Buyers Required Return

What determines buyers required return? Motivated buyers have to be willing to assume the myriad additional responsibilities of owning and operating a closely held firm. At a minimum they will be taking on the responsibility of providing services or products to more customers, clients, or patients (CCPs) than they had previous to the equity transfer. This added responsibility may entail that the owner spend more time providing services directly or supervising additional employee labor. Either way, these buyers are going to need and want to be compensated for assuming these additional responsibilities. This additional compensation may be characterized as wages or profit depending upon the degree to which the new owner’s personal labor is involved in the direct provision of services or management of the company. Either form of additional compensation can be described as a responsibility premium. The fact remains without an additional cash reward, there will be little incentive to taking on these responsibilities. This central fairness principle also states that whatever the amount of additional premium is, it has to be net of all other expenses including anything paid out for the equity in the firm.    

Standard Levels of Compensation or Profit

In each service or product sector there will be standard levels of compensation and/or profit normally realized based on the operational scale of the firm and the competitive nature of the local market. Frequently buyers of smaller service sector firms are skilled and experienced employees seeking to become self-employed small business owners. They will be seeking additional compensation for assuming the burdens of ownership. They will be seeking higher cash rewards net of the equity price paid out.

If the buyer is already a competitor in the local service market, there will be an expectation that the economic returns for serving the additional CCPs transferred by the seller will have to be at least comparable or better than the rate of earnings that they currently receive by servicing or providing products to their current CCPs.   

Finally, often the best reference return for prospective buyers is the level of return currently being realized by the seller. In most cases it will not be possible for the buyer to realize this level of return and pay the seller anything for the equity in the firm. However, if the equity payment is spread out over a limited period of time the buyer can attain the same level of return as the seller by the end of a buyout period.

See this link for profit margins for various business sectors.

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