Last year I was engaged to sell a profitable Kentucky-based business. The ownership was ready to retire, but were fully committed to helping the buyer make a smooth transition. The 50-year-old business had a positive reputation in the community, a loyal customer base, and a great location.
I located a prospective buyer through a referral from a banker, and once I showed this prospect my client’s business, he was soon engaged in a deep-dive evaluation process. His banker told him they would fund 60% of the acquisition, meaning he would need 40% equity, which he had available. He was tired of the travel in his corporate job, but he made a nice salary so he had rather high expectations as to what he’d need from a business acquisition, which this deal met quite nicely. In other words, the business had sufficient cash flow to fund the bank note, pay his salary expectation, and give him a reasonable return on his equity investment. What’s not to like, right?
Problem was, the business was overpriced by about $500,000, and the prospective buyer and his advisers couldn’t escape the belief they were paying too much. So, the deal fell apart.
As I reflect on what happened, I’ve realize that there are three reasons it might be okay to intentionally overpay for a business.
#1 The cash flow is strong and meets the buyer’s financial needs. It’s the essence of “penny wise, pound foolish” when a business meets all your expectations, especially if you plan to own the business for a long time
#2 There is a sustainable record of cash flow stability. Personally, I would rather overpay for a business I know I can count on, as opposed to get a “good deal” on a business that has unstable cash flow.
#3 There is immediate low-hanging fruit opportunity to grow the business. I bought a business about 15 years ago that had tremendous upside because it had an ineffective sales effort. By simply increasing the quality of sales machinery, I increased the revenue fivefold in one year. Yes, I overpaid for the business relative to its performance at the time I acquired it, but I was quickly able to make the business perform well beyond its level when I acquired it. I’m not saying you should value a business based on its potential (that can be dangerous), but the same time, don’t ignore potential when it comes to seeing a good deal.
So back to the story of my Kentucky-based client and the prospective buyer. I understand he is now looking at a “good deal” that will require a relocation. I hope it works out for him, he’s a great guy and will do well at whatever he decides. I just think in this situation he made a mistake trying to find that “good deal” which can come disguised as an over-priced business.
Tennessee Valley Group
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