Negotiating the Price of a Small Business: Part 2

Part 2: Understanding key value drivers

 

This is Part 2 of a multipart blog series on negotiating the price of a small private company. If you missed the previous post, click here.

 

Even if the small business valuation work discussed in Part 1 leaves a buyer and seller with similar independent estimations of value, and they overlap enough to allow for an actual transaction (in negotiation, this overlap is called a zone of possible agreement, or ZOPA), each party still has an incentive to widen the gap between the perceived value and actual price. 

 

Obviously, the incentive for each party – whether they’re buying or selling the small business in question – is inversely related. The seller wants the price to be as high as possible above his perceived value; the opposite is true for the buyer – she wants the price to be as low as possible below her perceived value. These opposing incentives create a “high-stakes” negotiation dynamic – one which first-time sellers of small businesses are often unprepared for.

 

Because of this, we’ve compiled a practical guide to negotiating the price of a small private company. Useful for a seller: basically, a checklist of all the factors that might make your business more valuable. And, useful for a buyer of a small business: essentially a list of questions to consider or ask during due diligence.

 

The most common arguments buyers and sellers use to justify higher or lower prices (than what an initial valuation might suggest) fall into one of a few broad categories, relating to the target company’s: 

 

  1. deal structure 
  2. business model 
  3. financial performance 
  4. shareholders & management track record 
  5. legal & compliance status 
  6. growth potential 

 

There are other critical factors that can influence price, beyond the target company itself. These include the:

 

  1. sales process 
  2. buyer/seller transaction readiness and approach 
  3. importance of “non-price” deal terms 

 

We’ll unpack each of these in turn but before starting, it’s important to remember two overarching points: 

 

  1. the example we’re unpacking is the sale of a small business – although often consistent, interpretation of what follows can be different for different assets (e.g., a high-growth startup, or a large corporate acquisition), so keep this in mind.
  2. almost every point we make in this series can be used by buyer or seller to argue price up or down, depending on the circumstances.

 

Our goal is not to present an absolute view on how price should move, but rather to explain the underlying commercial logic so you, the reader, can adapt the argument for your own situation-specific benefit, or perhaps better understand where your counterparty might be coming from.

 

To get into the detail of a small business valuation, check out Part 3 of our Negotiating the Sale of a Small Private Company series, where we unpack the price implications of deal structure. A reminder, a complete version of this content is available to EquityMaven’s subscribers in e-book format.