Selling a Business That’s Losing Money: Pt 1
4 September 2023: Selling a Business That’s Losing Money: Pt 1
Can you sell a business if it’s losing money?
We get that question more often than you might think. And the answer is a guarded “maybe”.
If a business is losing money, one has to ask, what are you actually selling? And how much is whatever you’re selling worth at the time you’re selling it?
For the moment, let’s forget about strategic buyers – those that want something other than the business’ profitability – and look at this dilemma with the proverbial jaundiced eye.
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What Buyers Look For
Most business buyers want to know the answer to the question, “How much will this business put in my pocket at the end of a year?” Once they have that answer, the next question is, “How much am I willing to pay for that?” If the business is losing money, the answer to the first question is a negative and the answer to the send is, “not much”; at least on its face.
Again, strategic buyers aside, a business has to do three things for its owners.
- It has to pay the owners (or the managers hired to run the business) market level salaries. If the business manufactures widgets, what’s the salary range other widget manufactures are paying? (Do an internet search.)
- It has to provide a return on the buyer’s cash invested. If the business is acquired for $1 million, the buyer will likely have between $200,000 and $300,000 cash invested. At the moment this post is being written, that cash could be earning 4.75%-5% in a money market account (according to Bankrate.com) and at a hell of a lot less risk.
- It has to pay for itself. That is, the business’ cash flow much be able to pay off the $700,000 or $800,000 the buyer borrowed for the acquisition.
A business that’s losing money would, by definition, not be able to do any of that. So, what is the argument that the business you’re selling – one that is losing money – is worth buying; That it’s worth someone else’s money?
What Am I Selling – and Why?
Is there a market for the product or service provided by the business? If so, this suggests operational inefficiencies: excessive expenses, ineffective allocation of resources, bloated payrolls, etc.; in short, poor management, something that can be corrected.
But if the business is selling a product such as buggy whips or a service such as cleaning the streets of unsightly equine deposits, you might be hard-pressed to find a buyer with an imagination so broad as to see some future potential.
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Operational inefficiencies can often be overcome. New energy, new eyes on the business, new technologies that haven’t been adopted may all give a buyer the sense that an opportunity exists.
The existing owner may even have some ideas as to how to turn the ship around, which gets to the point of why he or she is selling, a question that is very likely to come up in the early discussions with any buyer. And the reasons vary.
Are you ready to retire? Has running a business gradually ground you down and you just want out? This is not unusual at all.
It’s also possible that your 97 year old Aunt Tilda laid her Harley down in front of a semi on US 80 on the way to bike week in Sturgis and left you the 100 shares she originally bought at $22/per at Apple’s IPO – which, after stock splits are now 5,600 share worth something north of $1 million. Who wants to go to work?
What’s Your Business Worth?
This is the most interesting question; what is a business that’s losing money actually worth?
Again, leaving strategic buyers aside for the moment, businesses are generally valued on the amount of capital they spin off to the owners; the answer to the question, “What will this business put in my pocket at the end of the year?”
This month’s Live Stream on The Brokers Roundtable℠, the online community for business brokers, business owners, Realtors, lenders, appraisers and others in the business-for-sale industry, will feature an interview and live Q&A with Dave Moore, of Acclivity Financial, a subsidiary of Citizens Bank and a Small Business Administration (SBA) “Preferred Lender”. Dave and I will be discussing the recent changes to the SBA program, what business buyers should know when preparing for acquisition financing and what business owners should do to prepare their business to qualify.
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If there’s nothing being put in the owner’s pocket – if fact, if the owner has to come OUT of pocket just to keep the business alive – there wouldn’t seem to any value based on that criterion.
But businesses have value from other “assets”.
First, there may be some tangible assets such as machinery, equipment and vehicles. All of these assets have value and that value can be established by enlisting the help of an experienced business equipment appraiser such as Roland Davis at Davis Business Appraisers, a Founding Member of The Broker’s Roundtable℠.
Second, the business may own intangible assets that can be used to breath new life into its operations. Such assets might include license or franchise rights, a list of clients or customers that have been ignored or some underutilized equipment that the current market now makes useful.
But valuing all this is difficult; little more than an exercise in predicting the future. What we mean by that is the buyer will first have try to estimate what it will cost to stop the bleeding and how long that will take (opportunity cost). Next, the buyer will have to estimate what profit the business is likely to generate – “How much money will this business put in my pocket?” – once all the changes have been made. Once all that is calculated, the buyer will add a risk premium and determine a value.
But we have to remember that the value the buyer arrives at is future value, not current value. That means that the seller, to realize the highest possible value, will likely have to wait a while to receive it.
The way this could would work is through financing.
First, the seller would agree to finance the sale of the business under terms that allowed the buyer to inject their existing capital into the business to facilitate the necessary changes. Total acquisition costs and payment terms might be flexible and dependent upon the performance of the business.
The deal might also be structured as an earn-out whereby the seller stays on and the price of the business and the seller’s payout depends, again, on the business’ performance under the buyer’s leadership (and invested capital).
The Bottom Line
There are so many variables in the situation where a business that’s losing money is being sold that only the most general of considerations can be touched on in a single blog post. But suffice it to say that, though a business that’s losing money can, conceivably, be sold, the effort to do so ain’t for sissies.
But in some instances, selling a business that’s losing money is not as hard as one would believe. The conditions for such successes usually exist when strategic buyers are on the scene and that’s what next week’s post will discuss.
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at
jo*@Wo*******************.com
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If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
Joe
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 600 in the world. He can be reached at
jo*@Wo*******************.com