We were asked a question recently about Margin of Safety, this was our response.
To answer your question, “margin of safety” is a measure we came up with specifically for LPOs. It’s purpose is three fold:-
1. For potential business owners.
Very often a person will choose another business over an LPO because they perceive the LPO to be very risky. However, this is a somewhat unmeasurable concept. Margin of safety is our way of attempting to quantify this risk and in someway allowing the public added insight to risk. Therefore, the less risky a business is the more it should be worth.
2. For potential business owners.
If a person is at the final stages of choosing a LPO and have shortlisted 2 to choose from. The margin of safety in our mind is one tangible way of making the decision which LPO to choose.
3. For current LPO owners
If you know you have a business which has a good margin of safety, we believe it is one which is valuable and should command a higher sale price compared to other similar LPOs if it is well presented during the sale.
My qualification on this last point is that, the final price a LPO is sold for is ultimately determined between what a willing buy and willing seller decides on. You may have a great LPO, but if you need to sell it quickly, you may not achieve this premium that you are expecting. Likewise, another LPO may sell for a high multiple for other reasons. This is why I am in no position to say what return on investment should a LPO w a good margin of safety sell for. I have seen poor LPOs sell for large amounts of money because I believe the buyer paid too much and didnt perform adequate due diligence.
The LPO Advisor