What is Flipping A Business?
When the real estate market heats up, many investors attempt to flip properties. This is attempted by buying distressed properties (for cash), fixing them up, and then within a few months flipping the properties or selling them at a significantly higher price. Some investors have had success with such an approach in the real estate market, and some business buyers attempt to similarly flip businesses. Such buyers attempt to buy businesses at bargain prices (always a good idea), improve the sales and profits of the business, and then flip the business by selling the business for a higher valuation within a few months based on the recent improvements.
Why Flipping A Business Usually Does Not Work
- Buyers of businesses simply do not pay a premium for businesses unless the business has a sustained track record of sales and profits justifying the purchase price.
- At the minimum, business buyers will want to see at least 12 months of provable sales and profits that justify a premium business valuation.
- Business valuations ultimately depend on the seller’s owner benefit.
- The owner benefit is simply the adjusted economic profits or all of the economic benefits that the seller derives from the business.
- This includes unrecorded sales, depreciation, the owner’s personal expenses that are expensed through the business, and payroll that the owner (or their family members) derive from the business.
- The valuation of the business is typically a multiple (somewhere between 2 – 4 times generally) of the owner benefit for the last 12 months.
- Moreover, a common valuation technique of valuing businesses is assigning a multiple to the blended average of the seller’s owner benefit for the last three years.
- When one is flipping a business, the business is owned for only a few months by the seller and will not have the historical sales and record of owner benefit that justifies a premium valuation the flipper is seeking.
- In fact, the business usually was losing money or just breaking even prior to the flipper’s bargain basement purchase.
- Absent unusual circumstances or a business that is valued mostly by its asset value, flipping a business on a short-term basis usually does not work.
Longevity of Business Operations Important
As discussed, buyers of businesses typically will want to see at least 12 months of financial records from a business in order to base the business valuation on the current sales or profits. The business must have a sufficient track record to verify that the customers of the business are returning and becoming repeat customers. Even if a business has improved from prior ownership, the boost from sales must be shown to be more than temporary. Additionally, the business must be adequately and sufficiently staffed in order to properly serve its customers. A business that is improved but only operating for a few months has not necessarily proven that it has the staff and infrastructure in place to sustain the improved sales.
Asset Value Improvements Help Flippers of Businesses
Some businesses such as restaurants or auto shops do receive higher business valuations based (in part) on their physical assets or leasehold rights. An auto shop with $200K worth of equipment, for example, will sell for a higher valuation than a similarly situated auto shop (with the same owner benefit) with $50K worth of equipment. Also, a restaurant with a below-market lease and a fabulous $250K build-out will sell at a higher valuation than a similarly situated restaurant (with the same owner benefit) with a lousy lease and only $50K worth of physical assets. Thus, a flipper of either type of business that invests the time and capital in improving the physical assets or leasehold rights will receive a higher price. It is still highly questionable, however, if the flipper will receive significantly more from a sale of the business than what they invested in the business.
Example of Attempted Restaurant Sale ‘Flip’
- It is fairly common in the restaurant industry for investors to try and ‘flip’ restaurants.
- No doubt this can be accomplished with much perseverance and some luck, but it is not an easy task.
- Let us suppose that Jim is on the hunt for a bargain-basement restaurant which he can flip for a higher price within three months after the sale.
- Jim decides to buy Shelia’s Cafe, and gets a great deal for only $50K.
- Shelia’s Cafe is losing money while generating $10K/week in sales, has a long term lease at $5K/month, and has about $50K of physical assets.
- After three months, Jim spends $100K on leasehold improvements from renovating the restaurant.
- Upon re-opening, the restaurant is generating $15K/week and Jim immediately wants to list the restaurant for $300K.
- This would double his net investment of $150K ($50K for the business and $100K of renovation costs).
- The problem, however, is that very few buyers will assign a premium valuation to any restaurant that only has a few weeks of sales from which to measure its true worth and profitability.
- Customers are fickle and may not return after the restaurant’s grand re-opening.
- The employees of the restaurant may quit or not be properly trained to properly serve the customers.
- New competitors or poor online reviews may quickly result in a drop in the restaurant’s sales.
- Most importantly, the profits of the restaurant (as a percentage of the sales) have not been measured over a significant period of time.
- While Jim would indeed receive more than his original purchase price of $50K, he may not receive much more than the total asset value of the restaurant ($150K from its physical assets and leasehold improvements).
Remember, businesses that lack a provable and sustained level of sales and owner benefit over a 12 month period of time seldom receive more than the asset value of the business.
Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.
