Business valuation using market comparisons: how seller financing affects business selling prices
If you are in an industry where businesses sell often, chances are there is plenty of data to estimate your business value by comparison with similar businesses. A common way to do so is to use the so-called pricing multiples. These pricing multiples are ratios which relate some measure of business financial performance to its potential selling price. Typical ones are:
- Price to business gross revenue or net sales.
- Price to seller’s discretionary cash flow.
- Price to EBIT, EBITDA, net income or business assets.
When you use the pricing multiples to estimate your business value, you find quickly that such market value comparisons give you a range of possible business values, not a single number.
One reason is that no two businesses that sell are the same. Nor are the business sale circumstances. And one of the key factors which affect the business selling price is seller financing.
Seller financing is common in small business acquisitions
Small business acquisitions very often involve some seller financing. There are a number of reasons for this:
- Small businesses have a harder time raising capital from conventional lending sources.
- Lenders often insist on seller financing as an extra assurance that the deal is sound.
- Business sellers can attract more qualified buyers if they offer attractive financing terms. Competition among these buyers often results in a higher business selling price.
Business selling price tends to be higher for seller financed deals
How much higher?
While the actual business selling price premium varies by industry, one estimate is that for each 10% additional seller financing offered, the business selling price tends to increase by some 4%.
So, if your deal is 50% seller financed, the business selling price may be easily 20% above the all-cash deal. If the seller offers to finance 75% of the deal, this price premium grows to 30%.
Seller financing terms matter
This selling price premium tends to grow even more if the seller’s note maturity period is increased or the interest charged drops.