Thursday, October 13, 2011

Owner's Business Under Water

In too many situations, owner's still owe far more than they will receive from the sale of their business. This is not an unusual situation, yet it nonetheless shocks many potential sellers.

I recently analyzed a firm from the west coast with annual sales of about $550,000. Unfortunately, he was making only slightly more than what our formula specifies for a working owner. Thus, there wasn't much left over. What is left over, if any, is called excess earnings. These earnings are typically subjected to a multiplier between 3-5 and the result of that is then added to the total value of all net assets being transferred or sold.

The problem is, however, that you can't sell assets you don't own. You need to pay off all notes and loans to transfer the equipment free and clear.

In this specific situation, even giving the owner the benefit of the doubt in many areas, his business came in with a very modest valuation of $150,000. BUT wait! After the owner takes out all the cash in the business, collects the receivables AND pays off all the short and long-term obligations of the business there is a negative amount of -$(354,000) to be settled up on the balance sheet.

That means even if someone is willing to pay the seller $150-$175,000 for the business he is still going to be "under water" in the sense that he will owe more than he will receive from the sale. Meaning in many cases he will have to loan the company more personal funds as he has done in the past.

How did this ever happen? Well, there are lots of reasons but this owner over invested in equipment and never generated the sales he expected. He wanted his shop to be an all-digital operation and it is, just a very expensive one!

His current equipment could easily produce $1.5 million in sales, but at present and for the past few years it has been doing about 60% less than it should.

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