Evaluating the Target (I): Why Is the Seller Selling?

July 1, 2007

Let’s assume that the following events have already occurred. After doing an adequate amount of soul-searching, you’ve decided a business engaged in some form of construction is for you. You’ve always been a pretty good amateur carpenter and can speak the language of the building business. You also feel you have the managerial skill to handle a business that has a fair num¬ber of employees and outside salespeople.

You’ve also found a business broker you have confidence in, and with that broker’s help you’ve sharpened your thoughts about what you’re looking for and what you can handle, psychologi¬cally and financially. Fortunately, your broker’s inventory con¬tains a number of businesses that appear to fit the profile. You’ve investigated these, but all save one turn out to be blind alleys. All but one either cost far too much or are too small. Some are losing money and don’t appear to be good turnaround candidates. There’s one, however, Houston Sash & Door, Inc., that seems like a distinct possibility. Houston Sash & Door manufactures win¬dows, doors, and other specialty items for general building con¬tractors. The company has been profitable, and the asking price is at least in the ballpark. You’ve visited the plant on a couple of occasions and haven’t noticed anything (at least yet) that might scare you off. Your broker informs you the company was founded 10 years ago by its present and sole owner, Everett Houston, who for the past 10 years has been the inspiration and driving force behind the business.

It’s now time to start in on the serious analysis of the business, which may culminate in making a purchase offer at a given price and on stated terms. At this point there’s one question you must know the answer to as quickly as possible, for it, as much as any¬thing else, will determine whether you will buy and, if you do, how much and on what terms: Why does the seller want to sell the business? If you don’t know the answer to this question with rea¬sonable certainty, you don’t know anything. Sometimes sellers are reluctant to tell prospective buyers the real reason they want to sell. More often, the stated reason sounds suspicious. If you’re not comfortable with the stated reason, keep digging; you must know.

The real reasons sellers sell businesses usually fall into three categories:
1 The seller isn’t making enough money in the business.
2 The seller has a personal reason for selling.
3 The seller knows bad times are coming.

There’s a fourth, but rare, reason a business may be offered for sale. The business may have been bought by a “business doctor,” a person or company in the business of buying shaky or even bankrupt businesses, getting them on their feet, and selling them. This business may now be up for sale simply because it’s the appropriate time to sell it. The first two reasons businesses are sold needn’t give you great cause for concern; the third reason is the one you must be very careful about. Let’s look at each one.

1. The seller isn’t making enough money in the business.

Few sellers admit to prospective buyers that the real reason they want to sell is that they’re not making enough, even when the financial statements make that fact obvious. Most often, admitting you’re not making enough is admitting to failure. When sellers tell buyers that the reason they want to sell is to concentrate more on a new business they’re developing or because they have grown tired of business in general, the real reason is that profits have been too low to keep these owners motivated to stay.

The fact the seller hasn’t done very well shouldn’t nec¬essarily turn you off. After all, many businesses are bought and sold that haven’t made any money at all and that have lost considerable amounts. These businesses are often sold for no more than it takes to pay off the owner’s debts, if that. In any event the fact the seller hasn’t made enough money will result in either a lower purchase price or favor¬able terms or both. One person’s difficulty usually is another person’s opportunity. If the reason the business had low profits was the inability or lack of drive of the owners, you may be able to turn the place around fairly quickly. (In some cases this requires little more than a new coat of paint and a broom.) What you have to be careful about, however, are the results of ineptitude that can’t be easily corrected. The seller’s lack of savvy may have irreparably damaged the business’s relations with suppli¬ers and customers.