Its a common refrain when looking at businesses and its the business brokers favorite selling point. But what is potential and how does one value it? Its one thing to have a company’s top line is growing 10%, 20%, or 30%. I can understand the rationale for paying for this type of expected growth. And of course that’s why internet based companies command high premiums.
My concern is the notion of a business that has not been growing. Here is the problem: if you are buying a business then you are somewhat of an optimist by your very nature. As a result you are susceptible to the idea that almost any business – with an injection of “new blood” and additional capital can be taken to unforeseen heights. And that my friends will be your downfall.
And remember if its true that sales can be boosted – it will cost money so even if the broker is right it should be reflected in the valuation! More specifically if you have a business earning $150,000 per year and you need to spend $50,000 a year to get it really going – guess what? So be leery of boosted valuations for potential – in most cases you should be paying less not more.
So what to do? Here are my suggestions:
- Take what the broker says with a grain of salt – tune it out!
- Assume the seller is not dumb – they understand the competition
- Review the sales and marketing efforts and dollars spent
- Review the competitive landscape – can you really break out
- Review the growth of the industry – its hard to win in a dying industry
- Understand how sales are generated – who are the buyers
- Understand how buyers are engaged
- Assume you need to spend money – sales reps, advertising, etc etc etc etc