Business Owners Resource Network

March 11, 2009

How Does A Buyer Decide What Business To Buy? What Business Owners Need to Know….Part One

Filed under: Business Brokers,Business Valuations — alieser @ 9:29 pm

As a part of my daily business brokering activities, I routinely talk to business owners who are considering selling their businesses.  I’ve detected a common misperception among these folks regarding the purchasing habits of business buyers.  “Just let me know when you have a buyer who is looking for a business in my industry,” they frequently comment.  Or, “I have a beautiful location.  Once a buyer sees it, it will sell itself.”  What they do not realize is that, unless the buyer already owns a business in a particular industry and is looking to expand through acquisition, buyers typically come to me not really knowing what kind of business they want to buy.  And, while the appearance of the premises does help to sell a business, I have yet to have a buyer make a buying decision only because the place looks good.  So what makes a buyer choose one business over another?  First and foremost, it’s all about the numbers.

 

As a buyer begins to investigate whether a business would be a good acquisition candidate for him, the critical question on his mind is, “If I buy this business, how much money can I make?”  Because no buyer has a crystal ball to know the future profits of a business, the financial history of the business is the key indicator of what a buyer can anticipate for future earnings.  And though the actual cash flow numbers are important, it is nearly equally as important to a buyer that the documentation supporting these numbers is reliable and easy to decipher.  Also, because savvy buyers understand the power of leveraging their money, a very large percentage of the transactions that we broker involve some sort of financing.  Therefore, three years of accurate historical financial data is also absolutely critical for a buyer to obtain bank financing. 

 

So, as a business owner, how should this knowledge affect your day to day operations?  Many business owners proudly explain to me that they have received the benefit of tax free revenues for several years by merely underreporting their revenues (or over-reporting expenses by including excessive personal expenses) on their tax returns.  As a business broker whose goal is to maximize the transaction value for my seller clients, I fail to understand their pride.  Business value and the amount that a bank will finance are based upon some multiple of the seller’s discretionary earnings as substantiated by tax returns.  Not reporting some earnings to Uncle Sam may save a business owner the tax burden of around 30% on those revenues.  The end result, however, may be a reduction in the value of the business of 100% to 300% or more of those revenues.  In addition, when a seller explains to a potential buyer that there are unreported revenues, buyers and bankers suddenly look at the business and its owner with a suspicious eye, wondering what other unexposed skeletons remain in the closet.  All financial information suddenly becomes suspect.  Frankly, my experience is that the buyer pool for a business with unreported revenues is reduced to a small fraction of what it could have been if the tax returns told “the whole story”, and lenders will only lend based on the cash flow shown on the tax return, no exceptions. 

 

So, if you are considering selling your business within the next three years and want to maximize the value of your business, the numbers of buyers who will consider purchasing it, and the opportunities for the buyer to find financing, the first step is to ensure that your tax returns give an accurate portrayal of the financial performance of your business.

 

Stay tuned for additional tidbits on increasing the future value of your business.  Or plan to attend the Business Owners’ Resource Network presentation, Not Just Surviving, But Thriving, on May 25 when one of my fellow business brokers, Joe Warner, will present information on this subject.  I welcome questions and comments.

 

Anita Lieser, Senior Business Broker

913-433-2306

Sunbelt Business Advisors

7101 College Blvd. Suite 1650   Overland Park, KS  66210

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