So you’re in business..how do you get out?

I was meeting with a business owner the other day and he said to me “When I started this business I never gave any thought to how I would get out of it, never crossed my mind.”

His business now does over $3 million in sales and has significant value….but no where near the value he thinks it has…….for one reason.

He’s never looked at his business the way a buyer for the business would look at it.
 
In my line of work, I see this nearly everyday. Business owners don’t understand, or at least they don’t have an appreciation for, the difference between a good business for them and a business that would be valuable to someone else. Understand how to value a business from the eyes of a buyer is an important part of the business owners job.
A perfect example was the business owners (let’s call him John) strategy as it relates to the real estate the business utilizes.
John started the business 10 years ago, it grew quickly and started generating good profits. About 6 years ago John decided he needed a new, bigger, building for his growing business. John also decided he wanted exposure on a major freeway so everyone would be able to see his business.
John located a great building with an excellent location. He went to his bank who was willing to give him a commercial real estate loan to buy the building because the business had the cash flow to pay the note. Everything was great. He moved into his new, bigger business and life was good.
However, John was only focused on making the note payments on the building. As he said to me “the business paying down the debt on the building is my retirement fund.”
Now fast forward to today.
John’s business is generating a profit for himself of $10,000 per month or $120,000 per year. Pretty good, wouldn’t you say?  Maybe……maybe not.
The area around John’s business has grown and property values have increased while Johns note has stayed the same. Good right? Not necessarily.
John’s note is $8,000 per month which the biz can afford…BUT  the real estate is now worth much more than he paid for it. If John were to lease the property out at today’s fair market value he could lease the building for $15,000 per month.
But remember John’s biz profit is $10,000 per month. If John was getting fair value for the property he would get $15,000 per month which is $7,000 per month more than the $8,000 monthly note payment.
If we adjust John’s monthly expenses to reflect fair value for the building then John’s monthly profit drops from $10,000 per month down to $3,000 per month ($10k – $7k).
John is now stuck.  His business can’t afford a fair rent but he needs the building to run his business. John’s real estate value makes his business value very low. A buyer who pays fair value for the real estate won’t have enough cash flow from the business to pay the note and a reasonable salary for himself.
John came to me thinking he was in a great situation and left thinking his situation was not nearly as good as he thought.
Do you have a business that one day will need to be sold? What concerns do you have as you look ahead to that day?

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One Comment

  1. Posted February 22, 2013 at 7:50 am | Permalink

    Great article. Selling a business requires a considerable amount of planning on the owner’s part, and this article illustrates a few things the owner needs to prepare before hand.

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