Business Valuation Glossary
Total consideration, typically specified in the business purchase and sale agreement, paid by the business buyer to the seller in exchange for the ownership interest in a business or certain business assets.
What It Means
When a small business sells, the cash payments made are only a part of the business sale price. Business sale price and deal terms are interrelated. How you structure the acquisition affects the price the business sells for.
Business sale price in an asset business sale
Typical small business sales are structured as asset sales. In such an arrangement, the business buyer acquires ownership of some business assets, including goodwill. These assets are delivered free and clear. The business seller pays off all long and short-term liabilities. In most cases, the business seller also retains the cash and accounts receivable.
Business sale price in a stock business sale
As an alternative you can package the business sale transaction as a stock sale. In this scenario, the entire balance sheet transfers. The business buyer acquires all business assets, including cash and receivables.
The buyer also assumes the business liabilities, both recorded on the books and contingent ones, such as actual and possible law suits and pending regulatory compliance costs. If you are considering a stock business purchase, carefully review such contingent liabilities and their possible costs.
Market value of invested capital
The business sale price in a stock sale is called market value of invested capital. This includes both the equity invested by the business buyers as well as the long-term debt the buyer has assumed. Depending on the amount of leverage used by the business, the difference between the equity price and the business sale price can be considerable.
Valuation multiples are based on market value of invested capital
If you use valuation multiples to estimate the small business sale price, make sure you are using the ratios based on the market value of invested capital. Equity price ratios, which fail to account for the total invested capital, can give you very misleading business valuation results!
Additional elements of the business sale price
Small business sale contracts often specify valuable additions to the contract purchase price:
- Non-compete agreements
- Employment contracts with outgoing business ownership and key employees
- Valuable distribution and supplier agreements
- Lease and other rights assignments
The market value of these additional parts of a business acquisition can add considerable value to the deal and increase the actual business sale price.
For example, a supplier agreement arranged by the business seller on favorable terms may significantly reduce the cost of goods sold and increase the business profits. You should add the present value of this additional cash flow to the business selling price.
Business sale price: deal terms and cash value
Small business sales often involve seller financing. The amount of business buyer’s down payment is a major bargaining point – generous seller financing terms tend to attract a pool of competing business buyers which often leads to a higher business sale price.
Unlike an all-cash business sale, the financed deal has a cash value different from the contractually defined business purchase price. Since the business seller receives a balance of sale in the form of installment payments, the actual cash value includes the initial down payment plus the present value of the seller’s note payments received over time.
Business sellers analyze the buyer’s ability to repay the note very carefully. Your assessment of the business buyer’s default risk should determine what interest to charge on the note or whether it should be offered at all.
Contingent business sale price – earnouts
In cases where business buyers and sellers have trouble agreeing on the business sale price, part of the price can be held back for some time.
If the business achieves its financial goals by an agreed-upon date, the amount held back is paid to the seller. Such earnout arrangements are typical in sales of service businesses and professional practices where client retention may be uncertain.