Gary Benson says most buyers of businesses pay too much, because they don't accurately determine how much a business is worth. In general, a company's value is determined by the value of its assets (preferably book value or lower), plus some multiple of earnings (usually not more than three) or net income. All kinds of individual considerations can enter the picture here, but this rule of thumb isn't normally exceeded. Get a professional, independent valuation of any business you become serious about before buying.
Next, give serious attention to the terms of the sale, which many buyers consider even more important than the price. If you're being pushed to pay a handsome sum for the business, try to win concessions in the size of the down payment, the interest rate on any loans, the amortization schedule and the extent to which the seller is willing to assist in financing.
Mistakes Not to Make:
Buying a business should be fun, but even more so than when starting your own business it's practically consumed with activities designed to protect yourself from the unfortunate and unforeseen. In Breakaway Careers (Hawthorne, NJ: Career Press, 1994), Bill Radin offers five places to look for "surprises" in a business you're considering:
- Physical damage or deterioration. Check the building, equipment, furniture and fixtures of the business for hidden (or even obvious) signs of wear or obsolescence.
- Worthless inventory. Make sure that what you're buying is worth what you're paying. The goods in the warehouse could be the ones that were on the shelves for years and never moved. Along the same line, customer lists may bring little value to new owners, depending on their quality which may be very difficult to verify and the nature of the business.
- Ailing customer or supplier relationships. Before you buy a business, make sure a measure of good will already exists between the business and those who'll be critical to its success, ranging from bankers to vendors.
- "Pending" sales or business growth. Listen carefully for wishful thinking. You can't take "if only," "hopefully" or "any day now" to the bank. If possible, be sure to follow up by contacting several potential customers directly.
- Suspicious motives. Exactly why is the owner trying to unload the business? Is he or she sick, retiring or sick and tired of beating a dead horse? If necessary, use your private eye skills to ferret out critical information.
Wouldn't you think someone with enough megs of RAM to be a programmer at Microsoft Corp. could go into business for him self without crashing on business basics, such as those described above?
Robert Kjelgaard (pronounced KELL gard) of Lynnwood, Washington who'd burned out repairing software code for Windows NT provides a wonderful example of all the dumb things an intelligent, if naive, person can do (even after spending several months reading about how to become an entrepreneur!).
Briefly, as Kjelgaard told The Wall Street Journal, he used the proceeds from the sale of his stock options at Microsoft to buy a laundry: 75 washers and dryers and a small dry cleaning operation. It seemed like a simple business he could enter for under $100,000, hire someone to manage (his brother in law had just lost his job and could do this) and, according to the rather disorganized records, turn a nice profit. He put down $30,000 in cash and signed a note for $50,000.
Almost immediately, the laundry became a heavier load than Kjelgaard had imagined. The brother in law didn't work out, so Kjelgaard began spending quite a bit of time there. As a result, he was spending much less time with his wife Penny and their 3 year old daughter. Everyone was tense and Kjelgaard was exhausted. Then, abruptly and impulsively, Kjelgaard quit Microsoft (foregoing significant additional stock options) to take over the laundry full time.
Only then did he begin to see the laundry's real problems: cash flow wasn't what the previous owner had indicated; there were far too many small machines and not enough big ones; and a careful reading of the six year lease that came with the laundry revealed that Kjelgaard's building maintenance responsibilities beyond the $3300 a month rent made his space much too expensive for what the business could bear. In a rash move to make ends meet, he raised dry cleaning prices dramatically... and virtually killed that part of the business.
The bottom line: Less than a year after buying the laundry, Kjelgaard was losing $4000 a month. He put it up for sale, returned to Microsoft in a much lower paying position, hired a manager for the laundry and directed some of his paycheck to ward keeping the laundry afloat. Losses were narrowed to $2000 a month, but no one's snapped up the chance to buy the laundry, and the lease will last several more years.
Kjelgaard's experiences are like a Harvard Business School case study on what not to do when buying a business. Let's examine his story for lessons:
Transferring your skills: Kjelgaard's steady history of success at Microsoft lulled him into thinking he could succeed at something as apparently straightforward as owning a laundry. The lack of connection is almost laughable, yet it's frighteningly possible to imagine someone making such an assumption. In fact, beneath the obvious differences there is a certain similarity: Kjelgaard enjoys tinkering, whether it's with computers or coin changing machines. But the lesson here is: A single transferable skill isn't enough. What makes you a winner in one environment doesn't guarantee success in another.
Know the business: You may not need experience in every part of your prospective company's activities, but you should at least have an appreciation for what's required. Owning a laundry looked like a no brainer to Kjelgaard. Very few things are. More knowledge of what's important in owning a laundry could have helped Kjelgaard at the outset if, after learning this, he still wanted to get into it at all.
Researching the market: Kjelgaard bought the very first laundry he looked at. If only he'd looked around for comparable opportunities! This is so basic, not only for the purpose of buying the business, but forever after in keeping tabs on your competition. When else do you have this kind of opportunity to ask your competitors about their activities? Preparing to buy a business is one of life's greatest moments for leveraging your position into valuable market knowledge. Don't squander it! Learn everything you can under the umbrella of looking for an opportunity to make an investment. Be Peter Falk as Columbo: "Oh... I was just wondering... what kind of net profit does someone make in this business?" You'll be surprised.
Remember that market research can include the following: What are the pros and cons of buying this business versus starting my own? Why, really, is the seller selling? How useful will that equipment really be? What do this business's customers and suppliers think of it? Do not overlook this last point: Interview, in depth, every employee and supplier possible.
Getting the facts: Kjelgaard let the previous owner get away with vague or downright misleading information about the laundry's performance up until the time of purchase. The owner also described weaknesses in a way that made Kjelgaard feel he could easily overcome them. You simply must have reliable financial information about the business you're buying. If you're not skilled in this area and in most cases, even if you already are get professional help here. It's well worth the investment.
Similarly, he overlooked the inappropriateness of the equipment he was buying. Only an experienced laundry owner, or an especially inquisitive buyer, would have known before the purchase that the laundry lacked enough big machines and had too many small ones. These facts beyond the financials themselves escaped him.
