Business for sale: A Valuation Disaster

Share This:

Business For Sale: Another Disaster

I recently read an article in a Michigan newspaper about a business for sale. The article described the challenge a small local business owner is facing trying to sell his business. The story included a reference to a TV feature about this owner’s struggle to find a buyer and the broader problem of Baby Boomer business owners wanting to retire. The feature was reporting a condition that I’ve written about previously. The subsequent newspaper article, however, focused on the specific local business but was completely confusing in that it was conflating two distinct assets: the business and the real estate.

The author of the story compounded the problem by including misleading advice for would-be buyers. At first glace, I asked myself if it was really the business for sale.

This story is true, though I’ve omitted the names to protect the ignorant.

The story starts with the TV feature which was generally about the dilemma that Baby Boomer business owners are facing when they want to sell their business and retire. According to the TV report, the owners are unable to retire because they are unable to find a buyer. The TV feature included interviews with both the owner of the specific business and the director of the local chamber of commerce. Both the TV report and the newspaper article bemoaned the fact that the business was going to have to close because the owner could not find a buyer.

Now, anyone who has been reading this blog over the past couple of years knows that I’ve written about Baby Boomers several times, the importance of differentiating between a business and the real estate it occupies and, on many occasions, about valuations and the importance of them being tethered – even modestly – to reality.

Reality

The article was vague on a couple of issues. First, though a business broker was interviewed for the TV feature, the article does not state that the seller had engaged a business broker to help find a buyer. (Though I suspect a real estate agent was involved.) The article also did not refer to the value of the business and from that fact I presume no one did one.

But the article’s author, perhaps in a fit of community cheer-leading, stated that “And, the price tag they have on the business is ridiculously low. Nobody could build the [business name] for the price they are asking — just $395,500. I’ve heard estimates of well beyond $1 million dollars based on today’s construction costs. So, it’s a bargain.”

What's a Business WorthWhoa!!

Did you catch that? “Nobody could build the [business name] for the price they are asking…”? If you’re a broker what’s that tell you?

It tells me that somebody – maybe everybody involved in this story – has no idea what the heck they’re selling!

The “business” is not the “building”.  “Construction costs” have nothing to do with the value of the business. It’s that simple. You’ve got to know what you’re selling!

What’s the BUSINESS Worth???

There is a buyer for everything (even for a business that’s losing money). But the thing that is being sold will only be sold at its value.

It’s possible that the subject business is worth the $395,500 being asked but that issue was never addressed in either the TV feature or the newspaper article. There does not appear to have been a valuation performed by a professional business broker, so who knows what it’s worth?

What is the owner selling? An operating business? A building? Simple business assets? What?

Does the business own the real estate? If so, the seller made a mistake from the get-go (as explained here). My guess is that the business is not generating enough Discretionary Earnings to justify the asking price, let alone the reporters estimate of  “…well beyond $1 million dollars”. Otherwise it would have found a buyer.

Remember the three things a business MUST do for a buyer? My guess is that this business is not doing at least one of them – and possibly, NONE of them.

The Questionable Advice

The reporter – probably an English or Journalism major, but unlikely with a business degree –  states that there are three important things a person needs in order to buy a business.

  • Money. Well, yes, but this is somewhat misleading. The article states that banks will lend only against hard assets. While this may be true – especially when the borrower is buying a small business – most banks are going to want to see a business plan with financial projections and they’ll want those financial projections to be based on historical numbers. If the historical numbers – what the business has done over the past 3-5 years – don’t show enough profit to pay the lender back, a wise lender will deny the loan. In fact, a friendly community banker would hopefully advise the borrower to pass on the business. Yes, the borrower may have enough personal collateral to secure the bank, but the bank does not want to own the borrowers hard assets (they have to be disposed of if the bank is the get its money back) and the banker would not want the borrower to fail in such spectacular fashion. (The article does correctly note that sellers should be ready to assist with the financing.)
  • Experience. A buyer with experience in the type of business being sold certainly has a leg up. But smart buyers will want the seller to stick around for some period of time to train them and to facilitate the transition. Depending on the business, this could be for 30 days or multiple years. And to the previous point, many lenders will look more favorably on a deal if the seller is helping with the transition. This is especially true if the buyer will be borrowing from the lender that has served the seller and the business over the years.
  • Courage. Well, I can’t argue with that one!

Our course, The “How-To” of Becoming a Business Broker”, teaches how to value businesses and how to handle any real estate the business is tied to.

Become a Professional Business Broker…

The Bottom Line

Whether you’re a business broker or business owner – especially a business broker – you must know what you’re selling and you must know what it’s worth. Using the current cost to replace the building a business is in has nothing to do with the value of the business – and in many cases has little to do with the value of the building itself.

You’ve got to separate the assets. The business is worth X. The real estate is worth Y. If you want to sell either, it is critical that you understand the difference

If you have any questions, comments or feedback on this topic – or any topic related to business – I want to hear from you. Put them in the Comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.

I’ll be back with you again next Monday. In the meantime, I hope you have a profitable week!

Joe

#business #howto #sellabusiness #becomeabusinessbroker #businessbrokering #businessvaluation

The author is the founder of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) and can be reached at joe@WorldwideBusinessBlog.com

Share This:

Leave a Reply

FacebookTwitterLinkedInRequest InformationContact