By Troy L. Harmon, CFA, CVA, Chief Financial Officer, Henssler Financial
A quick perusal of the classified ads shows plenty of business opportunities available. Some of the most common among them seem to be businesses easily replicated with limited resources and readily available assets. Maid services, landscaping, and industrial cleaning companies, to name a few, are always available in the market. Almost anyone with limited training and a small budget could likely replicate these businesses, leaving one wondering, why would I buy this business?
Well, there are a few reasons, but you must do your homework before jumping into any investment. These businesses generally fall into the category of buying a job for the owner. However, starting a business may be more difficult than buying an on-going operation in some instances. The main benefit to buying an easily replicable business is that with an established customer base, you don’t have to endure the pains of limited cash flow common in a start-up. Additionally, a business with an established reputation, assuming it is positive, will open more doors more quickly and at a better price, than one with no reputation at all. Often a new business with no electronic track record, meaning no likes on social media or positive feedback via the Better Business Bureau (BBB), will find it more difficult to attract new customers than one with that experience.
We have addressed the valuation of intangible assets before. They are often the biggest advantage to buying an existing business when there is no other identifiable competitive advantage in an industry. However, it takes great attention to the details of the business to make sure a buyer will benefit from these intangible assets or even if they exist. Calling clients and vendors, checking BBB feedback, and credit ratings of the business may not always be sufficient. In fact, the risk that the current owner is perceived as the intangible and not the business itself is one of the main risks involved, because a transfer would mark a change in ownership and control. That being the case, a buyer should find it necessary to have a planned transition in ownership in cases when the cost to clients of changing to another service provider is minimal.
The transition should include a period sufficient to allow current clients to attach the business reputation to the new owner, not the common one week of training offered in many sales. This may take several months to several years, depending on the nature and size of the business, but an intentional transition plan is necessary. Additionally, a non-compete contract may be necessary to protect the new owner from the current owner setting up a competing business wherein they use their reputation to take the transfer proceeds and the clients from the new owner. A non-compete contract or clause is usually sufficient to protect the new owner. We encourage buyers to seek legal advice for these details.
As for how much a buyer should be willing to pay for an easily replicable business, it depends. A quick look at the market value of the used equipment included in the sale versus the asking price for the business should tell you the seller’s stated value for the intangibles. However, we warn buyers to beware, not all clients will follow you in the transitions, so discounts versus projected future cash flows are very common. Clients without contractual obligation can leave without notice, and it is not uncommon for a current owner to overstate the long-term relationship they expect from their clients.
If you have specific questions about business valuations, contact the experts at Henssler Financial: