Business evaluation can be tricky process. There are hundreds of factors that you have to take into account before you unload your cash on some pour soul who only wants to make as much money as they can from the sale of their venture.
One of my banking buddies once said: “If you really knew the business, you probably would not be buying it”. He could not be any closer to the truth. The fact is, if you knew everything the current owner knows, you probably would never spend a penny on buying the business, because you would know the underlying truth about all the problems you’re going to inherit as you try to breath new life into the venture.
While you might not know everything about the business, you can learn a lot by using a few of the tips I’m going to share with you. Most buyers on sites like Flippa like to ask for traffic stats, some type of screen caps on earnings, and then ask any off-the-wall question that makes them feel better. Then they dump their money into an escrow and call it a day, only to figure out months later that their investment is not panning out.
This illustrates my 1st rule: Ventures that are publicly listed for sale are not in good shape, are failing, or are out-right scams. But this does not mean they are all bad investments. This only means you should think a little more about your evaluation before you post up that bid.
Most of these ventures are failing because they have no real growth, the owner’s personal expenses are eating up the earnings, because of bad marketing, bad design, they have a bad idea, or the industry has shifted in some way that has left that company – or all companies in that industry – in a bad position. There are millions of things that could create a bad investment, however most of the time it is one of the above. Luckily, with the Internet, you can research most of these factors within a day or two, as well as give the seller some hard questions that will test the skills of people who are trying to hide the truth about their business.
Here is my 2nd rule: I never buy ventures that are failing because the venture is heading towards zero in earnings. If they are doing bad why buy them on the way down? Just wait until they have crashed and burned, then go and buy what is left from the owner at that time. There is no point in paying to lose money, when you can get the venture at rock bottom after they go belly-up. Besides, the company has only one direction to go in after that.
My 3rd rule: Grill them hard. Who cares if they say it could, or should, become something bigger. Could, should, and would is worth nothing. It is an excuse made for suckers who accept it as their answer to buy. Only care about what is happing now, not what could happen in the future.
When looking at any venture you want to get all the data you can. If the company was started 12 months ago then get all 12 months of financials, broken down by income source and expenses month-by-month. Never accept lumped expenses, estimations, or yearly sums in a case like this. If the company is 5 years old, ask them for their tax filing and yearly financials summed up by year. Then ask for the current year on a month-by-month basis. If applicable, get the balance sheet for those years as well. In this format, unless they are planning to out-right defraud you, it is hard to hide the truth.
My 4th rule: Most sellers are delusional on their evaluations and will try to force the hand of the buyer to pay too much for the venture. Never fall for it! Flipp’s stats show that 35% of their listings are successful at selling, while acquisition statistics within the United States show that only 2% of businesses are successful at being sold. Why listings never get sold is because the sellers have their heads in the clouds when it comes to evaluation, and refuse to see that their company is really bad off, or is nowhere worth what they think it is.
In the brick and mortar world of business most businesses evaluate at 0.5-10 times their yearly earnings, depending on their stance. If the business is shrinking, don’t expect much more than 1 times. To reach 10 times yearly, they normally have to have a yearly growth rate of 20% plus per year, proven over a couple years span. As most of us know, in the world of Flippa, websites are priced at 1-30 times their monthly earning, with most deals being closed at around 8-12 times their monthly earnings.
Just the other day I talked to a guy that had a website with revenues of around $2,500 a month, and a net earnings of about $980. Can you guess what the company evaluated at? After I asked some very basic questions, and requested access to his Google Account and financials, I made a pre-offer of around 10 times his earnings, he snapped back at me that is was worth no less than 26 times his earnings.
His company was less than one year old, it has already seen its explosive marketing, and was on a level point. Where it would go from there was anyone’s guess. I liked the site and was willing to pay 10 times the earnings simply because the owner’s design looked like something from the early 1990’s. He was over-paying hosting by 3 fold, and was missing 2-3 other revenue options that could make the site a million-dollar venture, if it all worked out. So, instead of offering 6-8 times his earnings, I felt I could hit a home run at 10 times and everyone would be happy.
Because he was so stuck on getting 26 times his earnings the site never sold to me, but someone else took the bate and offered 20 times earnings. Now they have to hope the site will double, if not triple, within the next year to adsorb all of that risk and capital they just invested. Unless it’s a home run, they will most likely lose the money they invested and then some.
Another business friend put it this way: “Businesses are VERY high risk, so when you invest in such small businesses you want to get 89% of your investment back within the first year”. What he is saying is this: as the business continues down a time line it is going to get even more risky for you to get your money back. So, when you pay 2 or 3 times the yearly earnings, or more, you’re upping your risk, as you must make the company profitable over a longer life cycle to get your investment returned. If you can fit the risk into the rate of return and growth, you can at least return some of your capital and move onto another investment, having learned your lesson, instead of writing down years of capital with just one investment.
This brings us to my 5th and final rule. This rule you never bend or break. Never. Get a business attorney to write the contract for you. I don’t care if the deal is $5k, $100k, or 9 million. Most sellers and buyers never get an attorney to write up the agreement. They go on word of mouth, or some shoddy agreement that one of them wrote or copied off of some website. Everyone that I have ever acquired or sold a domain or website to got an acquisition contract from me. If they refuse to write up an agreement they are shady and you are better off getting the hell out of that deal. Contracts clear up any questions anyone may have, and take care of people who are trying to trick you into buying a bad business.
When it comes to legal stuff, you want to insure that the company has no pending lawsuits and that, if it does, you’re not on the hook for those lawsuits after you buy the venture. You also don’t want to buy something and then learn that the domain or content is trademarked or has copyright owned by someone else and have to pull it down, losing your value or, even worse, getting sued. Additionally, you want to lock the seller from being in that type of business venture for 3-5 years, and make sure that they will not solicit your customers for anything else. You also want to insure that they are going to provide transitional support. This way they don’t get the money and leave you high and dry trying to figure how to run the business.
Lastly, the contract should include something that will bind them to what they said about the business. This helps shake off the people who falsified their financials or traffic, or plan to remove links or other items from the business that would make the company collapse. Always start off with an NDA (Non Disclosure Agreement), move to a LOI (Letter Of Intent), then move to the contract. If you follow these steps, and apply them to your best, you will find that your deals go better. You get what you paid for, and by following these steps you will know more ahead of time – before you get in too deep and lose a lot of money quickly.
Each week I look at over 30 ventures to buy, and each week I turn them all down. Every 2.33 years I find one business that has the amount of growth I want, and I buy it like a mad man.
I have heard people tell me they can not tell me who the hosting company is, so I looked it up with ARIN and learned that the hosting company was not able to give us the server the site was on, or sell us a new server to put it on at the price the owner was paying, thus making the business dead on arrival once the cash was moved into the sellers hands.
Another seller, after I had forced his hand to give me the numbers the way I wanted, looked over everything, and made him tell me all but one of the income sources, told me he would not tell me the name of a client. I walked away, as I thought it was not a good deal. He had preached for weeks about how it was a sure-hit business and would make 19 times more per month within next 12 months. After I walked away, he blasted me with an email saying I was just going to build the business myself, since I had all the information about his business. Then he added that, since I did not have that one client’s name, if I attempted to create the same business it would never make a profit. With that one statement he acknowledged what I had concluded: without that one client, whom he may not be able to find anywhere else, he would be in the red. And if that client split, found the same services cheaper someplace else, or anything else happened, the business would be dead.
Remember: unless they are trying to defraud you all the way, they cannot hide the truth when you ask for hard numbers and solid contracts.
This article is only intended for entertainment value and should not be used for legal or investment advice. Please seek help from a qualified business professional before taking any actions related to topics presented in this article.
