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Home > Tools and Resources > Ask the Expert > Hypothetical Business for Sale

Hypothetical Business for Sale

By Richard Parker | Diomo Corporation
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Q: Browsing through your ads I see a lot of businesses for sale similar to this hypothetical one: Business for sale, 9 million in sales, 2.3 million cash flow, selling for 5.5 million. This business does not have any hard assets, it is just a business that has been built through the years. Inventory is 150,000 and equipment is 200,000. I understand that there will be non-compete agreements when the deal is closed. My questions are:

  1. What precludes an individual from being a silent partner or a consultant in another business similar to this one?
  2. If a business like this is so good why doesn't this individual allow a family member or friend to run it?
  3. How do you compensate the amount of money invested for the lack of any tangible assets?
  4. How do you structure a business deal so as to avoid being burned by a seller in a case like this?

A: You raise some excellent points; let's address each one individually:

Regarding the non-compete, you asked: "What precludes a seller from then being a silent partner or a consultant in another business similar to this one?" A solid non-compete contract drawn up by your attorney will cover these points precisely and many more. The entire concept behind a non-compete is to ensure that the former seller has no role whatsoever in a competing business after the sale. This includes direct ownership,consultation agreement, employee, investor, or in any other capacity. It should also preclude them from having any continued affiliation in a competing entity that they may have now.

Your second question: "If a business like this is so good why doesn't this individual allow a family member or friend to run it?" There can be a numberof reasons why including: they may not have a competent friend or family member to run it. They may simply want to "cash in their chips" and move on. They may want to get involved in another business. They may be looking to retire. It could be health reasons. I think that a better question would be for you to learn why they are selling altogether and to try to assess their sincerity. Quite often, owners of good businesses have just reached the point where it makes sense for them to sell.

Question number three: "How do you compensate the amount of money invested for the lack of any tangible assets?" This is where the business buying process gets interesting, and confusing to many people. From my perspective, the assets of any business are nothing more than a vehicle to drive revenue. What are they really worth if the business isn't profitable? In other words, if you had $1,000,000 of hard assets (equipment, machinery, etc.) in this deal but the business continually loses money, who cares? Now, you may be saying that you can always sell the assets, and yes, you're right, but what are they worth? Have you ever tried to sell equipment in a liquidation scenario? I guarantee that you'll get a fraction of what they're valued on the books. What you're really trying to justify is the amount of goodwill inthe sale. While this is a terribly arbitrary number, one must evaluate the business itself. With $2.3 million in cash flow and a $5.5 million dollar asking price, the potential return on your cash investment should all things remain the same is simply phenomenal. Would you feel better if the business only generated $1,000,000 in cash flow but had $1,300,000 more in hard assets? Personally, whenever I've gone to the bank to pay my mortgage, they've always accepted cash and not machinery.

Your last question was: "How do you structure a business deal so as to avoid being burned by a seller in a case like this?" Unfortunately, I do not have enough details on the business itself and it's a hypothetical situation in any case. Assuming that the numbers in your example are correct, you would employ an accountant to validate them. Please keep in mind however there is far more to investigate than just the financial components to any business transaction. In addition, you need to investigate the assets, competition,customers, contracts, sales and marketing strategies, employees, the market, the industry and so forth. The determination must be made that this is a good business with a great future with you as the owner. This fact should be placed far above whether the owner is trying to "burn" you.

Furthermore, you will want an element of seller financing. This is another way to get the seller to validate the business. Over and above all this, you will have a non-compete, plus specific representations and warranties that the seller must make as part of any purchase agreement. While I believe that skepticism is a trait that every business buyer must have, the onus is on you to investigate the business flawlessly so that you learn everything before you buy.

Get more expert advice in Richard Parker's How To Buy A Good Business At A Great Price - the most widely used reference resource and strategy guide for buying a business.

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About The Author
Richard Parker is the author of: How To Buy A Good Business At A Great Price, the most widely used reference resource and strategy guide for buying a business. He has purchased ten businesses in his career and has helped thousands of prospective buyers worldwide learn how to buy the right business for sale. He is also founder and President of Diomo Corporation - The Business Buyer Resource Center.

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