The Process of Buying a Business Is Not an Exact Procedure

Outside of the hard assets and financial statements, almost the entire process of buying a business comes down to intangible issues. I do not mean things like goodwill. Rather, a business sale transaction involves personalities, and so all of the main stakeholders -buyers, sellers and brokers, have to understand that there are many more ambiguous issues than cut and dry ones.

This was so evident to me this week because amongst all my emails there was one from a buyer, a business broker and a seller, all asking my opinion about the same particular business and situation that had arisen.

Here’s the situation: There is a business for sale where the current owner has only had it for three years. The business has not done well – it has not made any profit since he has owned it. However, the seller feels that since he has been making substantial investments to the infrastructure, upgrading assets, and repositioning the company, all of these improvements will benefit the next owner and therefore it warrants a “substantial” premium in the valuation.

The business broker refuses to provide the buyer with any past financials, and will only allow prospects to look at future projections. The broker stands by the asking price and said in his email to me that “anybody can hit the numbers because the business is a goldmine” – to me, that is definitely not the right description for a business that has not made any money in three years.

The buyer has the funds to complete the deal and some prior experience in this type of business. They have told the broker that the projections are simply not realistic based upon their experience. However, they did say that he is open-minded to the projections but needs to review the prior year’s figures to see where the business is now, and refuses to meet the seller until he analyzes them.

Now for a dose of reality: While the business may possibly turn around, it is completely ridiculous for any seller to expect to get a top price for an unproven business. Further, the seller cannot expect to get the entire benefit from the next owner’s effort and skill.

My main question to the seller and broker was: If the business is “going” to be so wonderful, why not first make it so, and then sell it when you can rely on actual numbers and get the right deal? Interestingly enough, both parties told me that the seller is not a great manager (no kidding), but it is primed for someone to take it “to the next level” - I just hate that expression by the way.

What is incredibly bizarre about this particular case is that the buyer and seller have never spoken directly. The broker has recommended it, but the parties won’t listen.

The buyer says he wants past figures. The seller says he wants any buyer to agree in advance to pay a price based upon the projections. The broker is tearing his hair out.

I just love this business!

My take - they’re all right; and all wrong. There are several lessons here for the parties

For the broker: While it almost always makes sense to get buyers and sellers talking, it is incumbent upon you to instill realistic expectations into your seller. Further, suggesting a business that hasn’t made any profit in three years is a “goldmine” is completely reckless.  Although buyers will purchase based upon their belief in the future, the only way they can guess what the future holds is using the past as their basis.

To the seller: You have to realize that small business buyers are looking to generate cash flow. That is why they buy existing businesses. If you cannot prove that opportunity to them based upon the prior history of the business, then you have to adjust your thinking and deal expectations. If not, the chances of your business selling are very slim. This business clearly brings up a performance-based deal scenario similar to what you can expect if you want to price your business based upon a large future pending contract. Click here to read a great article that discusses how to factor a seller’s future promises into a deal.

Finally, to the buyer: While having access to past financials is critical, it is not always a requisite to have these before you have a meaningful discussion with the seller. You may discover after a call/meeting that you have absolutely no interest in pursuing the business so why get yourself crazy? Or, you may find that the seller has some valid points and a further dialogue may make sense. Instead of winding yourself up about protocol, take the time to learn about the business. The financial details will come, but first get an overview of the company from the seller. Besides, at the very least, you’re going to learn something.

My final word to any business buyer...

There are no rules cast in stone about how the business-buying process must be staged. While it would be great if all the parties followed an exact process, it just isn’t reality. If you want to be in your own business, you must understand that things do not always operate “like they are supposed to” or that everything is black and white. Get used to the gray areas, or you are going to be in for a huge surprise.

Comments

[Leon Parker]

Richard:
You were too kind to the alleged "business Broker" in this case. The broker is a time waster, and does not sound competent. If the broker can not get the Seller educated about how to present and sell the business he should not be wasting his time and the customers time on it.

[Rick]

I appreciate your thoughts. I have been looking for a business for several months. Your thoughts always seem to hit on key areas that concern me, and give me hope that the "right" business for me is out there. Keep up the great work!

[Sunil Z. Verma]

Quite typical for a broker to get caught up in 'projections' to secure the listing.
The broker should, during the listing process, make the seller understand that buyers mainly value a business on past and current performance and return on investment. Any potential that is materialized is the reward for the hard work of the business owner.
I love the look on a sellers face expecting $500k for his business when I tell him, the business is realistically worth only half of that, and for breaking that news to him, he will pay me out of the 250k when I sell the business.
Either he will throw me out, or sit down and discuss what steps he can take to make the business worthy of his asking price.

[Joseph Warner]

Richard, I agree with your points, but would go further in final word to any buyer: if you're uncomfortable with gray - if you have trouble making decisions (especially without irrevocable consequences), then you SHOULD NOT buy a business. Your personality is not a match for the life of a business owner. As a small business owner and broker for past dozen years, I agree this is a prime suspect for an earn-out; but it is the broker's job to get the seller to reality. I use the "see it from a buyer's (and lender's) perspective" method. But you're right that buyers must have perspective also. What if a meeting with the seller convinces the buyer that the only real problem with the business is the seller (haven't you seen this more than once?)...and the buyer knows how to remedy this and increase profitability ten fold. If he refuses to meet, she may never know. Learn about the business first...then financials can be a part of "Due Diligence". Any business may be a goldmine for the right miner.

[Ron Johnson, CBI, M&AMI]

Richard,

Great article (The Process of Buying a Business is not an Exact Procedure)! Keep up the good work.

Regards,

Ron Johnson
Past Chairman, IBBA
Past President, CABB

[Jon J. Dyer]

Hi Richard!
Great article and situation.

Frankly, I am suprised that the broker reached an agreement to engage him/herself to sell a business in which the "seller says he wants any buyer to agree in advance to pay a price based upon the projections." It is hard enough to generate an Letter of Intent, or even a more dilute Letter of Interest, or Term Sheet, prior to an initial meeting when the buyer has already reviewed the actual, historical financial records (it seems to work to some degree on large transactions, but gets you no where on smaller ones).

As a broker, we should educate the Seller that should they require an offer prior to an initial meeting (especially on smaller transactions) that such an offer is non-binding and therefore relatively meaningless. On a smaller transaction, as this sounds like, I would tell the seller that I would not take the engagement based on the requirement to present an acceptable offer prior to an initial meeting. Based on this hair pulling experience, I bet this broker doesn't do this again!

[Richard Parker]

FROM RICHARD: Great comments everyone - thank you! I always appreciate your input, whether good or bad, but it really is nice to get such warm notes from time to time. I certainly sense an agreement about making sure brokers take good listings and educate their sellers before a business hits the market. John makes a good point about decision-making. My good friend Andy Cagnetta of Transworld Business Brokers likes to tell buyers (and without boasting) that he makes hundreds of decisions each day, just like every other business owner, so if you can't make them, or do not believe it is in your persona to do so, a job may be a better bet. Sunil - you bring up a great concept - the sellers and brokers who have the acumen and patience to take a step back, improve the business, address the obvious buyer issues, and then put it on the market are clearly implementing the right strategy.

Thanks again everyone.

See you in next week's newsletter.

Richard

[Jeff]

Warning:

Do not use a Seller’s Pro Forma as toilet paper as it is an insult to your posterior!

[Kenneth Young]

The Business Broker is in error to take on this listing without the Seller willing to provide all the past financial information. P&L, Tax Returns, Seller's investments/upgrades to the business all should have been part of the listing agreement, all Buyers ask to see this documentation. FF&E has no value in selling a business, for without it, there would be no business to sell. Agreed that FF&E has liquidation value and replacement value for insurance purposes, but that is it. Future potential has no value, it is only in the mind of the beholder. Agree with the comment that the Broker should have sat down with the Seller and helped him realized that when the business becomes profitable, then is the time to sell. We look at Business Brokering as teaching, informing, consulting, then listing and selling businesses.
This Seller needs to hire someone that can bring the business to the next step to make it profitable.
The Broker needs to walk away from selling this one for the time being.
The Buyer needs to look for another business of this type or start a business of this kind from bottom up.

[business for sale]

Richard - this is a real circus! This is definitely a case of an inexperienced broker and a delusional seller. If this type of deal was presented to my company, we would never have taken the client or the sale on. Owner's hoping to sell their business based on blue sky are really in a state of denial! A broker that pitches from this point of view needs to go back to brokers school.
The buyer should already have moved on - there are far too many solid business opportunities to consider with good cash flow, established historical trends, and strong fundamentals, than wasting time in this mind game triangle!
David Fairley
Founder, Websiteproperties.com

[Edwin]

Yes, I'm agree. We must prepare our self for negotiation. Thanks for your post. Your article very useful for me. Great...