Selling An Unprofitable Business
Selling an unprofitable business is not an easy task. Normally, most buyers will be quite reluctant to take over a business that is losing money. As a result, they will only be willing to pay the worth (or a discount to the worth) of the company’s tangible assets (physical assets or hard monetary assets). This type of transaction is termed an ‘asset sale’ where the value of the business is not being determined by its present or future income stream. In such a situation, it is far better for the seller to try and make the business profitable prior to an attempted sale.
‘Asset Sale’ Values Business Based on Tangible Assets
If a business is breaking even or is losing money, then buyers will not typically assign any value to the business above and beyond its tangible assets. Physical assets may include equipment, leasehold rights and improvements, inventory, and company vehicles. Other tangible assets such as cash or accounts receivables are typically retained by the seller and are not included in the deal. It is important to value the physical assets by its depreciated or current value (not necessarily the price paid by the seller for the physical assets). Further, inventory should be valued at its cost to the seller (not its retail value). Accounts receivables are also frequently discounted when purchased by the buyer.
Example of ‘Asset Sale’
- Let us assume that Bob owns Bob’s Bakery and desires to sell his business.
- Unfortunately for Bob, the bakery is losing money.
- Bob receives a business evaluation from a professional business broker who determines that Bob has about $200,000 of physical assets.
- This includes $100K of bakery equipment (based on its current depreciated value), $80K of leasehold rights (based on $80K of recent improvements made to the transferable leased premises), and $20K of inventory (valued at cost).
- The business broker does not want to sell Bob short, however, and must determine whether there is any intangible value of Bob’s business.
- Of course, one can argue that there is no intangible value (or value based on the goodwill of the bakery by virtue of its brand recognition or established clientele) of Bob’s Bakery because it is losing money.
- It is possible, however, that the bakery creates excellent products beloved by its customers, has been established for decades with an excellent reputation in the local community, or is in a very desirable location for a bakery.
- Perhaps Bob simply is not running the bakery in a profitable way because of a bloated cost structure and mismanagement.
- Another bakery owner in the same location may indeed run the business quite profitably.
- If that is the case, then it may be appropriate to price the bakery for a premium to the value of its physical assets in order to assign some value to its intangible worth.
- Otherwise an appropriate asking price for Bob’s Bakery is $200,000.
Avoiding An ‘Asset Sale’
The only way for a business owner to avoid a future ‘asset sale’ of their business is by making their business profitable. Increasing the value of a business prior to its sale should be the goal of every business owner, but it is particularly salient for the owner of an unprofitable business. Most owners of unprofitable businesses may wish to rethink their business model. Only a business with a provably profitable business model will be assigned significant value to its intangible worth. Value is generally only given to intangible assets. Otherwise the business will only be based on its tangible assets as an ‘asset sale’ and valued accordingly.
Increase Company Sales
Every business owner wants increased sales. The question of course is how to do so in a profitable way. After all, just because a company has increased sales does not mean that a company will have increased profits. First, if a company has pricing power, then a business that is losing money should raise prices for their customers. A price increase will flow straight to the bottom line. Second, a company that is losing money may consider spending more time and money on marketing. This may include more social media advertising or hiring a full time marketer to seek out new customers. Sometimes marketing can be done in a more cost effective way by simply increasing referrals from present customers. Owners of unprofitable businesses must determine an effective plan to increase sales within their particular industry.
Lower Cost Structure
A bloated cost structure may often be the cause of an unprofitable business. For example, some businesses have higher than necessary occupancy costs. In a retail-related business, occupancy costs typically should be no more than ten percent of total sales. Business owners with too much retail space or too high rent relative to their sales may consider moving to a more favorable location. Another main cause of a bloated cost structure may be a having a bloated payroll. Removing staffing costs can significantly contribute to rationalizing a business model so that the business can achieve profitability.
Owner May Need To Be More Involved in Business
The more owner-absentee a business is run then the higher the business valuation. But if the business is unprofitable, then that must be the first priority. A business owner that is faced with weak sales or a bloated cost structure must become personally involved in the business. That may mean personally replacing a non-performing manager or key employee in order to immediately save significant payroll. Or it may mean attracting more customers with personal marketing efforts. After achieving profitability for a sustained time, the business owner may then hopefully de-emphasize their own role in the business in order to increase the business valuation.
While selling an unprofitable business as an ‘asset sale’ is possible, it is recommended that most business owners first focus (if possible) on making their business profitable prior to an attempted sale.
Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.