You need to figure out the answer to this question before moving forward (and definitely before closing)
What motivations might a business owner have to part with their business if it’s running well, especially if it’s doing so without their “hands-on” involvement? In other words, what are the acceptable reasons for selling a business? This question obviously needs to be addressed during any potential business sale, and it’s not an easy one to answer. Read on for some helpful tips that we’ve learned as business brokers on determining whether the seller has a good reason to put his business on the market and whether he’s being honest about his motivations.
While there are many legitimate reasons an owner may be ready to part with his business, there are often hidden reasons that may make it a less appealing purchase than it originally seemed. Let’s start with the normal and legitimate reasons that business owners usually give when they make the decision to sell.
The “good” reasons an owner might leave a business
Below is a list of the most common and acceptable reasons to sell. We encounter all these regularly and most situations will generally fall within these, but it’s certainly not an exhaustive list and each case is unique.
- The seller is planning on retiring: This is a very common reason, totally legitimate, and usually easy to verify. In most cases common sense will tell you whether a business owner is of an age to be considering retirement. However, we’ve seen several sales for this reason where the business owner really didn’t seem old enough to be ending their career. Often, these sales are still legitimate. Some people work exhaustively to be able to retire young, and again, every case is unique.
- Moving to a different region or divorcing: Moving is common in the U.S. and divorce is as well, making this another common reason given for a sale. Unfortunately, in the case of a divorce, you’ll have to exercise a lot of caution moving forward. If both spouses are owners in the business, there will likely be disagreements regarding sale price, conditions, and even whether the business should be sold at all. We’ve seen some incredibly contentious sales take place under these circumstances and have been party to some spousal disagreements that we won’t soon forget.
- Owner is moving on to other projects: This can be a great reason when true, but it’s also an easy to excuse to give when a seller is hiding unsavory information. Be careful to verify this information before moving forward.
- The seller only enjoys the “building” stage of ownership: We meet many entrepreneurs like this. What captures their interest is the novelty and the challenge of starting and developing a new business. Once the business is stable, they’re bored by day-to-day management.
- The seller bought on a whim and regrets their purchase: This is common, especially in businesses like catering, where people tend to have unrealistic expectations and buy what seems like a great deal without much thought or research. Just be sure you’re not repeating your predecessor’s mistake.
- The seller is seriously or terminally ill: This is sadly common and, while it’s not the most joyous circumstance in which to buy a business, it can actually be a big positive for both sides. You shouldn’t feel guilty for buying a business in this case as long as both parties are satisfied with the final purchase price. The seller will receive a quick cash influx and remove the stress of running their business from their life while you receive an uncommonly good deal on your purchase. When we’ve represented sales like this, it’s been very clear that the seller was not “faking”, and was indeed very sick. Unless this is the case, you’ll need to verify the accuracy of this with your business broker’s help.
- The seller isn’t able to put in the required amount of time working in the business: Most owners will actually downplay the amount of time that they spend managing their business to make it seem like less work than it really is, so this is a great reason to hear for a sale because it means the owner is likely being honest with you. Just be sure that you’re quantifying your own work ethic accurately when deciding if you’ll be able to handle it better. Most people greatly overestimate how many hours each week they can work while maintaining their personal and family life, which can lead to this cycle repeating itself.
The more nefarious (and often hidden) reasons
Below are a few that we’ve commonly encountered.
- A major competitor has arrived on the scene: For several months, it was possible to buy a gas station in Central Florida for an excellent price. We feel bad for anyone who purchased under those circumstances before the cause became clear: WAWA had begun building competing gas stations in the area, offering lower prices and better service.
- The business is losing money (despite what look like good figures): ALWAYS use a CPA to double- and triple-check the numbers you receive from the seller. The best practice is to never trust numbers that you receive until they’re been thoroughly verified. When it comes to buying and selling businesses, you simply cannot believe the other side; check and check again that what you’re receiving is factual. Otherwise, you may purchase a business in a financial tailspin that looks excellent on paper.
- The geographic or economic sector is in free fall: We’ve watched this happen geographically along the Space Coast of Florida since the space shuttle program was abandoned. As families employed within the program moved elsewhere, a huge number of local businesses were forced to close their doors. Fortunately, the SpaceX program came to the area and revitalized the local job market. Similarly, Netflix spelled the end for an entire sector of video rental companies, which all went on sale at temptingly low prices as the sector crashed.
- The business is a franchise of a failing company: We all remember seeing a well-known sandwich shop’s franchises popping up for sale all over the place several years ago. While you and I know that this was due to the franchise’s long-term decline and declaration of bankruptcy, someone who didn’t know this might have seen a great deal and found themselves trapped within a failing brand.
- Location problems: It’s possible that a business’s lease is about to expire and the owner knows it won’t be profitable to sign another five year agreement. Maybe the mall a seller’s store is located inside is about to undergo renovation or the rent is about to increase drastically. In this case, the business’s owner will “pass the hot potato”, selling you his business to escape the lease even if it means taking a ridiculously low offer (a “great” deal for you!) and sacrificing the true value of the business.
How Can I Determine the Seller’s Real Motives?
It’s important to know what a seller’s true motivation to sell is, but their version of the truth and yours may be very different. Ultimately, a seller may not even be aware that their minor dip in business recently is not a random occurrence, but the beginning of a major decline due to a new competitor in the area.
In truth, all you can do to discover the true market position and potential of a business is to do as much research as possible in the hopes of discovering as much information as you can about its circumstances. In other words, do your due diligence and you’ll very likely stumble upon any hidden issues, whether the business’s seller is unaware of them or intentionally hiding them.
Additionally, if something seems too good to be true, it probably is. For example, if I found a company for sale for $90,000 that the owner managed remotely, I would be shocked to find that it had an annual profit of $75,000. You’ll be hard pressed to find a business (especially that the owner is willing to sell) that generates this much profit while you sit back and relax, with a small purchase price as a cherry on top. If I found this business, I would do my due diligence and then buy it immediately after making sure all was as it seemed.
Finally, the broker representing the sale is required by regulation to inform potential buyers of any information they’re aware of that might be a “material fact”, i.e. relevant to the value of the business and, therefore, the purchase price. For example, if the seller owns a coffee shop and informs the broker that a Starbucks will open next door within 6 months, they cannot agree if the coffee shop owner asks them not to disclose this information to buyers, because it would drastically lower the potential value of the business. However, if that same coffee shop owner told his broker that he needed to make a short sale due to a serious illness, the broker is not required to inform buyers. Why? This has no bearing on the value of the business, and many buyers would try to take advantage of that knowledge by making an extremely low offer.
Clearly, the question, “Why is this person selling their business?” is not an easy one to answer with certainty. However, if you use your due diligence and think critically about every facet of the situation, you’ll likely avoid a major pitfall. If you’re in doubt about a seller’s motives, reach out to us or to another reputable business broker for help. It’s the best action a potential buyer can take to protect themselves, in addition to using a trustworthy CPA. If you’re still deciding whether you’re ready to purchase a business at all, our last article might help you determine that.