Business owners who are looking to sell often find themselves in one of two camps when it comes to potential buyers: either you are selling to a person or business that you are familiar with, or you are marketing your business to a broader list of potential buyers. No matter how familiar or unfamiliar you are with your buyer, knowing both the entry cost to the industry and the fair market value of your business relative to the industry must be taken into consideration in order to reach the true value of your business.
Entry cost. For those new to an industry, entry cost is an unspoken “fee” that the buyer is willing to pay, depending upon the level of rigor and complexity of the specific business operations of the seller. Each industry—along with the business transactions that occur within that industry—will either have a higher or lower entry cost, depending upon the nature of the work done and the resources required to operate the business. For example, a dental practice has a pretty high entry cost, because the equipment needed is expensive and requires being up-to-date with current medical practice. The operations of a dental practice also come with proper record keeping and specific medical training for most of the employees that work there. The owner of a dental practice should know before they sell that their buyer must be able to meet the requirements of this high entry cost. An example of a business with a lower entry cost would be a residential cleaning business; the products and training needed to meet the value of the business are not nearly as rigorous or complex as, say, a dental practice. This is not to say that a cleaning business has any less value in general than a dental practice; rather, they are two completely different industries and must be evaluated accordingly.
Fair Market Value. You may be planning to sell your business to someone you have familiarity with, such as a key employee you have had for years, or maybe even a family member. It can be tempting in these closer business transactions to rely on handshake agreements and trust between you and your buyer. It is important, however, that you sell your business at fair market value, especially to avoid negative tax consequences. Whether the business you are “passing down” has a high or low entry cost, you cannot make an exception on the price just because this is a person that you know, or that you trust with the operations of the business. Selling your business to them at fair market value not only avoids red flags for the IRS, but it will truly give your business successor a head start in owning and operating a business for everything that it is worth. Let’s put it this way: If this person is truly prepared to take on the roles and responsibilities of owning a business, then they will appreciate you selling your business to them for exactly what it is worth and giving them the opportunity to learn how to value this business as their own.
When evaluating your business’ place within the industry, consider what is required to maintain and grow it and always be mindful of the fair market value of the competing businesses in your industry; this will make your business negotiation a win-win for both you and your buyer