Example: A wife and husband are in the starting stages of negotiating a price for a florist that is being sold by an elderly lady who is selling “because her children want her to retire.”Since her husband died five years ago, the business has been going downhill, and for the past three years it has been “underperforming.” However, as they try to get financial information about the current business health, she is pushing to use the numbers that are over three years old to value the business. Is this a recipe for a fair valuation?
First, remember, it is her business and if she and her late husband ran the business for many years, she may indeed have a good feel for the value of the business and its potential for growth. Conversely, her valuation may be heavily weighted by her memories and emotional attachment to the business. This ‘value’ is very real to her, though maybe not to a potential buyer.
Next, be aware that “fair” really is an ambiguous word. Consider that “fair” will be whatever all parties finally agree on at the end of negotiations.
If the buyer does not like the number that the seller is asking, they have the right to pass.
If the buyer can build a case that three years ago the business was doing £100K and over the last three years it has averaged £60K, they can point out that this is a trend that may likely continue.
The seller may say that for reason-1 and circumstance-2 revenue has slumped but it would bounce back with the potential buyers, (younger, energetic, enthusiatic) at the helm.
One way to address both these issues would be to put a future performance clause in the purchase contract–
- the buyers pay the higher price but if the business does NOT come back, a certain amount of the purchase price is returned, or
- the seller accepts the lower price and the buyers agree to pay an additional amount when the business growth passes a predetermined amount or attains its previous level of business.
You can work a win-win purchase here with a carefully worded contract, some trust by both parties, and the desire, commitment and genuine effort on the buyers’ part to succeed.
Alternatively you can go down a more technical route and engage an accountant to value the business by assessing its ability to generate future cashflows and valuing it through the use of a Discounted Cashflow Analysis(DCF) or analysis of comparable firms in the industry.