Sunday, June 5, 2011

Should You Buy A Business?

Should you buy an existing business?  I would not pay much for one, myself.

Many folks dream about starting their own business.  As someone who has done so, in a business with low overhead and high prices, I can tell you that it is not easy.  In more marginal businesses - competitive businesses with high overheads and low margins - it must be murder.

And some folks, when they get a lump sum payout, think, "Gee, I'll start a business!" - which is usually a bad idea for someone who has worked as a salary slave most of their lives.  Simply stated, running a business is very risky, hard work, and if you don't know what you are doing, suicide.  A lump sum payout, invested modestly and securely, can support you for the rest of your life.  Don't risk your nest egg by "doubling down" your bet.  If you lose, you lose it all.

Starting a business is a very risky proposition.  And some folks think that buying an existing business might be a safer bet.  After all, you get all that inventory, store fixtures, name, location, good will and customers, right?  All you have to do is show up and turn the lights on!

And you see ads all the time for businesses for sale - and they sound like good opportunities - after all, they are making good money and it is a "turn key" operation, right?  Well, like anything else, they aren't giving out free money samples this week at the bank, and no one sells a money-making business for a pittance.  And in fact, many of these "business for sale" ads end up as gags for MLM or other schemes. 

But even a "legitimate" business for sale can be a bad bargain - far overpriced.   Many people end up spending a lot of time and energy getting a "turn key" business to just break even.  And with the staggering debt they incurred purchasing the business, they end up behind the 8-ball for years, if in fact they don't end up going broke.

I have had a number of friends decide to start businesses, and tried to "jump start" the process by buying an existing business.  In most cases, it turned out to be a bad idea.  They overpaid for the business and ended up with far less than they thought they would.  And many report that in retrospect, they would have done better simply by using that money to establish their own business independently.  It is not a bad idea to buy an existing business - but existing businesses for sale aren't worth squat.

Why is this?  A panoply of reasons:


1.  No One Sells the Goose That Laid the Golden Egg:  When looking at a business for sale, ask yourself why it is for sale.  In most cases, the business is for sale because it is losing money, about to lose money, or is making less and less money for the owner, who sees the writing on the wall - and you should, too.  A business that is making money is a "cash cow" and no one sells it.  If it makes enough money, you can hire someone to run it, and just sit at home and cash the checks.

But in many cases, what happens is, a business, particularly a retail business, is making enough money to pay the rent and the light bill, but the owner is basically working 60-80 hours a week for what is the equivalent of sub-minimum wage.  It is a money-making business, but just barely, and if it weren't for the "free labor" of the owner, it would be a money-losing business.

Business owners give various reasons for selling their business - they are retiring or whatever.  But in most cases, they are getting out because the money isn't there.  If you pay them a lot of money for a business that makes little, you will end up in their situation - only worse.


2.  Inventory is Worth Nothing:  Many folks assume that when you buy the business you are getting all this great inventory at a reduced price and thus are jump-starting the process by starting up with a store full of product to sell.  There are two problems with this.

First, in any business, whether it is a book store or an industrial hydraulics supply house, the inventory that accumulates in the back room is the crap that doesn't sell.  Whether it is surplus copies of Newt Gingrich's Memoirs, or left-handed metric hose adapters, the things that accumulate in inventory is usually the crapola that no one wants.  People buy the good stuff, which leaves most retailers with a lot of junk that accumulates.  So you buy all this "great inventory" and none of it moves - it just takes up space.  Don't make the mistake of paying a lot - or anything - for inventory.

The second problem is, often the merchant will have a "going out of business sale" after you sign the papers, and sell off the best of the inventory.  I've seen this happen, and yes, it is arguably fraudulent.  Make sure, if you are buying a business, that there is documentation as to what is in inventory, otherwise you may find yourself the proprietor of a lot of bare shelves.

Frankly, what you should do, if you buy a business, is have an inventory sale the first day and get rid of all that crap and start over.  But then again, it is simpler to just start fresh than to buy someone Else's failed dreams.


3.  Fixtures are Worth Nothing:  New store fixtures are staggeringly expensive.  A computerized cash register can cost thousands.  Simple shelving seems astronomically priced.  So to the prospective business buyer, it seems that all those great store fixtures are a real value!

Wrong again.  While new fixtures are staggeringly priced, used ones are, well, nearly free.  Yes, you may see some dreamer try to sell his used shelving for 90 cents on the dollar.  But don't be a chump by playing his game.  In most cases, you can pick up store fixtures from other, failed businesses, for pennies on the dollar, usually at auction.

When you buy a business, the seller often far over-values the store fixtures and the like, so you are paying a premium price for stuff that is old, worn, used, and probably nearly worn out.



3. Clients Flee:  One idea behind buying an existing business is the idea that you are buying an existing client base.  This is particularly true for professional services, where people are selling a Dentistry practice, a Law practice, or an Accounting practice.

The problem is, these are personal services, and people don't automatically carry over to the new practice.  In fact, they use this opportunity to "shop around" and often, they find other options.  Most professionals report that when buying an existing practice, about half the clients are gone after the first year.  After the second year, half of the remaining are gone, and so forth.  Within a few years, most of the clients are clients that the professional obtained on their own merits.

Compounding this is the actions of the seller.  Sometimes the seller will say that you are "getting" his clients.  But if asked personally, he will recommend another professional to the client - undermining your own practice.

Clients, of course, do not "belong" to anyone, and people have their own ideas of who they should patronize.  So the idea that you are "getting" a captive client base is bunk.

Even for more impersonal businesses, like restaurants or the like, the client base is not a guaranteed thing.  If everyone came to "Ed's Diner" because Ed was behind the grill flipping eggs, they may not automatically transition to "Bud's Diner" - particularly if you make the eggs a different way.


4.  Good Will is Worth Nothing:  Many people pay extra for a business on the basis that you are buying the "good will of the business" -  a term of art in Trademark Law.  You get the business name, logos, and the fuzzy warm good feeling that people have about the business.  These intangibles, you are told, are worth a fortune.

On the other hand, you also are getting all the bad will of the business - the reputation of the crotchety owner who chased people out of the store, and the reputation for shoddy products and business practices.  You never know which you are getting, if not both.

Often, people respond positively to change - and a new business with a new name and logo tend to generate buzz and interest - more so than a temporary sign saying "Under New Management!" - the latter being a tacit admission that the old management sucked.

You are better off, many times, paying less for a business by just buying the store and the fixtures and then renaming it and starting over, than trying to continue someone Else's dreams.


5.  Know-How and Show-How is Worth Nothing:  Often, as part of these business sale deals, the seller offers to act as a consultant the first year, to help you out running the business.  The idea is, he will train you on how to run the business, and you will get a leg up over starting a business from scratch.

There are two problems with this, perhaps three.  First, the owner has no incentive to see you succeed.   You've paid him, and he may tell you some but not all of the information you need to know.  He has no motive to make you succeed in the business.  And in fact, he may secretly want you to fail, for psychological reasons, so he can say that "no one could run the business like I could!"

Second, you really have to want to learn, and many people, surprisingly, don't want to learn, but rather want to selectively pick and choose data that corresponds to their preconceived notions.

The classic example of this is the Barbecue Stand.  I have seen this happen on multiple occasions.  Someone buys a thriving Barbecue business and within a year, drives it into the ground.  The problem?  They change the sauce.  Barbecue is all about the sauce, and when you change that, you lose customers.

So, either the seller doesn't give you the proper recipe for the sauce (chefs are weird about this - they would rather sell you their children) or they neglect to mention certain ingredients, because they don't generally write down how they make it.  Or, you as the buyer, decide to "improve" the sauce by adding ketchup, because you like a milder and more tomato-y sauce.  (And that is a big problem for any business person - doing things according to their tastes and not he customer's tastes - assuming that "everyone likes it this way, better!").

The net result is, people leave in droves.  The Dixie Pig Barbecue at Beacon Hill lasted barely a year after it was sold to Koreans.  The home made corn bread went out the window, replaced with slices of white bread.  And the sauce was changed - made sweet and bland - and they even changed how they smoked the ribs.  Everyone came once, got disgusted, and left.

A similar thing happened to a Barbecue place here in Brunswick.  A lunchtime, there was a line out the door.  It changed owners (A Christian couple bought it, praise Jesus!) and the place turned into a ghost town.  Yea, they blanded out the sauce (none of those devil spices) and sold only soda pop.  It has changed hands, yet again.  Maybe the new owner will succeed.

And that is another issue right there.  If you are a 50-year-old 300lb black man who learned how to barbecue pork from your great-grandfather, chances are, you are going to do a banging barbecue business.  On the other hand, if you don't know squat about pork, chances are, you are going to bomb out.  Buying a business that takes a particular talent - a talent you don't have - is a really bad idea.

* * * 

So does this mean that buying an existing business is a bad idea?  No, only that the only person who really makes out when selling a business is the person selling the business.  They find some person with the "Be My Own Boss!" stars in their eyes and gets them to fork over cash for a store lease, some unsellable inventory, worn out store fixtures, and the odious reputation of the previous owner.  At most, this stuff is worth pennies on the dollar, not tens or hundreds of thousands of dollars.

Be skeptical.  No one sells the goose that lays the golden egg.  If you buy a business like that, ask yourself realistically - would someone else buy it from you?  Chances are, the answer is "No".

Starting your own business is often a bad idea.  Buying an existing business is often a bad idea to the tenth power.

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