When someone is looking for a business to buy, there are a number of factors they consider. But what are the most important things he or she will be looking for? Read on to find out.
What is a Potential Business Buyer Looking For?
In a nutshell, the top four things a potential business buyer is looking for are:
- Cash flow;
- Cash flow;
- Cash flow; and
First, when I reference cash flow, I am not talking about the cash flow in and out of the business. Rather, I’m referring to the actual bottom line earnings of the business. The actual free cash of the business.
The cash flow of the business being purchased should be able to provide a reasonable living wage for the time invested in the business by its owner. All too often, in small business, the owner does not pay him or her self since the business cannot afford to do so.
The cash flow of the business being purchased should also be able to support a reasonable level of debt service if leveraging one’s investment whether it be through traditional financing, or vendor financing, or in some cases both. Most good business decisions and investments today will include a component of debt. Debt should not be seen as bad since a little leverage if done right is good. Too much leverage and not only places a high demand on the cash flow of the business but also increases the risk and reduces the profitability of the business. Leverage should be well balanced with equity. The reasonable level of leverage should be covered however by the cash flow or earnings of the business.
Over and above the owner’s wage and debt service, the cash flow of the business being purchased also needs to be able to provide a reasonable return on one’s invested capital (ROIC).
If the cash flow provided by the business cannot cover the owner’s wage, the debt service and a reasonable return on the invested capital of the owner, then one needs to ask oneself, “What am I purchasing? A job?” That is fine if that is one wishes to do as long as one is aware of it. What I often see, however, is purchasers buying a business with lots of hope and the inability of the business providing the three essential cash flow coverages.
Additionally, the business being purchased should also possess growth opportunity since if something is not growing, it’s dying. Purchasing a business in a saturated industry or market may not be the ideal investment.
Cash Flow and a Living Wage
The cash flow of the business should be able to provide a living wage for the time invested in the business by its owner. This may vary depending on the business, industry, buyer’s expectations, type of buyer whether strategic or synergistic or main street individual as we call it, this amount will vary. But the reality here is that a buyer of a business should expect to receive a salary otherwise why would he or she buy a business and not start one from the ground up?
Cash Flow and Debt Service
The cash flow of the business should also be able to support a reasonable level of debt service if leveraging one’s investment whether it be through traditional financing or vendor financing or in some cases both.
In today’s world, very rarely do businesses transact for all cash unless dealing with a very minimal amount. The earnings of the business need to support such debt service. Otherwise, the fit is not right since the leveraged amount is too high, or the cash flow earnings of the business are too small. Or, if there are little to no earnings, perhaps there is nothing more to sell than some assets and possibly, an opportunity. In this case, expectations of value would need to be reassessed since low cash flow means low value.
Cash Flow and ROI
The cash flow of the business should be able to provide a reasonable return on one’s invested capital.
Buyers are mostly astute buyers and understand the power of leverage. In many cases, a reasonable amount of leverage is an efficient use of one’s money. The expected yield on such investment should be reflective of risk compared to safer investment vehicles. Entrepreneurship is risky.
Typically, such yield would command an ROIC of somewhere between 15%, to 35%, and even 40% where there is a high-risk component.
The business should possess growth opportunity. Anything short of buying growth opportunity is a tough sell to any reasonable and astute buyer; unless, of course, one is merely looking to buy a job and that is a legitimate purchase, sale, and motivation, but expectations of value need to be realistically reflective of that.
If you are thinking about selling your business, put yourself in the buyer’s shoes, and look at things through their window for a bit. It will help you be realistic, and consider things you may need to do and or adjust to maximize the value of your business.
If you are looking to buy one, consider these four things to ensure you successfully purchase the right business.
Whether selling or buying, contact the professionals Pacific M&A and Business Brokers Ltd. An experienced business broker can help you successfully achieve your goals.