Last year I was engaged to sell a profitable Kentucky-based business. The owner was ready to retire but was 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 discovered three reasons it might have been okay to knowingly overpay for a business.

#1 There is strong cash flow that meets the buyer’s financial needs. Don’t be “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. I would rather overpay for a business I know I can count on, versus getting 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. By simply increasing the quality of sales machinery, I increased 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 the prospective buyer of my Kentucky-based client. I understand the buyer-wannabe 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. But I can’t escape the belief that he made a mistake trying to find that “good deal” which can often come disguised as an over-priced business.

{This blog was originally published in April 2017, but boy howdy, is it still applicable today!}

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Tennessee Valley Group

Jim is an attorney (non-resident status with the Missouri Bar) and though he no longer practices law, he has read and negotiated enough legal documents to fill a cargo tanker. He has an MBA from Harvard Business School and knows how Wall Street and private equity operates. Jim is a Tennessee Supreme Court Rule 31 listed general civil mediator with tons of experience helping business owners (large and small) work through sensitive problems to achieve winning results. He is the author of "Home Run, A Pro's Guide to Selling Your Business, Seven Principles to Make Your Company Irresistible."

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