Buying a business is a significant financial decision that requires careful consideration to ensure you pay a fair price and protect your investment. Ensuring you pay a fair price when buying a business is essential to protect your investment and ensure the long-term success of the venture. There are many risks associated when you plan to buy a business and the value exchange is the cornerstone of the transaction.
In this blog we’re focusing on the major risk, the value exchange, and how you can manage that risk.
Managing the ‘value exchange’ risk
This is the ultimate risk; the doubt a purchaser may have regarding: ‘Am I paying fair market value for this business?’
The answer here lies in ensuring you have good advice and a sound market valuation and, more importantly, the extent to which you have confidence the business maintainable earnings (BME) are likely to be repeated in the first 12 months to two years of your ownership.
BME is about what the business is likely to generate in the first 12 months if you just move in and do pretty much what the current owner is doing.
Business purchases are often complex transactions, and evaluating the fairness of the price you're paying is crucial to a successful acquisition. The concept of Business Maintainable earnings (BME) is a key factor in assessing this risk. Let's delve deeper into managing the 'value exchange' risk and understanding BME.
- Calculating Business Maintainable Earnings (BME):BME represents the expected earnings a business can generate in the first 12 months to two years of your ownership while maintaining its current operations. It essentially answers the question: "What can I reasonably expect to earn if I run this business as it is?"
- The Role of Due Diligence: Comprehensive due diligence is essential in estimating BME accurately. It involves a meticulous examination of the business's financial statements, operations, customer contracts, supplier relationships, and market position. This process helps uncover any hidden risks and opportunities that may affect BME.
- The Value of Expert Advice: When it comes to evaluating the 'value exchange' risk, seeking professional advice is invaluable. Engaging a valuation advisory firm or business broker with expertise in your industry can provide an unbiased assessment of the business's value. They can help you navigate complex financial data, market conditions, and industry benchmarks.
- Historical Performance vs. Future Projections: While historical financial data provides insights, it's essential to consider the business's growth potential and future prospects. What strategies can you implement to enhance BME in the first 12 to 24 months of ownership? These projections should be realistic and based on thorough market research.
- Confidence in Management and Operations: Your confidence in achieving BME hinges on your understanding of the business's operations and the competence of its management team. If you're planning to make significant changes post-acquisition, ensure you have a well-thought-out transition plan to maintain or improve earnings.
- Negotiating Price and Terms: Armed with a solid understanding of BME and the value of the business, negotiate the purchase price and terms with the seller. Be prepared to walk away if the price doesn't align with your assessment of fair market value and potential BME.
- Contingency Planning: In case BME projections aren't met in the early stages of ownership, have contingency plans in place. This might involve additional investments, operational adjustments, or alternative revenue streams to safeguard your investment.
- Continuous Monitoring: Managing 'value exchange' risk doesn't end at the purchase. Continuously monitor the business's performance against your BME projections. Be ready to adapt and make strategic changes as necessary to achieve or exceed your financial goals.
In a nutshell, managing the 'value exchange' risk in a business purchase involves a combination of thorough research, expert guidance, and a clear understanding of the business's earnings potential. Remember that each business acquisition is unique, and the strategies to mitigate risk will vary accordingly. By diligently assessing and managing this risk, you can increase the likelihood of a successful and profitable business purchase.
