Well, does it? Is it even worth a cursory glance from a serious buyer? Let’s see…
One of the aspects that business sellers often fail to consider when they begin thinking about selling their business is the Three Basic Requirements trilogy that a buyer must be satisfied with before considering any business acquisition. The following three requirements, taken together, are critical considerations because they comprise the basic requirements of a buyer:
- The business must generate enough profit to pay the buyers (or their hired managers) reasonable salaries with which they can support their families.
- The business must generate enough profit to pay for itself.
- The business must generate enough profit to provide a return on the buyer’s investment.
Let’s consider each of these points individually.
Adequate salaries. The business must generate enough profit to pay adequate or industry standard salaries to the owners. A serious buyer will know what he or she wants to make from their investment of time in running a business but will also have an idea as to what similar businesses provide for their owners. If the buyers will be absentee owners, the business must generate enough profit to pay competitive salaries to the managers hired to run the business. Let’s use as an example a business being sold for $1 million, which we assume is its correct value. If our research tells is that we would have to pay $150,000 for someone to operate or manager this business, a buyer that intended to operate the business would want at least that much compensation. A buyer that planned to hire someone to manage the business would factor in that amount into their calculations.
The business must be able to pay for itself. Further to our example, we’ll use our assumption that the business in question has a value of $1 million dollars and that the seller and buyer have agreed to that figure. Let’s also assume that the buyer will finance a portion of the $1 million purchase price using conventional bank financing. The bank will require that the buyer have at least 20% of his or her own cash – $200,000 – in the deal. The bank will loan the remaining $800,000. As I write this (early Spring 2017), commercial loans can be had by qualified borrowers at about 6% interest for terms of between 10 and 15 years. A self-amortizing $800,000 loan at 6% interest with a 10-year term requires principle and interest payments of $106,580 per year. in addition to the amount needed to compensate the owner or a hired manager to operate the business, the cash flow from the business must service this debt.
The business must provide a return on the buyer’s investment. In our example, the buyer put $200,000 of its own cash in the deal. That is money he or she could invest in many other investment opportunities from the stock market, precious metals and real estate to CDs and government bonds. Each of these other investment opportunities provide a return of some kind, generally commensurate with risk. The buyer’s $200,000 investment to buy your business must provide a similar return. If we use a modest 5% return in our example, each year, above and beyond the compensation for running the business and the capital to cover the note payments, the business must generate an additional $10,000 as a return on the buyer’s investment.
The bottom line here is that this business, to even be considered by a serious buyer, must generate at least $266,580 every year from its current revenue stream simply to cover theses three basic requirements. Assuming the buyer wants more than the basics – a not unreasonable assumption – and assuming that the $1 million valuation is justified, the business will likely have to generate more than that – or exhibit the significant potential to generate more than that – to interest a serious buyer.
Granted, there are small businesses and single-unit franchises that do not generate enough profit to meet these basic requirements. Granted, also, that there are buyers out there that are willing – even eager – to simply “buy a job” for the “freedom” and self-satisfaction of being their own boss that they perceive working for themselves would bring. But such buyers are few and far between and the businesses they are drawn to generally are small. That’s a topic for another post, however.
If you are considering selling your business, these basic issues are easy to consider upfront and should be among the first questions you ask yourself. Assuming your business passes this initial scrutiny, it would now be time to contact a broker/specialist to find out what the market suggests your business is worth.
Questions or comments? Send them to me in the comments box, below. I may address them individually or, if the same issues are raised by enough readers, we may address them in one of our future blog posts or podcasts! And don’t forget to check out – and subscribe to – our podcast at WorldwideBusinessPodcast.com on WBBN-fm, the Worldwide Business Brokers Network.
Joe