A few years ago I was retained to sell a profitable business in Kentucky. The owner was ready to retire, but 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. Once I showed this prospect my client’s business, he was soon engaged in a deep-dive evaluation. 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 for what he’d need from a business acquisition. This deal met his parameters. 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. They wanted a “good deal.”
As I reflect on what happened, I’ve learn there are at least three reasons when 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. Don’t fixate on whether the seller is getting a windfall, go for it, 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 22 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 the 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 that prospective buyer 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 should 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.
JIM CUMBEE is President of Tennessee Valley Group, Inc. a retainer-based business brokerage and transition mediation firm in Franklin, TN. Cumbee is an attorney and has an MBA from Harvard Business School. He has a wide range of corporate and entrepreneurial experiences that make him one of the most sought-after business transition advisors in the state of Tennessee. The names and fact patterns above have been changed to preserve the parties’ identities.
Tennessee Valley Group
Latest posts by Tennessee Valley Group (see all)
- Enterprise Value Includes Asset Value - July 25, 2022
