The market for selling a business is very ‘inefficient’. This is one of the reasons a well designed and executed exit can easily increase the business valuation by 50% or more.
The best way to illustrate this is with a counter example – the residential real estate market. Most of us are familiar with selling a house. If you contacted the top ten realtors in your area and asked them what you could sell your house for, you’d probably get answers within 5% of each other. Similarly, if you could find a number of buyers who were currently in the market for a house just like yours, and they had recently spent time looking at comparable properties, they could also give you a very accurate estimate of the selling price for your home. This is because the market is ‘efficient’. This means the market has lots of buyers and sellers, is relatively liquid and information is readily available.
A ‘liquid market’, or one with good liquidity, is one where transactions happen frequently and with good predictability. The NASDAQ stock market is a good example. If you own shares in a NASDAQ listed stock you can post them for sale at the market price and you will usually have a buyer within a few minutes.
In an efficient market it’s very difficult for a buyer to find properties that are significantly undervalued. This is the fundamental premise behind the ‘efficient market theory’. A practical outcome of the efficient real estate market is that the price you can get for your house isn’t going to change much regardless of how you market the property or which real estate broker you choose (my apologies to real estate brokers everywhere).
In contrast, the market for selling a business is inefficient because:
- there are very few buyers and sellers,
- the market is illiquid, and
- information is not easy to access.
Scarcity of buyers and sellers
‘Market depth’ is the term that describes the number of buyers and sellers. When you sell a business, there are probably only a few hundred suspects, and a couple of dozen potential buyers in the world. From a buyer’s perspective it’s even worse. For example, if your corporate strategy is to purchase an established photo sharing site like Flickr, video sharing site like YouTube or URL sharing site like Del.icio.us, there are probably only a few companies like those available for purchase at any one time. This relative scarcity of sellers and buyers means a buyer may have to pay substantially more than a ‘typical value’ to successfully acquire one of the few businesses for sale.
For business brokers, finding those dozen or so prospective buyers that are ‘in the market’ for a specific business is an enormous amount of work. This is exacerbated by the reality that most of the best buyers won’t even know they want to buy a particular business until someone gets their attention and shows them why they should be interested. Another way to say this is that companies are ‘sold, not bought’.
The market for buying and selling businesses is also very illiquid. In contrast to the NASDAQ market where transactions only take minutes to complete, or the residential real estate market where sales usually only take a few weeks, selling a business (the right way) often takes a year or more. There are many reasons for this including the:
- lack of available information
- time required to contact suspects
- time it takes to explore a fit
- complexity of the non-monetary term negotiation
- months required for due diligence and, of course,
- delays related to the legal process on both sides.
Lack of information
The third factor contributing to the inefficiency of this market is the difficulty in accessing information. Every market needs information on:
- who the potential buyers are
- what properties are for sale
- information on those properties and
- data on comparable transactions.
In the real estate market, for example, all of that information is available online except for the names of the potential buyers.
In the market for buying and selling businesses, none of this information is readily available. For example, if you wanted to buy a company like Flickr, YouTube or Del.icio.us, there is no website where you can do a search for companies like those for sale. Similarly, if you wanted to sell a business like those, there is no website you can go to find prospects who are in the market. Some entrepreneurs have tried to sell their businesses on eBay or Craig’s List, but we just aren’t there yet. We might be one of these days, but I suspect the market for buying and selling businesses will remain too small for online matching to make sense for the foreseeable future.
This scarcity of information isn’t just a problem during the matching phase of a business sale transaction. Even after a buyer and seller have found a good fit, lack of information is still a significant challenge. Even the simplest element of a transaction – the price – is difficult to find information on. Even if you could build up a list of prices on similar transactions, the information you really need is not just the selling price, but also details on the main value drivers in the transaction, like revenues, profits, growth rates, etc. Using the residential real estate market as a comparable again, it’s easy to find a website listing the details of comparable property sales in your neighborhood. You can see the selling prices along with the size of the lot, age, number of square feet in the home, number of bedrooms or bathrooms and a dozen other key metrics.
I recently spent a half day looking for a list of Web 2.0 company acquisition prices that compared selling price to number of pageviews, unique visitors, ad revenue, etc. I found one, which looks like the only one, but it only includes about a dozen transactions, and there is only complete information for a few of the companies.
This lack of market efficiency is, like a lot of things in life, both good and bad. It means that a tremendous amount of work is required to sell a company well. But it also means that a well designed and executed exit transaction can increase the selling price of your business by 50% or more.