This article are provided for information purposes only, and are not intended as legal advice.


Buying a business – do you keep the status quo?

April 6th, 2009

When you buy a house, you want to pay the lowest possible price and hope that the market recovers as soon as you buy it.  Same as a business, you want to buy a business and know that it is appreciating under your leadership.  If you look after your house, it goes up with the market value in your area.  If you own a business, it may or may not go up in value, it all depends on how you run the business. 

 

If you buy a business, do you keep the status quo and make no changes?  If the revenue was dropping before you bought it, do you just assume it is the market and one day it will recover or do you make changes?  Keeping the status quo is good if you have a static mature business.  In a changing market, you have to be innovative and always looking for ways to expand your business. Doing nothing will eventually lead to a company which also is worth nothing.

 

I am aware of a company who had good sales 10 years ago and was very profitable.  The owners decided to spend the profits and did not look after the business.  No one was in sales, as time went on, customers started to leave and the company was no longer as profitable.  It could not afford to pay the high salaries to the owners.  Now in year 10, the owners woke up, made some changes and realized that they needed to get some sales.  They woke up before it was too late.

 

Another company was a wholesaler with reasonable sales. Unfortunately, the owners had a lifestyle that they needed to maintain without regard to the profits of the company.  Draining a company profits hinders growth but personal compensation was a priority.  As a result, they ended up having to pay exorbitant financing costs for the business.  They believed that it was better to pay high financing costs at 25% vs bringing in a partner with cash.  That would dilute their equity plus would require that their compensation be cut.  Sales kept dropping due to the economy and the company merged with a synergistic partner.  The integration of the two companies was difficult and the partners became impatient with the high overhead of the business.  The profitability of the firm was not sufficient to maintain paying the high interest rates for the asset based financing.  This was in effect venture capital financing. 

 

A company cannot keep servicing the debt with such a high interest rate, the principal never drops.  Eventually, the lender and the partners forged an alliance and called the loan resulting in the sale of the business.  What happened?  The concept of merging companies to create economies of scale was correct.  Building overhead and maintaining a life style rather maintaining a healthy company and looking at ways to cut down debt are not compatible.  They merged companies in order to improve the opportunities of the company but maintaining the status quo of  high leverage does not always make a successful company.  In this case, it lead to the demise of the company.

 

In most cases, keeping the status quo sometimes keeps what is there but does not build a company.  If you are looking to maintain what is there such in a franchise, then maintaining status quo works.  If you are looking to build the company, you should be creative and look for new methods of marketing and expanding the business.


Filed under: Buying a business — Gary Landa @ 9:48 am


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