I meet with a client the other day who was looking to purchase a business in a neighboring state to help grow his existing business. Our client’s business provides oil field supplies and so did the business he was considering purchasing so there were some natural synergies between the two businesses. The asking price on the business was just over under $1.6 million. While preparing for our meeting, I went over the financial statements and tax returns our client provided of the business new he was considering acquiring and noted the average profit for the company was about $40k a year over the last four years. There was roughly $300k in assets that would be included in the sale so this put $1.3 million as the price for the goodwill (i.e. the customer base). Based on a asking price of $1.6 million and a profit of $40k a year that would take 40 years to get your money back on the purchase. Needless to say I advised our client to run as far away from that deal as possible!
Let’s pretend for a second the earnings really did support the asking price what should be considered in making a decision to purchase an existing business to help grow your existing business. I think one thing that should be considered is if you spent the same amount of money, as what the goodwill would be in this case $1.3 million, on your existing business could you grow it larger than what you are considering purchasing? In the prior case I believe if our client just spent that money trying to grow the existing business it would be a far better investment. In this case the company he was considering acquiring didn’t have any secret sauce as far as a special way to do doing business that would give him a competitive advantage.
When considering purchasing a business it is so important to step back and really look at what you are buying. A lot of times people who are considering purchasing a business get so caught-up in the moment they can not objectively evaluate the business and it turns into one very expensive impulse buy. The best thing to do is take a deep breath it is extremely unlikely anybody is going to swoop in and snatch up the business before you make up your mind. I would recommend sitting down with your CPA or a close friend that has gone through the process of buying a business and get their input on the business and what you should do if anything.