Every business owner knows that no matter how great their business is, there is always room for improvement. When you own a business you are often faced with decisions that mean you are investing your time and money into certain aspects of the business, leaving the door open for opportunity. When it comes time to sell your business, this is marketed as the “potential”. At Acquisitions Direct, our brokers are often faced with this question from our buyers, “If the business you are selling has big potential, why hasn’t the current owner been able to develop the potential?”. The specific reasons will vary from seller to seller, but the bottom line is always the same – potential is determined by market value.
Ever since the internet boom, online business owners have been able to easily put their products and ideas out onto the web for customers to enjoy. Long gone are the days where you need to buy real estate, renovate and stand on the sidewalk inviting customers to “come see what’s new”. You were limited to a specific town, and in some cases an even small community. Today, the start up for an online business owner is perceived to be easy. Take a few pictures, write some content and upload it on the World Wide Web. Traffic from all over the Globe can start pouring in. If you’re lucky, your business is well received and it goes viral. The successful ones are noticed by big corporations and acquired. Many of these businesses have been in the spotlight for accomplishing just that. The trend started in the late 90s. In 1998 the free email service, Hotmail, was acquire by Microsoft for $400 million. In 2002, eBay acquired Paypal for $1.5 billion. In 2006, Google paid $1.65 billion for You Tube. And most recently Instagram was acquired by Facebook for a mere $1 billion.
Success stories like those have internet business owners saying, “That could be me!”. Our Acquisitions Direct brokers have conversations that start like this daily. Every business assessment starts out reviewing the unique selling points of a business, the backend of the business operations and understanding the industry. Most sellers want to spend all their effort focusing in these areas, but the reality is that most buyers spend the majority of their time during a business assessment looking at the financials. The financials are an important health indicator for a business and a major contributing factor for risk. The “potential” may help sell the business but usually does not increase the multiple much unless your company is the industry leader.
In today’s economy, most businesses sell for between a 2.5 and 3.5 multiple. This is the most common disconnect between buyers and sellers. When determining the asking price of an online business, sellers often cite potential as the justification for a larger multiple. The brokers at Acquisitions Direct often see sellers looking to obtain a multiple well north of 5-7. Business owners see the companies like Instagram and Paypal making billions off of acquisitions and immediately think that raises their asking price. What they don’t see is the other million businesses just like them that aren’t able to obtain that asking price, or the ones that failed.
The bottom line is buyers have choices today, and investing in a business that has “big potential” is high risk. Just like in the stock market, the majority of investors are looking for strong investments in businesses that have little risk, but with strong upside potential. A small percentage of investors are looking at penny stocks and oppressed businesses that are very high risk, but are priced at a very low multiple due to the risk associated with purchasing these stocks. The same goes for online businesses. Businesses with huge risk sell for low multiples due to the risks.
Odds are you are more likely to win the lottery than to sell your business for an extremely high multiple. If you won the lottery, would you immediately take your winnings and head to the casino? Applied to your business it is the same concept. Once your business is hitting its’ peak of where you can take it, you should highly consider selling. Letting it ride may result in a lower selling price down the road as buyers look negatively at businesses with declining sales and profits. At that point you have two choices: renovate your business to maximize the selling price or sell at the current market rate. Our brokers can help you understand when the right time to sell your business is and how to spotlight the potential that buyers are looking for.
