Ed owned a rental property in Ashburn, Virginia. He didn't want to own one, but he did as a result of a second marriage. For five years, he couldn't sell the property for enough to pay off the mortgage. Finally, prices recovered in Ashburn and Ed felt sure he could unload the property. In fact, prices had not just recovered. There was a shortage of houses for sale. Ed signed up with a real estate agent, prepared to list the house, and set an asking price. After years of rental, the house wasn't in perfect shape, but he was prepared to make some price allowances.
Ed's agent notified the tenant, Sandeep, that the house was about to be listed for sale. She also told Sandeep the asking price. In Ashburn, most houses received multiple full price purchase offers in the first few days after listing. Some sold without ever making the MLS listing service.
Sandeep wanted granite countertops, new hard wood flooring, and a host of other improvements. He offered Ed the listing price less $25K for his desired improvements. Ed's real estate agent wanted to negotiate based on Sandeep's offer.
Ed declined to make a counter offer and instructed his agent to proceed with listing the house. After the first weekend, Ed received an offer very near his asking price and accepted it. Ed knew something his real estate agent didn't. Accepting Sandeep's purchase price formula was really Ed negotiating against himself. The price he originally set included an allowance for the condition of the home. He was offering to sell for the price the hot market was setting. Accepting Sandeep's price logic was negotiating down from the market price. Business owners do this all the time when they buy businesses.
The price for a business is determined by the identity of the buyer. Yes, cash flow determines price, but the cash flow to different buyers can be different. For instance, a competitor can usually afford to pay more for a business, since he / she doesn't need the overhead expenses of the purchased business. He will lay of the office staff, close the office, and consolidate operations in his office. A buyer, who needs the entire business operation, will realize less cash flow and thus will be willing to pay less.
Given the above, how do buyers end up negotiating against themselves? They let the seller control the terms of the negotiation. A business purchase is successful when the seller and the buyer agree on a price. The buyer calculates the value of the business to him. The seller calculates the price he will accept.
The seller controls the terms of the negotiation when the seller accepts the buyer's implicit assumptions. The seller will try to increase the price by selling the future potential of the business. For instance the seller will state that the business will be worth much more to the buyer if he takes actions like increasing promotion or entering a new line of business. When the buyer accepts the validity of these assumptions, he negotiates against himself.
The buyer should be buying what the business is, not what it might become. Even if the seller's suggestions are valid, the buyer will have to carry out these actions with no certainty of success and a good deal of risk. If the actions eventually increase the value of the business, that profit should go to the new owner not the old one.
I'm not suggesting that you blindly stick to your offering price. For a desirable business with many potential buyers, you will have to split some of the future potential value of the business with the owner. But be aware you are doing this. It lowers your rate of return on investment. If you have to give up all of the future profit, why should you be interested? You will be better off pursuing another opportunity. Sometimes the best deal you make is the one that doesn't happen.
Have you bought a wedding gift for RGIII yet? Time is running out. He is registered at Bed, Bath, and Beyond. RGIII's acceptance of gifts from fans became a major sports talk topic last week. On idiot sportswriter suggested that fans could better spend the money on charity than RGIII. Of course, the sportwriter's employer might better spend the idiot's salary on charity as well. A wedding gift for RGIII is much better use of money than spending it on a sportswriter.
As always, thanks for reading. For daily snarky business advice, please like the Facebook page, "How to Screw Up Your Small Business." Until next time, let's do it to them before they do it to us.
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