By Jeffrey D. Jones, ASA, CBA, CBI
This article is not about cases where the buyer knowingly purchased a failing business and was not able to successfully turn the business around or change the concept but rather this article will focus on those transactions where the business was profitable prior to the sale but failed shortly thereafter. The following is a review of 12 factors that commonly lead to the failure of a business:
- Poor purchase price and terms of deal
There are many transactions that take place between sellers and buyers without the involvement of business brokers such as sellers who sell to an employee or relative. Without professional help, these types of buyers often agree to a price and terms that almost guarantees failure. In many cases, the sellers set the price based on their own needs and then agree to finance the purchase with a low down payment and a short term note payout. This results in a high monthly payment that the buyer cannot pay when business is slow or cash is needed to handle unexpected repairs. The seller then begins the foreclosure process and the buyer who has very little investment in the business steals what he can and departs. Seller financing is often used to finance a business acquisition especially when the business records are insufficient to meet a third party lender’s requirements. The key to seller financing is for the seller to get a significant down payment, say 25 percent to 40 percent, and then a payout that the business can afford to pay. Typically, it takes five years with current interest rates being 6 percent to get monthly note payments low enough wherein the profitability of the business can afford to pay the buyer a reasonable salary and the note payments.
- Refuses to develop a relationship with the customers
A business only exists because of its customers. When you take over the business, the customers do not care that you are overwhelmed by the workload or that you do not really understand their question. What they care about is that you call them back within a short time. They need to vent and obtain some satisfaction for their complaint. However, you do not like confrontation or unhappy people. Therefore, you do not talk to them. Within a short time, they will be gone. In addition, with them goes your opportunity for success. Make two things a priority: Number 1 – Go see or have a meaningful contact with every customer within 30 days of purchasing the business and Number 2 – Return every phone call within 24 hours or less. If necessary, make sure your assistant or secretary makes the return call. Be certain that your new customers know that you are thinking about them. This is vital and is one of the main reasons these new business owners fail. They do not understand that operating a business is essentially a people-to-people enterprise. If they fail to develop the relationship with the customer, the business will fail.
- Replaces key employees
Frequently this action occurs. The new owner takes over and within a few weeks has a falling out with one or two key employees. They just paid a staggering sum for the business and did not expect the employees to be insubordinate. Nevertheless, the new owner forgets that the experience is new for the employees as well. So rather than work through all the newness, it seems more fitting to replace the insubordinate employee with a handpicked confederate of their own. In one case that I worked on, within two months the new owner had replaced the chef with over six years of experience and the entire wait staff. Without realizing it, he had replaced every person that all of the customers and vendors had grown to think of as ‘the business’. Many of the customers who knew the staff by name no long felt comfortable coming to the restaurant with mostly new employees. As a result, sales dropped by 50% from prior levels. Within five months, the business declared bankruptcy.
A business acquisition can be a great way to get into a business or expand an existing business. Avoid the above factors that can lead to failure and enjoy the benefits of being an entrepreneur of a profitable business. Next month will be Part 2 of the 4-part article on the 12 Factors that Kill a Business Acquisition After the Sale.
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Jeff Jones is the President of Certified Appraisers, Inc. and Advanced Business Brokers, Inc. located at 10500 Northwest Freeway, Suite 200, Houston, TX 77092. He can be contacted by phone at 713-680-3290 or by email at jdj@certifiedappraiser.com.
