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Investing in New Equipment When Selling a Business
As a general rule, you should not invest in new equipment or other hard assets when in the process of selling your business, unless it immediately increases your cash flow. Improvements to cash flow can come from both increased revenue and decreased expenses. Why shouldn’t I invest in new equipment or other hard assets? Reason: You are highly unlikely to recoup your investment upon selling your business. Buyers value businesses based on cash flow. They multiply cash flow to arrive at a business value. There are only two parts to the equation – the multiple and cash flow. They may appreciate your investment in the new equipment but they are unlikely to assign any value to it. If the buyer is considering two similar businesses, then the age and condition of the equipment may be a determining factor, but cash flow always trumps everything else.
The type of buyer that is likely to pay the most for your business does not have direct experience in your industry.
Two Main Steps When Dealing with Buyers
Step 1 – Attracting Buyers
This involves advertising your business for sale and convincing buyers to respond to your ad and request additional information. Buyers consider a limited amount of criteria when initially looking at your business. Their main criteria are cash flow or profitability. Few will take into consideration the investments you have made in new equipment or other capital assets. In other words, investing in new equipment will not produce a higher response to your ads, because this is not their initial prescreening criteria.
Step 2 – Convincing Buyers
After you have attracted the buyer and they have responded to your ad, you must now convince them to buy. The buyer will now consider a wider range of criteria once they are closely inspecting your business. Part of this criteria is the current condition of your equipment. Let’s examine the buyers criteria at this stage in more depth.
Buyers main criteria for buying a business is cash flow or profitability. Anything you can do to increase the cash flow of your business will have the greatest impact on the salability and ask price of your business. Only buy new equipment if it immediately increases your cash flow.
Two Ways to Increase Cash Flow
Increases in Revenue
If the equipment immediately increases your revenue without having to market or sell a new service, then you should perform a calculation to see if the investment in the new equipment and resulting increase in cash flow will have a positive ROI for you. This will not be true in 99% of cases.
Decreases in Expenses
If the equipment immediately reduces labor or other costs, then it may be a wise investment. This needs to be handled on a case-by-case basis.
If the new piece of equipment is nice to have, or represents a new product or service line you could pursue, then we recommend holding off on this investment. Point out the opportunity to the buyer, let them decide if this is something they want to pursue, then let them make the investment.
The type of buyer that is likely to pay the most for your business does not have direct experience in your industry. If they do have direct experience, then they will not see as much value in the goodwill of your business, or the training that you are willing to offer. They will, therefore, be willing to pay much less for your business than inexperienced buyers. Experienced buyers will focus on the age, condition, and type of your equipment, but you shouldn’t target this buyer because they don’t pay as much as buyers without direct experience. Of course, there are exceptions, but this is the general rule.
You should target buyers that have no or unrelated experience to your industry. These buyers will pay the most for your business. They value immediate cash flow, training, and support when looking to buy a business. Ironically, they pay little attention to the condition and type of equipment you have.
Which business would you rather buy?
Profit of $20,000 per year. Asking $150,000 – A restaurant with beautiful improvements, all new equipment, and a state-of-the-art POS system. A total of $250,000 was invested in the restaurant.
Profit of $100,000 per year. Asking $150,000 – A take-out pizza shop with no dine-in area and limited equipment.
From our experience selling hundreds of businesses, we estimate that between 95-98% of buyers would not even want to look at Business A. They wouldn’t even take a look at it if both businesses were presented to them.
Save your money. Hold off any investments in your business unless it immediately increases cash flow.