So, what is Price? Webster would define Price as the amount of money needed to purchase something. In the context of a business transaction, a term closely related to Price is investment value - defined as: the value to a particular investor based on individual requirements and expectations.
The definition of Price above refers to a "particular" investor (buyer), just as there will be a particular seller. The real world of business transactions involves people. People with deeply held values, differing backgrounds and knowledge, and who are emotional - just being human. That's why people are so often unpredictable.
So when buyers and sellers look at a business to be bought and sold, the Price they see will be influenced by their particular motivations, perceptions of risk and growth of the business, and their overall knowledge of the process. Price is also affected by how it's negotiated. The adage is:
"You determine Value and negotiate Price".
The test for possible overpayment begins with an analysis of the operating cash flows of the business. EBIDTA (earnings before interest, taxes, depreciation and amortization) is often the cash flow measurement from which pricing decisions are made.
If a buyer and a seller can agree tha the business produces a certain level of EBITDA, then the Price can be tested to see if it satisfies the buyer's post-transaction claimholders to EBITDA.
Those four claimholders are:
- Uncle Sam: The state and federal income taxes on entity profits
- Lenders: The principal and interest repayment on acquisition loans
- Investors: The return on and of the cash equity the buyer puts in to make the acquisition
- Company: The working capital and capital expenditures needed for future growth
If the buyer's claimholders to cash flows are not met, then the Price may be too high and/or terms too stringent. The reverse is true as well. If after meeting the buyer's claimholders' to cash flows, there are excess post-transaction cash flows remaining, then the Price may be too low, and/or the terms are too lenient. Therefore, not giving what the seller wants - the highest Price and the best terms.
Ultimately, the objective is to demonstrate that the pricing and deal structure satisfies the buyer's post-transaction claimholders to cash flows, while also satisfying the seller's expectation of receiving the highes Price and best terms.
A Win-Win Method in Negotiating Price
In the well know best seller on negotiation - Getting to Yes - the authors suggest this four-step negotiation methodology:
- Step 1-Separate the PEOPLE from the problem
- Step 2-Focus on INTERESTS, not positions
- Step 3-Invent OPTIONS for mutual gain
- Step 4-Insist on using objective CRITERIA
Ideally, the goal is to negotiate a Price that's a win-win for both the buyer and seller; and, leads to a wise agreement, which the authors define as: one which meets the legitimate interests of each side to the extent possible, resolves conflicting interests fairly, is durable, and takes community interests into account.
