It looked like it might be a match. I was looking at buying a business, and I started a conversation with a small business owner. By the end of our initial meeting I thought his business might be a fit.
The owner said he wanted $350,000 for the business, and he was willing to share tax returns with me, so I dove in for a basic evaluation.
Here’s what I found:
- The owner and his wife both worked part-time in the business and between them took $30,000 a year out of the business (total owner’s cash-flow) for the work they did.
- The work the owner’s wife did would cost about $20,000 to hire out once I bought the business if I didn’t want to take on her workload as well.
- That left cash-flow of about $10,000 to work with.
- The real estate included with the deal had a value of $150,000.
I took those numbers and plugged them into the reality I would face if I bought the business.
- At full price, if I paid 20% down ($70,000), I would need to finance $280,000.
- Monthly payment on that $280,000 was roughly $28,000 per year given asset allocation.
So, essentially, I would be buying:
- The need to come up with $18,000 of cash each year to service the debt.
- The opportunity to work part-time for free.
Bottom line, this was a loser for me and really any other buyer, even with a dramatic reduction in price. As planned, the owner and I got back together.
“I’m not interested.” I told the owner.
“Why?” he asked sincerely.
I walked him through the points above.
“But there is a lot of opportunity here”, he said.
“All you’d need to do is . . . “, and he described improvements that could be made to increase the value of the business. He continued for some time trying to convince me his business was worth $350,000.
We went back and forth for a while. He didn’t understand why I couldn’t see the value he saw in the business. Not wanting to prolong the conversation on a business I wasn’t going to buy, I finally tried to explain the challenge as bluntly as I could.
“If I buy your business, I’m out $70,000 and all I get is the opportunity to lose $18,000 each year. Can I just burn the $70,000 instead of buying your business? At least then I can keep the $18,000 yearly and not have to work for free.”
Still not convinced, he paused, looked me in the eye and responded:
“But I need at least $350,000 for the business. My wife and I are going to retire in Florida and we need that money to buy a house there.”
I was shocked at the time. I thought, “what do your retirement needs have to do with what I should pay for your business?” I’ve learned since that this perspective on value is regrettably common.
Like many small business sellers, he had forgotten how important a buyer’s basic needs are when determining the value of a business.
Do you know what your business is worth?
Not what you want to get from it when you sell, but what it’s worth to someone else?
Someone who’s going to have to pay the bills after they buy it?
