The market for selling a business is highly inefficient. This is one of the main reasons why a well-designed and properly executed exit strategy can increase a company’s valuation by 50% or more.
A Counter Example – The Residential Real Estate Market
The best way to understand this is to compare it with a more familiar example, the residential real estate market. Most people have sold or bought a house, so they know how predictable that process can be. If you asked ten top realtors what your house could sell for, their estimates would probably fall within about 5% of each other. Likewise, if you talked to several potential buyers who had recently viewed similar homes, they could also provide an accurate estimate of your home’s value. This is because real estate is an efficient market, with plenty of buyers and sellers, strong liquidity, and readily available information.
A liquid market is one where transactions happen often and predictably. The NASDAQ stock exchange is a good example. If you own shares in a NASDAQ-listed company and list them for sale at the market price, you can typically find a buyer within minutes.
In an efficient market, it’s nearly impossible for buyers to find assets that are significantly undervalued. This is the foundation of the efficient market theory. As a result, no matter how you market your house or which real estate agent you hire, the final price won’t vary much. (Apologies to real estate brokers everywhere.)
Why the Business Sale Market Is Inefficient
In contrast, the market for selling businesses is inefficient for three key reasons:
- There are very few buyers and sellers.
- The market is illiquid.
- Information is difficult to access.
1. Scarcity of Buyers and Sellers
The term market depth refers to the number of active buyers and sellers. When selling a business, there may be only a few hundred possible candidates and a few dozen serious buyers worldwide. From the buyer’s perspective, the situation is even narrower. For example, if a company wants to acquire an established photo-sharing site like Flickr, a video platform like YouTube, or a bookmarking service like Del.icio.us, there are only a handful of comparable businesses available at any given time. This scarcity means a buyer may have to pay significantly more than a typical valuation to secure a deal.
For business brokers, identifying those few qualified buyers requires an enormous amount of effort. Many of the best buyers don’t even realize they want to make an acquisition until someone shows them why it makes sense. This is why people often say, “companies are sold, not bought.”
2. Illiquidity
The business sale market is also highly illiquid. Unlike NASDAQ, where trades happen in minutes, or real estate where deals close in weeks, selling a business properly can take a year or longer. Several factors contribute to this, including:
- Limited availability of information
- Time required to identify and contact potential buyers
- Evaluation of strategic fit
- Complex negotiations over non-monetary terms
- Months of due diligence
- Delays in the legal process on both sides
3. Lack of Information
Another major factor is the limited access to reliable information. Every market relies on data such as:
- Who the potential buyers are
- Which businesses are for sale
- Details about those businesses
- Comparable transaction data
In real estate, nearly all this information is available online, except for the names of individual buyers. In contrast, when it comes to buying or selling a business, almost none of this data is accessible. If you wanted to buy a company like Flickr or YouTube, there’s no central website listing similar companies for sale. Likewise, if you wanted to sell one, there’s no database to find qualified prospects. While some entrepreneurs have tried selling on eBay or Craigslist, the business-for-sale market remains too small for that model to work effectively.
This lack of information continues even after a buyer and seller have connected. Something as basic as finding accurate data on pricing is difficult. Even if you compile a list of comparable deals, you also need details about revenues, profits, growth rates, and other value drivers. By contrast, in real estate, it’s easy to find data about comparable home sales, including lot size, age, square footage, and other key metrics.
For example, I once spent half a day looking for a list of Web 2.0 company acquisition prices that compared selling price to pageviews, unique visitors, and ad revenue. I found just one list, covering about a dozen transactions, and even then, complete information was available for only a few of them.
The Good and the Bad of Market Inefficiency
This inefficiency, like many things in business, has both advantages and disadvantages. On the downside, selling a company properly requires a tremendous amount of time and effort. But the upside is significant: a well-planned and executed exit strategy can increase your company’s sale price by 50% or more.