to figure it out. The truth is that value, like beauty, is in the eyes of the beholder. There is no scientific rationale why a business is worth 8 times its annual EBITDA one year, and then 5 times a month later.

Yes, market conditions, and attitude play an important role in determining the value of a going concern. But, how much is it really worth? No one really knows. The price of a business is determined solely by what is paid. Under normal circumstances, businesses are purchased in an arms-length transaction. As the definition states, the fair market value of a business is what a seller and buyer, both in possession of all pertinent facts and conditions, and not under duress, agree to as a price.

But, as you are the buyer, what price should you offer? We get that question a lot. Be careful here. As a buyer, make sure you have objective advice when and if you want to determine an offering price for a business. Remember, most brokers and intermediaries are really agents of the Seller, and as such, ethically should caution you on asking them for advice on price. They cannot be objective on your behalf.

They can help talk over issues with you, but in the end it is you and ONLY you who makes the final decision on what to offer. Your paid advisors are usually hired to bring out the flaws and risks of a decision you want or need to make. The real level of risk you agree to and are willing to take is something you need to take ownership of. No one will do it for you.

When YOU want to make an offer on a business to own, YOU are the only one who can make that leap of faith as to how much is enough. That winning PRICE is something that tips the scales in your favor. It is something that makes the business owner take pause and think of the value to them. In a word, it is a price (and terms) that INCENTS them.


A buyer should only make an offer based upon what a business is worth. But that offer must incent the business owner to agree to the sale. Many buyers, unaware of the process that they should use to determine the value of a business, or determine an offer price, get confused and make unrealistic offers, both high and low.

An offer price that incents a seller to sell, but that is not representative of the business value, is a bad offer. Offering a high price to ensure success could be disastrous. The cash flow of the business may not support the debt service incurred, or provide a competitive return on investment to the shareholders. An informed seller may be scared of the prospect of you defaulting on the money you owe THEM, and then be forced to repossess the business is not something they likely do not want to occur.

Unfortunately, the opposite is also true in many cases. Buyers make offers for businesses everyday that do not work. Why, because the buyer did not offer the business owner enough incentive to sell. This article does not attempt to help you price a business, but bearing that in mind, it will help you understand the psychology of a sale. A good business that is profitable, has a strong positive cash flow, and has an excellent prospect for continuing operations, has a definable value. As a buyer, you must determine how to place a value on the business that you find attractive and meets your needs.

You likely will never know exactly what will incent the Seller. However, during your discussions with the Seller and other investigatory work, you will need to try and make a determination as to what would incent them. I have seen businesses sell for 10% of their value because a seller wanted to retire and just ensure that their customers would continue to be serviced. But, as you likely guessed, that occurs once in 10,000 times.

When determining what price to offer, first determine a range of prices that makes sense for you. Ask yourself how much you need to earn? What are the possibilities of increasing cash flow? What are the risks? Find comfort with the range. It is not unusual to be nervous about that amount, especially at the upper end. But, it still needs to be workable for you.

Now, try to determine what the Seller would consider reasonable, and what would incent them to turn over the reins to you. Keep the following items in mind when trying to make this determination:

1.How much is the multiple of cash flow? Is it within the current industry standards or not? If it is too low, the likelihood of a better offer from someone else is very high.
2.Are the mix or price and terms reasonable? There is a big difference when a price is really back ended with loan payoffs or earn-outs. Remember this formula that a seller will consider:
a.Price=Cash Now (Cash in the future * risks of collection).
3.How long would it take an owner to EARN the money you are paying them at close and that is not at risk of collection? If it takes 2 to 2 1/2 years or LESS, than most Sellers would rather stay in the business, keep what they earn in that time, and then just close it. They will not have any closing expenses, aggravation of a sale, or have to deal with a third party calling the shots during the transition period.
4.If the allocation of your transaction will result in a high tax consequence for the Seller, it may not pay for them to sell. Ask your intermediary or tax accountant for the true implications of an allocation on both you, and (it is not directly obvious without considering their personal tax situation), the Seller.
5.An offer can be viewed as insulting (in dollars or terms) and not indicate to the owner what the value of their efforts has achieved. This could lead to being disqualified to receive a counter-offer or even negotiate a new offer!
6.You are not doing the Seller a favor by buying their business. They are likely proud of what they have built, and would no more sell it at a low price or terms than they would give away a prized painting they own because they have had it for too long.
7.Offers need to be priced on a non-emotional basis. However, that does not mean in all cases the Seller will evaluate it without emotion. If you, as a buyer, believe that a seller will place too much emphasis on emotion versus value, you may be wasting your time. You must evaluate the Seller as well as the business to ensure you are using your time, money, and resources effectively.

When you are finally successful in getting a business owner to agree to an offer price, it will likely be that both you and the Seller did not get exactly what you wanted. You will think you paid too much, or maybe made the terms more in favor of the the Seller, and they will think you got a bargain price, and are being too harsh in your terms and payout requirements. That does not mean there was a disagreement. It just is the nature of negotiations. No one thinks they really won.

Be prepared! Understand the psychology of what incents a seller. Be careful to only offer what a business is really worth. Understand that you may have paid more than you wanted, but if you have faith in the business as well as your experience and skill set, your investment will hopefully pay financial and psychological dividends for years to come.