Asking for Guidance (Part 2 of 3)

Asking for Guidance (Part 2 of 3)

(6) All our “formula’s” start, as almost all brokers do, with an analysis of the historic cash flow, and an EBITDA recasting.

But, we never do a projection. That’s one of the “conservative” elements that are rare in business brokerage. All our analysis are based on history, not forecasts. That, alone, causes the recasting to be more conservative (and more sell-able, and more finance-able) than the recasting done by brokers and other experts who base their pricing opinions on future growth of the business. Why do we not use projections? Because you can’t prove that opinion. And, today’s more sophisticated, and more informed, buyers (and their bankers) usually look on projections as “the oldest, and least honest, broker trick in the book”. But, we can prove the historical cash flow. We rarely get any arguments about those conclusions.

Another reason for our avoiding forecasting, especially in tough times, is that buyers and bankers simply are ultra uncomfortable with the risks associated with over-relying on growth we can’t prove. In 2011, especially with the negative forecasting that now burdens most of the national economic news, buyers and bankers are even less willing to “buy into” growth, than in past years. But, they will “buy into” the idea that, if our buyer does NO WORSE than the seller is currently doing, and if that cash flow is sufficient to service the debt and provide the buyer with a decent salary, those buyers are signing those offers, and their bankers are approving those loans. In one of my agencies, we accomplished a 100% increase in commission income in 2010 over 2009, and are headed for a dramatic increase in commission income this year over 2010. This, in the midst of news that about 1/3 of the business brokerages in the USA have gone out of business during the same time.

Another “rule” is that we don’t’ use “add-backs” that are arguable. We stick to easy-to-prove EBITDA plus “owner benefits” paid by the business in the past. So, with this conservative historical-only approach to analysis, we are able to say to all buyers….”If you’d owned the business this year, or last year (or the year before, etc), here’s the cash flow that should have been available to you to (a) make your loan payments, and (b) pay yourself a salary, and (c) generate a return on investment, and (d) provide operating reserves without having to borrow additional funds.

And, we never recast the Cost of Goods, for example, nor the Sales. Even when we know the seller is “skimming”, we leave the sales and the CGS just as they appear on the tax return or P&L. So, we’ve never been sued by a buyer who bought a business, then took over the business, then discovered that the “skim” the broker alluded to (or promised) simply wasn’t there for the buyer. The thousands of businesses we’ve sold have always been “at least as good” for the buyer as the historic records showed. The only exceptions to that truth are the few deals whereby the buyer neglected the business after buying it, and didn’t do well. But, they don’t hold us responsible when that happens. By far the majority of transactions we’ve brokered turned out for the buyer to be good enough for them to feel they made a good investment. Our slogan for this approach is to “under promise and over perform”, the opposite of the brokers who “over promise and under perform”.

Yes, when you analyze financials this conservatively, some sellers won’t list with you, as they want the broker to “build in” the “skim”, knowing that such a tactic might nudge the broker to price the business higher. But, in my experience, that practice is a “deal killer waiting to happen”, and is a huge contributor to the awful statistic that most brokers only sell 20% of their listings. It’s also ultra high risk for the buyer (and his banker), which I abhor. Pricing in the “skim” is also “a lawsuit waiting to happen”, which I refuse to allow to happen in my agencies.

Another fun aspect to this conservative approach of not “selling the skim” to a buyer, is, when a buyer buys a business from us, they almost always discover, after the take-over, that the business was actually BETTER THAN we’d represented, as they discover the skim we didn’t talk about. That “bonus” cash flow not only doesn’t make them mad at anyone, it usually leads them to highly recommend that others buy a business through our brokerage.

I’ve also learned that, if a broker is constantly “pitching” over-priced deals to banks, with questionable ability to service debt out of historic, “provable” cash flow, with those transactions unlikely to be able to service the contemplated debt, unless the buyer is magically able to somehow increase the sales and profits, that broker will gain a reputation with those bankers as an “exaggerator”, at the least, and as a liar/crook/untrustworthy person, at worst, making future deals with those banks unlikely.

On the “flip side”, a broker who presents projects to bankers wherein the PRESENT cash flow, without growth, will easily service the contemplated debt, and will also deliver a salary the buyer needs, and will provide the buyer with a ROI that is better than CD’s, the stock market, or bonds, or other investments, that’s a broker that will (a) be trusted by buyers, and will sell a high percentage of his listings, and (b) will be welcomed by the buyer’s advisors as someone who is operating intelligently and with logic and believability, and (c) will be considered by the banks to be a “deal maker” that is someone the banks want to do business with. For my money, I’ll take the later relationship building, rather than the former.

(7) Some argue against this pricing approach by saying it’s a dis-service to the seller to “make” them price the business properly. I disagree.

I believe that the worst dis-service we can inflict on a seller is to not sell his business. And, since exaggerated evaluations leads the broker to sell only 20% of his listings, 8 out of 10 times, the over-pricing broker is, in fact, performing a DIS-SERVICE, not a service, to the sellers, by over pricing, thereby insuring a weak possibility the broker will get offers, let alone get it sold. If a broker “tells sellers what they want to hear” about price, just to get a listing, instead of sharing with the seller the truth about pricing, if that broker would tell the seller the rest of the truth, that the broker is likely to fail 80% of the time, the seller would likely not list.

But…here’s the great news about that…I’ve found that sellers commonly “bluff” brokers into over pricing their businesses, and thereby wasting the marketing and the energy 80% of the time. Some sellers are happy to talk a broker into “testing the market high”, out of the broker’s pocket (since many times it’s the broker who’s paying for the marketing). I’ve also found that, when told the truth about pricing, and when confronted with proof that buyers are unlikely to over pay, and that bankers are unlikely to “back the play” of a buyer who’s paying an illogical price, many sellers will then allow the broker to list the business at a more reasonable price, thereby insuring dramatically better “closing ratio’s” for the seller and the broker.

Some brokers charge evaluation fees, as a hedge against handling un-sellable listings. I’m not “anti fee”. But, I am energetically against charging a fee to list or evaluate a business, if the broker doesn’t simultaneously tell the seller the truth about the price potential. Charging a fee to lie to a seller is no more admirable than lying to a seller on straight commission.

In my opinion, it’s not smarter to fill your office with overpriced junk, on which you are likely to have lousy closing ratio’s. I prefer to fill my agencies with properly priced businesses, on which we are highly likely to see a commission, and on whom we never get sued, and on which we get lots of referrals, from the buyers, sellers, attorneys, accountants and bankers involved.

Exciting News: A New Business Brokerage Website Is on the Horizon! Keep an Eye Out for Updates.