Negotiating the Price of a Small Business: Part 7

Part 7: Understanding price implications of people when buying or selling

 

This is Part 7 of a multipart blog series on negotiating the price of a small business. If you missed the previous post, read about understanding price implications of financial metrics here

 

Moving from the relatively clear and quantifiable financial factors explored in Part 6, we switch back to more messy qualitative factors, tackling perhaps the biggest value-driver in any small business: people. Talent can make or break any business, so, perhaps unsurprisingly, shareholder and management team dynamics almost always feature in negotiations to buy or sell a small business. The factors that most commonly create price pressure are:

 

  1. Minority Shareholders. A small business that has one owner, or a clear majority owner with unassailable control, is typically considered more valuable because there is less risk of small(er) shareholders blocking a transaction or making unreasonable demands before approving it. There is also a lot less multi-party negotiation and coordination required, which reduces deal time and cost. Indeed, the more minority shareholders a business has, and the stronger their minority rights are in terms of the company’s shareholders’ agreement, the greater the discount an outside buyer is likely to apply because of the potential for friction. 
  2. Key Personnel. A small business that does not heavily rely on its founder/s and/or its other key “C-Suite” personnel is often seen as more valuable, because the risk of the business failing if one or more these key people “gets hit by a bus” is that much lower. Indeed, many small businesses remain one-man bands, which can place a huge drag on price because if that “man” is lost, the “music stops”.
  3. Second Tier. Closely related to key personnel risk is the notion of second tier management capacity. A small business that has a strong “second tier” of senior managers, below the “C-Suite” across all key functions is typically considered more valuable, because there is less continuity risk if any one key person exits the business. 
  4. Tenure & Attrition. Building on the notion of strong management teams, the longer a team has been together, delivering strong results, the more favorably it reflects on price, because it speaks to high stability, strong morale, and deep institutional knowledge that is likely to keep profits rolling in. The opposite is true in a target company that demonstrates short staff tenures and high attrition rates. If this is the case, outside buyers of the small business can start to worry about its business model, leadership style, culture, and/or compensation structures, and knock price down accordingly.
  5. Business Intelligence. As the old saying goes, “knowledge is power”. Nowhere is this truer than in business, especially in small private companies where data tends to be spotty, systems can be non-existent or unsophisticated, and owners often rely on “gut feel” to make critical decisions. On the other hand, a business that captures and reports quickly and accurately on all of its key data – and has the analytical capability to interpret and act on it decisively – is almost always more valuable, because there is less risk of “flying blind” and crashing as a result. 
  6. Background Checks. It’s reasonable to expect that a small business buyer will do pretty thorough background checks on shareholders and key members of management, including credential authentications, credit scores, criminal records etc. Although a buyer can make exceptions when there are compelling mitigating circumstances, a business that has no shareholders or senior managers with “red flags” is more valuable, because there is less risk of fraudulent, negligent and/or criminal behavior from key principals in future.

While many of these people issues are circumstantial – and hard to change once already in place – they are well worth proactively managing if you’re a small business seller, because the rule of thumb is, the more capable and stable the team, the better the price. 

 

To learn more, keep reading Part 8 in our Negotiating the Sale of a Small Private Company series, where we look at the legal and compliance issues in a target company that may destroy value. A reminder, a complete version of this content is available to EquityMaven’s subscribers in e-book format.