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So is a business worth more to you if it has the potential to grow?
Hey everyone it’s David Barnett from InvestLocalBook.com the awesome blog site where we talk about
buying and selling businesses and local investing, personal finance issues and things like that.
First of all I want to thank everyone who attended my Business Buyer Advantage live
workshop in Moncton, New Brunswick last week. It was an amazing day, Business Buyer Advantage
goes for about nine hours it starts at 9 a.m. and this time we finish up just before 6 p.m.
around suppertime and what was so amazing about it was the group of people that were
in the room. In fact most of the people who attended actually have already owned businesses
before they wanted to come and learn about buying businesses because they have a plan
to either buy more companies or grow their existing business through acquisition and
what’s great about these groups of course is that when people share their own stories
are really enhances the experience for everyone who are there in addition to learning the
incredibly expensive material that I go through over the course of the day.
This week though in my video series. I have a question about potential one of my viewers
wrote in and said ‘I’m looking at buying a business and I’m meeting business sellers
who tell me that their business is worth more because of potential to grow the business’
or because there’s potentially a new development in the area for example a convenience store,
restaurant across the street from a construction site where a huge building might be going
in there maybe 5,000 new people moving into the neighborhood does this make a business
worth more?
My opinion is that you don’t want to buy a business period unless there’s potential
to grow and improve the business but that doesn’t necessarily affect the price. Let’s
consider different terms that we use in the world of buying/selling businesses so that
you can see what these things mean with respect to your own deals. Let’s say that we are
talking about a small restaurant and as we know from earlier videos that I’ve done
businesses are valued based on discretionary cash flow. So let’s say that we have a business
and you do your research and you examine the business, you do a proper normalization of
the income statement and you determine that you feel this business is worth let’s say
$100,000.
So we have $100,000 is what you think is the fair market value of this business. This is
what you want to pay for the business. So within a business we have certain tangible
objects. We’ve got maybe there is an oven and there’s tables and chairs and some cutlery
maybe you know signage outside etc., maybe there’s a POS system and when you add up
the price of all of these things let’s see you arrived at a value of $65,000. So we have
$65,000 and this is the asset value or what we call tangibles. These are things that you
can actually put your hand on, you can touch them. So in business purchase terminology
the difference between these two if the seller agreed to sell you the business for $100,000
the difference between these two would be $35,000 and would be the goodwill. So what
that represents to you as a buyer is the value of all those people who regularly come to
this restaurant, the people who get paid on a Friday and decide they don’t want to cook
supper for themselves at home and there is a regular habit of coming to your restaurants,
the guys who have your restaurants phone numbers stuck on their fridge so that when they come
home late on Saturday night they can call order pizza, etc. so that’s good will and
if the cash flow is there to make this business worth $100,000 then the goodwill is certainly
something real that is worth paying for you want a restaurant with those regular customers
you want to have the guy with the phone number on the fridge because this is what drives
the business is what gives the business value.
Now in this example, if the owner of the restaurant said you know what? There’s a new building
going up across the street or I have a new recipe or there’s a new product coming out;
you hear this and all sorts of different ways you’re going to be able to do more with
his business then I have had because you have a greater potential instead of agreeing to
sell it to you for $100,000, I want $120,000. So he wants $120,000 and he says that there’s
$20,000 here for the potential. Now here’s the problem, who is going to do the work to
obtain the earning that is going to support that additional value because it’s not there
today. So what a seller is trying to do in a case like this is he’s trying to get a
buyer to pay him for work that the buyer’s going to have to do after the buyer takes
over the business and of course because the sales don’t exist today, we don’t know
for certain that these sales ever will in fact exist, the might never appear.
So a value put on potential over and above the fair value of the cash for exists today,
we call this Blue Sky. So Blue Sky is literally paying for the promise of a clear blue day
down the road. You’re paying for the idea that the business is going to perform better
over time. Now I said earlier that to me the only reason you buy a business is because
of improvements that you are going to be able to make. So I always tell my buyers when I’m
working with them, find a business that either has problems but is still profitable or that
has issues or inefficiency is that you know how to fix. Because once you buy the business
and you fix the problems where you improve the efficiencies that you know how to fix
the performance of the business will be improved. This is your motivation. This is the reason
to buy the business but you shouldn’t be paying a seller for this effort that you’re
going to put in. you should be spending the seller for what you get on closing day, which
is a business that has performed at a certain level and generated a certain cash flow. So
in this case it would be that $100,000 fair market value. So you should pay for goodwill
and good will is valuable it’s something that’s real and it enhances the business
and makes it worth owning but you shouldn’t in my opinion paper blue sky because you’re
the one who’s going to have to do the work in order to deliver the results.
I hope that’s helpful. We’ll see you next time. Don’t forget if you enjoyed the content
of the video please like and share it’s the only way that YouTube, Facebook, LinkedIn,
all these platforms have of knowing the content of the video is actually good and it helps
to share the message with other people and as always visit my website and sign up for
my email list. I send one email a week with a video just like this one. Thanks and we’ll
talk to you soon.