“I’ll gladly pay you Tuesday for a hamburger today.” If you are 60 or older, you probably recognize that comment frequently spoken by J. Wellington Wimpy. This character from the Popeye cartoon series seemed to be a successful businessman (after all, he wore a suit and tie). But curiously, Wimpy never had money in his pocket to buy his favorite lunch. He seemed to always be saying “you can trust me, I’ll have it in the future.”
I call this the “Wimpy effect,” and I frequently see it in my work as a business broker. It goes something like this: an owner contacts me about selling their business. To understand the business’ value, I review its product/service offerings, financial performance, organizational structure, and prognosis for the future. When we get to that future part, I notice most owners are very optimistic. It’s fascinating how the future always seems to be much brighter and more profitable than the past. It’s as though the owner is saying “come Tuesday, things will be much better.”
Business owners are genetically wired to be optimists, but when it comes time to sell a business, many owners suddenly become wildly optimistic about the future. They describe what the business can be if it just had more marketing, another salesperson or two, or this or that. Never mind what has been, look at what can be. Hence the Wimpy effect, “I’ll gladly pay you Tuesday …”
Of course, buying a business is all about how a buyer sees the future. Future cash flows are what a buyer is buying, so forecasting the future is the essence of a business valuation. However, that future forecast must be rooted in some kind of reality, and that reality is usually the past. Buyers are also an optimistic lot, and when they will look at a business opportunity they will, by definition, see ways they can improve it. But a business owner must understand a buyer will not value the business based on what they, the buyer, can make it. A buyer will value the business on its current performance.
Bart (not his real name) owns a company that distributes residential garden equipment. For the past few years, the company’s annual revenue has been about $8 million with profit around $1,500,000 per year. I recently told him his business would likely sell for $6.0 million to $7.5 million. He responded saying he thinks his business is worth $10 million because of its growth potential. He proceeded to tell me all a buyer needs to do is add a new product line, hire a sales team to cover the upper Midwest, and install state-of-the-art inventory tracking software in the warehouse. If the buyer would do those things, Bart says his company could double revenue and easily be worth $5 million. And you know what? He’s probably right!! Those are all logical and likely necessary improvements in the business. However, those improvement initiatives are investments (i.e., risks) in the future the buyer will make to grow the business. Unless Bart is willing to stay involved and have an equity (i.e., risk/reward) role in that growth, a buyer will not reward Bart today for what the business might become in the future.
The “Wimpy effect” is when a business owner implies “I might not have it today, but it’ll sure be great tomorrow.” When I encounter this, I don’t assume the owner is up to shenanigans to connive me or the potential buyer for a free hamburger. It’s just a seller’s nature to be overly optimistic. Here’s the essence of business valuation — an optimistic future is why a buyer buys, but it’s not how the buyer values the business. The business today is what is being bought. Today is what matters, not what you promise for Tuesday.
Tennessee Valley Group
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