“Back in the day, our EBITDA was about one million a year, and we had blue-chip clients. But a couple of years ago, we lost some key clients and it killed our cash flow. We still have a great reputation, so a buyer could take the goodwill we’ve built and really grow with it.”
Norm (not his real name) called me on the advice of his personal financial planner who I knew through the Nashville chapter of the Exit Planning Institute. Norm started his B-to-B service business in 2010, and it hadn’t taken long for his company to establish a great reputation. His client base sounded like a Fortune 50 list, and to hear him tell the story, they were on a roll. I am not sure what caused the roll to come to an end, but Norm was ready to sell the company and start a new business around another idea.
The problem was, Norm wanted to sell his company on a valuation based on their reputation from the days when he was riding high. He was essentially hoping a buyer would just ignore his recent financial results. Norm had been funding losses for a couple of years from his personal bank account. “My net worth is going down every month,” he told me. He was assuming a sale of the company would allow him to get all those losses back. “I haven’t been able to make the hard decisions to be profitable, but a smart buyer can see what needs to be done and make a fortune based on our reputation,” he said.
I had to explain to Norm there were two problems with his expectation. First, the value of goodwill in a business is generally linked to the amount of money it is making at the time of sale. It’s rather common sense: if a business isn’t making money, it isn’t generating economic goodwill. Second, the reason anyone buys a business is based on what they think THEY (the buyer) can do to make the business perform in the future. But the amount of money a buyer is willing to pay for the business is based on what YOU (the seller) have done with it in the recent past. Generally speaking, a buyer will not pay the seller for the future value the buyer expects to generate, nor will a buyer base a valuation on results from the distant past.
Norm is being unrealistic, but I have to tell you, I frequently hear this kind of thinking. Business owners who find themselves in financial trouble can be very creative when trying to sell their business. It’s like the captain of a sinking ship trying to sell it based on the quality of the ship’s design. Norm’s company might have had valuable goodwill at some point, but right now, it’s taking on water.
JIM CUMBEE is President of Tennessee Valley Group, Inc. a retainer-based business brokerage and transition mediation firm in Franklin, TN. Cumbee is an attorney and has an MBA from Harvard Business School. Jim is the author of Home Run, A Pro’s Guide to Selling a Business. http://www.amazon.com/Home-Pros-Guide-Selling-Business/dp/1599329239 . He has a wide range of corporate and entrepreneurial experiences that make him one of the most sought-after business transition advisors in the state of Tennessee. The principles above are true, but the story, names and fact patterns are changed to preserve the parties’ identities.