Finding Value Propositions When Buying a Business

Feb 7, 2017

The two most common motivations for selling a business in transactions facilitated by IBA business sale intermediaries are retirement and a desire by an entrepreneur to move onto their next project due to a preference to engage in the creation & development stage of a business life cycle rather than the management & refinement stage. These motivations for sale commonly result in a “good faith” negotiation between the parties where the seller receives a “fair” value for their business and the buyer purchases the business at an appropriate value for its industry and the associated risk of the investment.

80 – 90% of the companies sold by IBA annually involve sellers with one of these two motivations for sale. However, it is also common for IBA to represent quality businesses for sale where the motivation or dynamics of the sale create an environment where the buyer either based on the pricing of the business or through negotiations has the ability to acquire a company as a value proposition.

The following are nine situations experienced at IBA in completed transactions where buyers were able to acquire a company at a value price:

1. Death or Sickness – No greater motivation to sell a business exists than when an owner dies or is in a health situation where they cannot manage the company and make strategic management decisions. The urgency of the situation is enhanced when no appropriate executive management talent is available to fill the shoes temporarily “in house”. “Time is of the Essence” in these situations as replacement of the labor contribution & leadership of ownership is needed or business operations, customer & staff retention, etc. will likely be impacted for the company moving forward. It is recommended for buyers negotiating in this environment to show empathy to parties facilitating the sale on behalf of the estate or family and to listen for & respond to information related to motivations for sale. It is common for continued employment for staff and transitioning the legacy of the owner’s life work into the proper hands to be as or more important than value received for the company in sales with these underlying motivations.

2. Bankruptcy or Financial Difficulty – Buying a company out of bankruptcy or financial difficulty is not recommended for the first-time entrepreneur. A company “on the rocks” or “headed for the rocks” may not be able to be saved. It is strongly recommended that a business buyer evaluating a business in this situation conduct a comprehensive due diligence, so they are taking action from a position of knowledge prior to completing the acquisition. The above said, many business situations exist where a transition of ownership and discharging of debt will allow a business to set sail under new ownership for open waters and gain positive momentum. One example of this from the recent recession is the situation where a company manufacturers products in “good faith” for a customer incurring labor, material, and overhead costs while simultaneously providing favorable purchase terms including the ability to pay invoices months after delivery. But, what happens to the manufacturer if the company they are selling products to goes bankrupt and does not have the ability to pay their invoices. If a line of credit was employed by the manufacturer to assist with cash flow management between production & payment, the debt needs to be repaid regardless of whether payment is received from their customer. Accumulation of debt that cannot be paid in the normal course of business can create a descending whirlpool where the only exit option other than bankruptcy or liquidation is a sale of the business to remove the anchor weight of debt from the company’s balance sheet. A company purchased in this environment traditionally creates opportunities for business buyers to acquire companies at value prices, although at enhanced risk versus a financially stable company.

3. Divorce or Partnership Breakup – The least popular transaction to facilitate at IBA is one where a sale is motivated by divorce or partnership breakup. In these transactions, negotiations are commonly enhanced in their complexity due to a lack of trust between the selling parties, divergent goals of selling parties, and/or the inclusion of additional professionals in the transaction (e.g., both the husband & wife having their own business attorneys negotiating legal verbiage with the buyer’s counsel). The above said, if a buyer has the patience and willingness to negotiate a business purchase in this environment, value propositions are often achieved.

4. Lease – In a retail context, a common motivation behind the timing of a business sale is a desire to not incur future liability associated with signing a new lease. Signature strength is the most important qualification attribute for landlords when establishing or negotiating leases with tenants. It is common for landlords to retain the signature power of the tenant assigning the lease (selling the business), for this reason it is often prudent for sellers to time business sales with the short horizon expiration of a lease forcing the creation of a new lease between the business buyer and landlord without the seller as a signatory. The risk with this strategy is that the space could be marketed for lease by the landlord, essentially reducing the business to a liquidation value if an alternative tenant is located, or the seller could be forced to carry on month to month at an enhanced rent rate, or sign a new lease if a buyer is not located prior to the lease expiration. The closer a lease is to its finish and the higher the motivation of the seller not to sign another lease, the greater the leverage for a business buyer in negotiations and the better the price achievable in acquisition.

5. Employees – There is no slavery in America. Employees cannot be sold with a business. This creates a unique dynamic for entrepreneurs selling a business because in most cases the sale of a business will be contingent on the retention of key employees. If key employees cannot be retained, it is reasonable for the business to be sold at a discount. An opportunity to purchase a business at a value price may exist if key employee turnover is anticipated following completion of the transaction. Reasons for employee turnover can include retirement, migration to a different employer, or family members leaving the company. Loss of key employees can impact a company negatively. However, it can also create opportunities to replace employees with higher skilled and/or lower paid individuals. The purchase of a business is an excellent time to evaluate staff. A skilled buyer may have ability to achieve a discount in negotiations due to staff loss even when they perceive it is in the “best interest” to have turnover in that position.

6. Technology – It is common for IBA to facilitate business sales for “Baby Boomers” who are retiring. The value achieved in these negotiations are traditionally “fair market”. However, a value proposition frequently exists in these situations if the buyer has the ability to introduce modern technology into the operations resulting in increased revenues, productivity, and profits. Examples of this occurring include the introduction of inventory management or POS (Point of Sale) systems for management of the business decreasing labor and/or waste or redundant purchases or creation of a 2017 technology website that provides a more user friendly experience.

7. Sales – A second value proposition opportunity created from enhancing business operations can occur related to sales. It is common for retiring owners to have marketing & sales methodologies that are dated or the “way they have always been done”. A buyer who recognizes these exist at a company can introduce online, channel, and direct sales & marketing techniques that can be used to build revenues & profits on top of an established market reputation for providing quality products at a fair price to a loyal customer base.

8. Capital Constraints – Throughout the life span of a business capital will need to be injected into a business to replace equipment and grow the company. It is difficult to spend capital with an eye to the future when a short horizon of ownership exists. Value propositions exist in the marketplace where a business will sell at a discount because the present owner is unwilling to spend money in the “best interest” of the company. A buyer who recognizes this fact can often purchase a good business at a discount reflective of this situation making the needed investment after the purchase is completed with a long horizon view of the investment.

9. Geographic Location – Businesses sell at a premium and discount based on their location. Traditionally businesses located in metropolitan areas sell at better prices and quicker than businesses in rural environments due to the principles of supply & demand generated by a larger versus a smaller group of potential buyers. The same is true in metropolitan areas based on public perception of the area and buyers’ desire to work & potentially live close to their business. Value propositions often exist for buyers who are willing to purchase businesses in less desirable areas or neighborhoods. These value propositions can be significant. I recall an EXTREMELY PROFITABLE veterinary hospital located in a “bad” neighborhood with a large clientele of Pit Bull Terriers, Doberman Pinchers, and German Shepherds that sold at a value price because finding a veterinarian interested in owning the practice was problematic.

Valuation of a business is subjective science. The actual value of a business is what a “willing buyer” will pay and a “willing seller” will accept. Value propositions exist in the marketplace for business buyers if they know what to look for and have the ability to negotiate effectively. It is IBA’s objective to sell every business we are engaged to sell as a professional representative. It is our opinion that we have successfully completed our assignment if our client signs the purchase & sale agreement and receives the amount of money outlined in the agreement. It is not our place to comment on whether at the same time the buyer walks away from the table feeling they got a “fair” deal or purchased the business as value proposition.

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, and mergers & acquisitions community 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”.