When buying or selling a business....timing matters... a lot!

I am often asked when is the “right” time to buy or sell a business. Unfortunately the answer is complicated. When I’m asked that question my response is “as compared to when?”.

Below is an example:
Mary wants to buy a business and John thinks he wants to sell his small business.

The Biz: In 2009 John’s business struggled like many businesses. He was down about 30% in gross sales and earnings. For 2009 his sales were $600,000 and earnings $100,000. John wants to know if he can get his business back up to earnings of $125,000 can he sell it for more money in 2011 (he’ll need full year 2010 results to get credit for any increased earnings).

The buyer: Now there’s Mary. Mary has $100,000 for a down payment and she need’s $60,000 per year in salary from the business to live on.

Let’s quickly figure how much Mary can afford to pay John for his business:

Mary has $100,000 for down payment
Current interest rate used for Mary’s loan 9%
Biz earnings today- Mary’s salary of $60,000 leaves $40,000 ($100,000 – $60,000) left for debt service.
An SBA lender would, today, loan Mary about $197,000 based on the available $40,000 for debt service.
So Mary can pay John $197,000 + her down payment of $100,000 = $297,000.

What if John’s earnings increase to $125,000 but interest rates 18 months from now are 11%
Then the bank would likely loan $237,000, add that to Mary’s down payment of $100,000 = Selling price of $337,000.

So even though John’s earnings increased 25%, his selling price only goes up about 11% because of the increase cost of financing caused by higher interest rates.

So when the right time, hard to say? If John waits, what happens if his earnings stay at $100,000 but interest rates increase? Then his selling price would drop!

Usually the best time to sell is when earnings are up and interest rates are down, but that doesn’t always coincide with the events of the buyers and sellers lives.