Avoiding Overvalued Companies and Finding Value Propositions as a Business Buyer

Feb 21, 2023

Have you ever purchased an used automobile just prior to it needing major mechanical service making what you thought was a fair transaction, an unanticipated expensive experience?  How about buying a vehicle from someone who was selling it for a deceased relative or because they were relocating and did not want to take it with them?  The second category often results in a value proposition acquisition.

As an approximately thirty year mergers & acquisitions professional, I have heard about both acquisitions where companies were bought above the value warranted in a “win-win” transaction where there was full disclosure of all relevant facts and a proper assessment of the entity and deals where buyers purchased companies for multiples of EBITDA significantly below what similar companies had sold for in the marketplace.

The following are four items to look for in identifying both overvalued companies and value propositions in the business opportunity marketplace.

Attributes of Overvalued Companies

  1. Undisclosed Deferred Maintenance  The last thing a business owner seeking to sell their company wants to do is replace or repair equipment. This action can be expensive and typically results in a net loss on the investment when incorporated into the sale price of the business.  For this reason, it is important to properly assess the “as is” condition of equipment, review maintenance records, and understand the lifespan and replacement costs associated with important tangible assets prior to acquisition.  Failure to complete proper equipment due diligence, can result in expensive post acquisition capital costs that drain needed operating working capital.
  1. Damaged, Obsolete, or Slow-Moving Inventory  A management decision is made by a business at a specific time & place when inventory is purchased either as a component for manufacturing, providing a service, or for sale to retail or wholesale customers.  No company successfully transitions every inventory purchase into a sale. That is why Nordstrom has The Rack and companies like Overstock.com (https://www.overstock.com/) exist.  One goal of virtually every business owner selling their company is to have the buyer purchase their inventory at the highest possible value.  Caveat Emptor, Let the Buyer Beware. Inventory should be evaluated to identify any items that are damaged, obsolete, slow moving, or out of season.  If they fall into any of these categories, they should be discounted to an appropriate level where a buyer can make a profit on the purchase and turn them in a reasonable time period.    It is also important coming out of the COVID-19 pandemic to buy product at the lower of market or purchase price.  Many companies bought inventory at inflated purchase prices when supply chain issues existed in the economy.  That inventory should be purchased at market value, since the viable alternative always exists for a business buyer to purchase new inventory if it is cheaper.IBA as a nearly fifty-year-old business brokerage firm that employs best practices and attempts to facilitate transactions in sunlight with full disclosure between the parties corporately embraces the “golden rule” of do unto others as you would want them to do unto you when facilitating transactions.  It is our belief that if this philosophy is adopted by both parties an outcome of a “win-win” transaction is a high probability.
  1. Below Market Operating Costs  The basic components of business valuation are EBITDA and a multiple.  If long term employees are paid below market or a favorable heritage lease that is coming up for renewal are going to need to be adjusted post acquisition, that information should be incorporated into valuation or an enhanced price will be paid in negotiations.
  1. Changing Market Dynamics The COVID-19 pandemic inflated revenues and profits in multiple sectors of the economy.  In 2020 & 2021, a significant amount of disposable income was allocated to home improvement projects and fitness equipment.  This resulted in strong financial performance by businesses operating in those areas.  People will continue to remodel kitchens, bathrooms, upgrade home entertainment systems, and buy treadmills and stationary bikes.  Those business models are not going away.  However, will they perform like they did in those two years or will revenues and profits normalize to 2019 or a level in between.  A prudent business buyer will always incorporate societal trends and economic conditions into their assessment of a business model.

Attributes of Value Propositions

  1. Changing Market Dynamics  Every economic environment creates opportunities for business owners pursing the American Dream.  The entrepreneurs who can predict market demand for products and services can build infrastructure to capture customers and harvest revenue and profits.  It is not hard to predict that the marketplace will see value in supplemental, private sector education for children in the next couple of years as parents try to catch their children up academically from lost years when they were not allowed to go to school in person, the most productive environment for education, especially at younger ages.  It is also not hard to foresee a surge in wedding activity with all its ancillary economic activity now that traditional dating activity is again available to twenty & thirty year olds.
  1. Business Model Evolution  Business founders often put operating models in place and maintain them for extended periods of time with limited incorporation of new technology and practices.  A business buyer that identifies opportunities for evolution in a business model in an existing company often can purchase a diamond in the rough that when polished has substantially greater value.  An example could be a company that has a fleet of gas powered vehicles that could be converted to electric vehicles reducing operating & maintenance costs while enhancing profits.
  1. Geographic Expansion and Population Growth  As population grows, new opportunities are created.  25 years ago, Hillsboro and Woodinville were considered the end of the world for the Portland & Seattle metropolitan areas.  Today, they have robust, thriving economies of their own.  Buying a business in a growth area where a rising tide will lift all boats can make a purchase in 2023 look like a bargain deal in 2025.  Similarly, buying a strong company in a growing county (e.g., Snohomish County) and expanding operations into an adjacent county (e.g., Skagit County) can take a seven figure revenue company to eight in a few years.
  1. A Business Buyer Willing to Make Difficult Decisions  Business is the ultimate competitive sport.  The Seahawks decision to trade Russell Wilson and let Bobby Wagner leave were viewed as poor management decisions by many members of the 12 in 2022.   In 2023 with 20/20 hindsight, prudent executive leadership resulted in a youth movement for the organization, freeing salary cap space for new talent, and a playoff birth for the team, an achievement neither Wilson or Wagner experienced with their new teams.  New ownership has the ability to make changes, including replacing highly compensated and lower performing team members.  A business buyer with the ability to execute successful changes that enhance company performance often has the ability to recognize a value proposition at time of acquisition.

As a business broker who has successfully facilitated over 300 transactions since 1994, it is my pleasure to share this information with buyers in the marketplace to acquire companies.  IBA does not traditionally represent buyers in transactions, instead focusing our knowledge, experience, and professional skill set on helping business owners retire or transition their hard work into cash.  However, it is our goal to set up buyers for success, for we know that the average entrepreneur operates a business seven years before selling it, and it is our belief that if we facilitate a “Win-Win” transaction employing best practices when they are on the buyer side that there is probability they will return to our offices when they want to sell.

Walt Disney had it right when he said, “Do what you do so well that they will want to see it again and bring their friends.”

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, real estate, legal, and accounting communities on subjects relevant to the purchase & sale of privately held companies and family-owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.