Valuing a Business from a Buyer's Perspective

Often times, public company data is used when attempting to value a privately-held firm. This comparison usually requires substantial adjustments to offset the risks inherent in the privately-held or closely-held company. These potential risk characteristics are usually elements that are overlooked by sellers, but not by potential buyers.

Sellers obviously look at their companies much differently than do prospective acquirers. Owners and company officers tend to place value on different factors than does a buyer. However, when it comes time to sell, it's important that the seller consider those factors that are important to a buyer.

Interviews with buyer prospects reveal that they are concerned with, and influenced by, the factors outlined below. They are often the basic considerations that determine whether they actually purchase the business, as well as the price they are willing to pay. It is the buyer's evaluation of these factors that can make or break a possible sale.

Buyers tend to look at these elements as risk factors. They also look at the expectation of future earnings. The following characteristics affect, both positively and negatively, the future earnings potential of and the risks involved in a target business.

Historical Earnings

The history of a company's earnings is very important to a prospective buyer. A long history of stable, and hopefully increasing, earnings is a positive factor in whether the buyer will pursue the acquisition. Conversely, a brief history or inconsistent earnings will certainly be a negative factor. A short time frame (for example, a company that has been in business for a year or less) and erratic earnings present obvious risk factors.

Entrepreneurs often underestimate the costs (and time) necessary to get the company to a profitable level. Start-ups are difficult to sell under the best of circumstances. The next time period in the life of a business is after three years, at which point there is some history, and a track record is beginning. The third period is usually after the company has been in business for a minimum of five years. Now the company has a track record and a reasonable history of performance.

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