Another popular fallacy among business owners is the assumption that there is value in their business simply because it is profitable. Unfortunately, that is not always the case.
Many business owners who fail to plan their exits in advance learn this reality the hard way. Conversely, there are businesses that fail to make a profit that can have tremendous value.
Simple. Buyers buy businesses to procure future cash flows, not past. Take for example a service business such as a General Contractor that is typically reliant on the owner to maintain existing relationships, or secure new ones. Here you have a business that likely has no value above and beyond the book value of the assets. Regardless of how profitable they’ve been in the past. Any buyer would know that without the owner in question running the show, the clients would likely leave with him. After all, he’s the one with all the knowledge and relationships. Essentially, he is the business. Naturally, buyers are hesitant to take that risk.
On the other hand, consider a franchised auto dealership. Break even or “in the red” stores trade for premiums over net book value all the time. In fact, that number can sometimes reach 8 figures. Why? For starters, these businesses can run without owner-operators, they have scarce and hard-to-obtain franchises with protected territories, recognizable brand names and built-in demand. Even if they aren’t making a profit, buyers know there is precedent that they can make money, if run properly. As you can see, completely different risk profile and value proposition.
Seasoned buyers of businesses are pros at evaluating risk and upside. Proper exit planning focuses on de-risking the business and positioning it for growth. In conclusion, we know that the same factors that drive profit often differ from ones that drive value.
“There are no secrets to success.
It is the result of preparation, hard work, and learning from failure.”
– Colin Powell