Should I Buy New Equipment Before I Sell my Business?

by Jacob Orosz (President of Morgan & Westfield)

Executive Summary

Should I buy new equipment before I sell my business?

As a general rule, you should not invest in new equipment or other hard assets when you are in the process of selling your business unless it immediately increases your SDE (seller’s discretionary earnings) or EBITDA.

Why?

Because you are unlikely to recoup your investment.

Buyers value businesses based on the cash flow (SDE, EBITDA) they generate. If the new equipment does not increase your cash flow, it likely won’t pay for itself.

While the buyer may appreciate the shiny new equipment, they are unlikely to assign enough value to it to justify your purchase of it. If the buyer is considering two similar businesses at the outset, the age and condition of the equipment are a small part of many factors they take into consideration. At the same time, the cash flow the business generates always trumps everything else, and buyers are always attracted to businesses with higher cash flow.

What an Investment in Equipment Has To Do with the Process of Selling a Business

To illustrate this point, let’s break the process of selling a business down into steps.

When selling your business, there are two main steps when dealing with buyers:

Step 1 – Attracting Buyers

This first step involves confidentially marketing your business for sale and responding to buyers who request additional information. At the outset, buyers consider a limited amount of criteria when initially evaluating your business. At this stage, their main criterion is the profitability of the business they are considering.

Few will take into consideration the investments you have made in new equipment or other capital assets at this stage in the transaction. In other words, investing in new equipment is unlikely to produce a higher response to our marketing campaigns. At this stage, the buyer’s decision focuses on just a few criteria — your multiple (asking price vs. cash flow), your competitive advantage, your growth rate, and perhaps a few other industry-specific measures.

Step 2 – Convincing Buyers

After we have attracted the buyer and they have responded, we must now convince them to buy. The buyer will now consider a broader range of criteria once they are closely inspecting your business. Part of this criteria is the current condition of your equipment. If a buyer doesn’t make it to this stage, then your investment in new equipment is moot.

The Importance of Cash Flow

Buyers’ main criterion for buying a business is cash flow or profitability. Anything you can do to increase the cash flow of your business will have the most significant impact on the salability and value of your business. As a result, you should only buy new equipment if it immediately increases your cash flow.

There are 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, you should perform a calculation to see if the investment in the new equipment and the resulting increase in cash flow will have a positive ROI for you. This will not be true in the majority of cases.
• Decreases in expenses. If the equipment immediately reduces labor or other costs, it may be a wise investment. If the new equipment will increase the profitability of your business by more than the cost of the equipment, it makes sense to purchase the equipment. The reverse is also true — if the new equipment will not increase the profitability of your business by more than the cost of the equipment, it does not make sense to make the purchase. To calculate how much the new equipment will increase the profitability of your business, simply multiply how much the equipment will reduce labor costs and, therefore, increase your EBITDA, and then apply your multiple. For example, if the equipment will reduce labor costs by $100,000 per year, and your multiple is 4.0, then the equipment will increase the value of your business by $400,000.

Conclusion

If the new piece of equipment would simply be nice to have, or if it represents a new product or service line you could pursue, we recommend holding off on this investment. Point out the opportunity to the buyer and let them decide if this is something they want to pursue, and let them make the investment.