Business owners are often accused of overvaluing their businesses.  But value is in the eye of the beholder and a business may be more valuable to the existing owner than anyone else.  When that happens, no sale will occur.  But the relative desire to keep versus sell may change over time so that a business owner will eventually price the business to sell.  Until then, the business owner will probably overprice his business

We all prefer to hold onto anything that is ours. Psychologists call it "the endowment effect", the tendency to place a higher value on things that belong to us.  That may explain why business owners price their businesses so high, but other factors are probably more important in explaining the disparity between sellers and buyers.

I value my 1993 car higher than its blue book value.  I know it is a good car and has had little trouble.  But a prospective buyer doesn't know that.  He will discount the car's value because he is uncertain whether it is really a good car.  As for me, I'm in no rush to get rid of it.  It's a good car, and even if I was interested in selling, I know it wouldn't be easy to find an acceptable replacement.

Business owners face a similar dilemma.  The business is often more valuable to them than it is to any prospective buyer.  In that case, the owner would be perfectly reasonable in retaining it.  But if he wants to sell it, he has to price it within the buyers' range of values.

Business appraisers sometimes compare small privately held businesses to publicly held companies in hopes of getting a more objective indication of fair market value.  But the motivations of the buyers and sellers are altogether different.  The typical seller of publicly held stock is not an insider.  Selling his stock does not affect his job, his relations with fellow workers, or his identity in life.  He is simply undertaking a financial transaction.  The owner of a small business, on the other hand, must consider all the consequences of a sale.  Will he have a place to continue working after the sale?  Will he be able to take direction and orders from the new owner?  Will he be able to deal with his loss of his identity as owner of the business?

Business owners know that once they sell their businesses they may have lost their opportunity to be self-employed.  If they are advanced in age, they may not want to start a new business in an entirely new field.  And they probably can't start a competing business if they have entered into a noncompetition agreement with the new owner.  Business owners should also know that their chances of remaining as an employee under new owners are not very good.  It's very difficult to be an employee once you've been an employer. 

Even when an owner is prepared to move on, there are usually significant differences in the way the existing owner and buyer perceive the costs and benefits of the transaction.  Owners tend to evaluate deals based on what they will net after taxes and expenses of sale.  Buyers tend to evaluate deals deal based on the gross purchase price.  Frequently, owners will incorrectly compare the after-tax proceeds from a sale to the pre-tax annual earnings of the company and the pre-tax compensation to the owner and conclude that it is not worthwhile to sale because they will get a lot more simply by running the company a few more years.  In those cases, the owner is ignoring not only the higher tax rates that apply to corporate earnings and compensation but also the opportunity cost of continuing to work. 

What ultimately causes an owner to get serious about selling is one of four situations:

1. Desire for a Dynasty.  Business owners are willing to sell part or all of their businesses to see their businesses grow into big businesses.
   
2. Financial Security.  Like the high school basketball star who reluctantly forgoes college to take a multi-million dollar contract in the NBA, business owners may agree to sell if the proceeds are expected to be high relative to their current net worth and will make them financially secure.
   
3. Opportunity Cost Gets to Be Expensive.  Time becomes the most precious resource.  After devoting so much of their time to the business, business owners want to spend more time with family, travel, play more golf, move on to a new venture, or pursue charitable goals.
   
4. Sick and Tired of the Business.  Even when there is no chance of a dynasty, financial security or more time to do other things, many owners are so tired of the business they are ready to forgo some of the financial benefits of ownership to move on to something else.

Although many buyers and sellers of businesses ultimately reach agreement on price, far more transactions fall apart because of the gap between what a buyer is willing to pay and what a seller is willing to accept.  Before you waste too much time arguing about proper valuation methodology, make sure that the owner is really ready to sell.

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