Is Your Business a Peach or a Lemon? That Depends on Your Perspective

Prospective buyers and investors aren't out to dig up risks in a business where they may not exist, but they want to have a clear understanding of any downside in the business before they get overly excited about future potential. By first minimizing the downside and then increasing future opportunities, you can maximize the value of a business.

Studies show that when faced with a coin toss that offers the chance of losing $50, most people will only take the risk if they can have a chance to make substantially more than $50, which is the expected return on the coin toss. This demonstrates that even though there's a 50/50 chance of winning or losing $50, the pain (fear) of losing is much greater than the reward of making more, even when given better odds. It's known as Loss Aversion.

Loss aversion is real, and the more prepared you are to address when selling your business, the better the emotional and economic outcome will be from the sale. Whether you're selling a car, a house, or your business, understanding the concept of loss aversion aversion will help prepare you emotionally during the sale process.

Loss aversion is when potential buyers focus on business risk and what they might lose instead of what they could gain from the same opportunity.

According to the Behavioral Economics Group, "Loss Aversion is encapsulated in the expression "losses loom larger than gains" (Kahneman & Tversky, 1979). It is thought that the pain of losing is psychologically about twice as powerful as the pleasure of gaining."

Let's say you watch the odometer click over 60,000 miles on your trusty pickup. You're thinking, "dang, this has been a great pickup! It's never let me down." You know the vehicle, it's dependable, reliable, and you are comfortable knowing it can probably run another 60,000 without a breakdown. Now you decide it's time to sell that trusty pickup. But you find that prospective buyers don't have the same confidence in the vehicle and aren't willing to offer your sales price. You know the truck, you're confident in its dependability; to you, there's very little risk in continuing to drive it. But to the buyer, the vehicle is an unknown. It's a used truck with over 60,000 miles of wear and tear on the engine and tires and could unexpectedly break down. In this transaction, the viewpoint of the seller and the buyer are decidedly different for the exact vehicle. The seller is confident in the pickup's dependability. You know the truck is a peach. The buyer fears it could be a lemon.

Loss aversion is a very real aspect of selling your business. Understanding, preparing for, and addressing the fear of loss (real or imagined) exhibited by prospective buyers will help create a more emotionally and economically positive sales process. Business owners and investors both understand that there are risks and opportunities with any transaction. However, downside risks can seem larger as prospective buyers investigate the business, which, whether real or unreal, can outweigh the value of the opportunity or growth. The increased risk that the seller doesn't understand or address can minimize the value of their business. We can never assume that a business's excellent growth potential alone will drive the desired sale price. Rest assured that investors will always pay a premium for and business with significant upside, but they must understand and weigh the growth opportunities against the downside risks. Working with an experienced professional, like a business broker or M&A attorney, can help business owners understand and prepare to deal with loss aversion exhibited by prospective buyers.

We've seen that as the overall potential of loss to the prospective buyer or investor increases, the imagined fear of loss can seem out of perspective compared to normal expectations. In some cases, the downside risk of loss can ultimately outweigh the growth opportunity, regardless of the potential. As a result, an interested buyer or investor may pass or lower their valuation of the business.

Being prepared can help ease prospective buyers' and investor's fears and lessen their aversion to loss.

Sellers will want to take an objective look at their business and identify those risks they may be comfortable with, but a buyer may find to be a risk. Here's a sample of some questions.

When A Buyer Asks:

Why are you selling, and what are your plans for involvement after the sale?

What The Question Means (Fear/Risk):

• Will you be available to help transition the business?

• How will clients react to you leaving, and will there be a potential revenue risk from lost clients if you leave?

• Are you planning to sell and run?

When A Buyer Asks:

Do you have plans in place after you sell your business?

What The Question Means (Fear/Risk):

• Are you worried about the future of the business?

• Are you planning to leave the business and the area with no availability?

When A Buyer Asks:

How will employees react to the sale?

What The Question Means (Fear/Risk):

• How attached are you to employees? Will you have regrets about leaving them?

• Will there be a loss of key employees after the sale?

• What will the impact on morale and productivity be if a sale is unwelcome?

When A Buyer Asks:

Why is inventory trending higher than in previous cycles?

What The Question Means (Fear/Risk):

• Is business decreasing?

• Are your products no longer salable?

• Have you lost clients?

Not all risks in business can be minimized or avoided, and being prepared with honest, transparent answers will help ease a prospective buyer's or investor's fears.

You can't cover risks up – any real or perceived risks to the business will come out in the due diligence process. And if significant risks aren't disclosed that arise after the sale is closed, there's potential for lawsuit.

How does a business owner prepare to ease the fears of a potential buyer, no matter how rational or irrational? Before your business goes to market:

1. Make sure you complete a professional valuation of your business by a reputable firm to understand the business's current market value.

2. Look at your business as a buyer. Then, using your most objective lens, take a deep dive into your business and make a list of possible risks.

3. With the list of identified risks, develop a plan to eliminate or lessen the risk.

4. If the risks are inherent in the business, think about what a buyer would ask about it and prepare an honest response. A response that will make a new owner feel assured that the risk is a normal part of the business.

5. Make a list of your growth opportunities – again, objectively from a buyer's perspective.

6. With the list of growth opportunities, what can be done to enhance them? First, do you have a written growth plan? If not, get your strategic growth plan in writing. A written growth plan helps a prospective buyer better envision future opportunities. (If you need help crafting a growth plan, check out Paradise Capital's GrowNOW workbook).

7. Compare your lists. Do the risks outweigh the opportunities? If not, get to work on risk mitigation and growth opportunities.

8. Be prepared to help potential buyers understand any risks and all opportunities to drive the true value of your business.

If you need help in preparing your company for sale or need help in growing your company before you're ready to sell, contact Paradise Capital. Our team of experienced business professionals brings 50+ combined years of marketing, communications, finance, business planning, and acquisition services working with a variety of brands.

Ann Smallman, Partner at Paradise Capital and co-author of GrowNOW! Your Fast Path to Growth. With a background in business marketing and relationship management, Ann has worked with some of the nation's biggest brands and helped drive millions of dollars in revenue. In addition, she manages Paradise Capital's sales process helps clients navigate the ins and outs of selling their company which lets her apply her marketing experience in positioning companies for sale.