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


When should you abort the purchase of a business?

February 25th, 2010
You are looking to buy a business and have finally found your dream business to own. After lengthy negotiations you have come to an agreement. You start your diligence and you were surprised to find out certain things.
 

During the preliminary investigation prior to issuing the letter of intent you were provided information on excel spreadsheets. I have seen this where they are selling part if the business but sometimes they tell you that many of the expenses that they incur are discretionary therefore they are not reflected on the information provided to you.  Sometimes those are not discretionary expenses and are necessary. As a result the net profit may be materially overstated.

 

In the example of the division for sale mentioned above, they were renting a machine to retailers and then supplying them with product to be used in the machine. The sellers made statements of how many machines they owned, how many they rented and the amount of product that was sold to each retailer. In actual fact, the total numbers of machines were significantly overstated on the excel spreadsheet, many machines which they claimed were in good condition were broken and unusable, the amount of product sold to each retailer was overstated, sales were overstated. In fact the majority of sales were made to 50 franchise stores. The product in these franchise stores was not approved by the master franchisor and the company  was not an approved vendor therefore the franchiser could force the franchisees to get rid of the machines and stop buying the product from this supplier. They had 65 customers and 50 could disappear that was a very risky investment.

 

The information originally in the excel spreadsheets was an extrapolation of 80 average customers and not based on reality.  They claimed that they had 80 machines and this was the revenue and profits that should be earned from those 80 machines.  Everything provided was inaccurate. Needless to say, the investor decided to abort the purchase of the business.

 

The buyer really wanted this business but if he purchased it was based on emotions this definitely would not have been a good business judgement.

 

You do have to fall in love with the business that you want to buy but your decision to buy the business and the price to pay should be based on economics and actual financial data rather than projected data and hypothetical customers

 

Some people are unrealistic. I got a call from an inventor who wanted to sell his idea for $800,000 even though he had no sales.  He thought that there would be lots of people who would be willing to pay for his idea.  Everyone always wants to believe that their house or their business is worth far more than a prudent investor will pay.  The trick is to pay for a business based on its actual earning power and do not buy on emotion and regret the decision to buy that you made.


Filed under: Buying a business — Gary Landa @ 1:39 pm


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