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Negotiating the price level when purchasing a business requires finesse, especially when using a strategy reminiscent of underselling. The key is to balance an offer that works for you while maintaining a relationship that keeps each parties comfortable.
Use the following 4 strategies to master the art of strategic underbidding for business acquisitions.
1. Understand that sellers overprice out of emotion and optimism
Sellers tend to overprice their businesses, and it is vital to recognize this as a common behavior rooted in each emotion and optimism. As with real estate, business owners often consider that their company is value greater than the market would justify based on personal attachment and theoretical future potential. They may make their assessment based on potential revenue or expansion plans that have not yet materialized.
As a buyer, you should approach negotiations with the knowledge that sellers will naturally inflate prices based on these emotions. When salespeople focus on future opportunities fairly than simply hard data, there is a disconnect between their expectations and the realities of the current market.
This allows you to enter a lower bid based on actual numbers and achievable results, which is able to enable you to position your lower bid in a logical and fair manner.
2. Discover hidden data during due diligence
There is at all times hidden data that needs to be uncovered during the due diligence process – information that does not appear during initial conversations but is crucial to determining the true value of the company. Some buyers wait until the Letter of Intent is issued to dive deeper into financial matters, but taking a proactive approach can help establish a stronger negotiating position sooner.
Ask for financial statements, preferably three years of monthly money flow, and look at the numbers beyond creative accounting or GAAP financials. This allows you to assess the real ability of the company to generate money. Analyzing actual money flow data will enable you to calculate a realistic multiple and tailor your offer based on your organization’s actual performance.
With this understanding, you can confidently justify a lower offer based on the company’s financial health fairly than square footage numbers.
3. Use customer retention and churn to your advantage
Customer retention and churn rates are key aspects that sellers can often use to paint a more optimistic picture of the company. If customer retention is low or customer churn is high, salespeople will often have explanations for why – perhaps citing one-off events or special circumstances. Whatever the reasoning, this represents an opportunity for you as a buyer.
Customer retention has a direct impact on a company’s future revenue stability, and high customer turnover is a warning sign for long-term profitability. Use this as a sticking point to negotiate a lower cost. If you are faced with unclear explanations regarding customer churn or any inconsistency in customer satisfaction metrics, this is an excellent opportunity to justify strategic underbidding.
The key is to frame the discounted offer as reflecting the risk of low customer retention, which is able to ultimately prevent you from overpaying for unstable revenue streams.
4. Consider industry and market risks
One area where sellers often overlook or downplay risk is the state of their industry or broader market trends. Business owners could also be unaware of potential changes in the industry or, worse still, try to hide these risks during negotiations. However, as a buyer, you would like to have a good understanding of each the short- and long-term risks in the industry you are entering.
Take the example of Blockbuster, which was once a powerhouse before being blindsided by the industry’s shift toward digital streaming. Sellers could also be hesitant to admit that their industry is facing disruption, but these changes make a strong argument for a lower cost.
Conduct thorough research on the competitive landscape, emerging technologies and changing consumer behavior in the industry. Then use these insights to highlight potential risks to future profits, providing you with additional leverage to lower the price. A sensible approach to the way forward for the industry can result in an offer that reflects its true long-term viability.
By following these 4 strategies, you can confidently underbid strategically without jeopardizing the deal. Understanding a seller’s inflated expectations, uncovering hidden financial details, being attentive to risks reminiscent of customer churn and making the most of market dynamics all contribute to successful negotiations that profit each parties. With the right balance of tact and assertiveness, you can secure the acquisition of your business at a price that reflects its true value.