Good Reasons vs. Bad Reasons

Posted on February 7, 2007

One of the most important things to understand about sellers is why they want to sell. Don’t expect that they’ll just tell you the true reason they are selling if they think it will hurt the price or likelihood of the sale. Here are two lists:  good reasons to sell and the reasons that should set off alarm bells.

Selling a business is a big change. Given that most people don’t want to change, something typically is motivating the change. If the seller’s business was about to hit the jackpot, trust me, he or she would not be selling.

Of course, there are legitimate reasons that a business owner would sell a business, even in good times. For your sake, I hope that the business you buy will be on the block for what I call a “good” reason. That means it’s good for the buyer.

Just as often, businesses are sold so that the owner can avoid an impending problem. He or she sees that the business will, in the future, perform more poorly, so better to sell it now. That’s what I call a “bad” reason.

It’s your job to discover all the reasons the seller is selling and to fully understand the impact they will have on your deal.

Without further ado, I’ll run through the checklist. First we’ll review the “good” reasons, then the “bad.” When you start looking at a deal, come back to this essay and use it to insure that you are being thorough.

Good Reasons

1. Retirement. That’s understandable. Not everyone wants to die with their boots on.
2. Burn-out/Boredom. It was fun for the seller for a number of years, but not so fun now. They want to move on. This is a good reason only if they have just begun to burn out. If they’ve been burnt out for a long time and have not been driving the business forward lately, look out.
3. Limits to Growth. The seller has a path to growth but can’t get there himself. He lacks something. It’s a good reason if you have what he lacks.
4. Needs Liquidity. This is a common limit to growth—the seller doesn’t have enough money to allow the business to thrive.
5. Death. Pretty hard to fake this one, and most won’t go this far just to get a better multiple on EBITDA!
6. Divorce. Divorce often requires liquidity—a legitimate reason to sell a large asset like a business.
7. Illness. Sadly, sometimes people get too sick to run the business.
8. Estate or Family Reasons. Sometimes the family needs cash, and selling the business is what is required. Or estate taxes are due, and the only source of liquidity is the business.
9. Shareholder Disputes. Most partnerships run into trouble. Sometimes the best thing is to just sell the firm. It’s true!
10. Sale of a Division That No Longer Fits In. This good reason relates more to conglomerates. Many times a great business is sold because it is too small or not a major area of focus for the main business.
11. Sale of a Subsidiary by a Foreign Owner. Another good reason, usually occurring in multi-nationals, or following an acquisition of a multi-business company.
12. Cash Needed for Another Part of the Business. Again, selling one division can generate needed cash for the main operation.

Bad Reasons

1. Competition Is Looming Large. The seller feels that in the next few years they will lose market share to strong competitors, and they wish to sell to a sucker who doesn’t realize that.
2. Construction Imminent. Important only for retail, but road construction or shopping center remodeling can last for a long time and kill traffic. The seller seeks to shift the pain to you.
3. Obsolete Products or Knowledge. Change is everywhere, and if the seller realizes that their big advantage is about to be obscured by new technology or products on the horizon, they will wish to sell before doomsday arrives.
4. Lease Problems, Impending Increase. More of an issue for some than others; be sure to understand what you will have to pay for your physical space. I’ve seen some old-line businesses in high-rent districts be profitable only because they had a very long-term lease at incredible rates. As soon as the lease goes up to market levels, they are gone. Avoid holding the bag when this happens.
5. Franchisor Problems. Much of the value of a franchise is based on the viability of the franchisor. Check this carefully so that you don’t buy in near the end of a franchisor’s life.
6. Aged Infrastructure About To Fail. Maybe the computer and phones work now, but how old are they, and how much life is left? Add to the caution, many-fold, if the business has lots of essential equipment. Look for the bubblegum holding it all together.
7. A/R Problems. Never assume that A/R is collectible. It the seller really wants you to assume the collection risk, look out.
8. Supplier/Creditor Problems. In some businesses, supplier relationships are everything. If you had several exclusive dealerships for equipment and knew that you were going to lose them in the next year or two, wouldn’t you try and sell quickly?
9. Changes in Marketplace or Technology. Some industries don’t last forever. Is this one in trouble, or is it going through changes that will hurt the business?
10. Increased Cost of Debt. If the business is heavily leveraged, and rates are rising, be sure to factor this into your projections. Some businesses are really interest-rate sensitive.
11. Hostage to Others. Hey, Wal-Mart has just become their biggest customer. Time to sell, so that as they demand price reductions that devastate your margins (but to which you can’t say no), you feel the pain and not the seller…
12. Buyer/Seller Strength Shift. The patent has three years left. Sell now, because without the patent, the seller won’t have the control over the customers like they do now.
13. Internal Conflicts: Loss of Key Employees. The technical genius quit or died, or the charismatic rainmaker has left and the business is coasting.
14. Union Agreement Problems or an Impending Strike. Wouldn’t that be a nasty surprise the month after closing on a deal!
15. Customer Concentration/Threat to Major Customer. Maybe the seller’s business is fine, but the dominant customer is in trouble—best to sell before the house of cards collapses.
16. Impending Regulatory Headache: Tax Assessment/Audits, New Laws, Government Prosecutions, etc. Legislation can make or break a business. Make sure you know the tides in this area before buying in.
17. Outstanding Stock Options, Undisclosed Bonus Plans or Similar Arrangements. Dig into these kinds of details carefully. They can represent huge surprises and often are in place for your most valuable employees—so you can’t choose not to pay them.
18.  Industry/Business/Economy About to Begin a Down Cycle. Of course every seller would want to sell near the crest of a cycle. And you want to buy just before the bottom of a downturn. Make sure you know where the cycle is before moving forward.

I’m sorry, you might now be feeling depressed. If so, re-read the “Good Reasons” section above!

Takeaways:

• Sellers won’t want to tell you the true reason they are selling if they think it will hurt the price or likelihood of selling.
• Be sure you fully understand the true reasons why the seller is selling.
• If they’re selling to avoid upcoming problems, be certain that you do know how to avoid those problems as the new owner, or that you’ve factored in the costs to the business.