• Sat, May 23, 2020
  • Can a Distressed Business Sell?
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  • There is little question the present COVID crisis is impacting every small business.  Having spoken to many business owners over the past two months, I see businesses falling into three categories:

    1. Businesses where the virus has increased sales, e.g., grocery stores, liquor stores, on-line education, etc..
    2. Businesses where the virus had little impact, e.g., pool routes, pest control, electrical contractors, etc..
    3. Businesses where the virus either had them shut down or operating at a severely reduced capacity, e.g., gyms, sit-down restaurants, hair salons, etc..

    The Time to Act is Now!

    For business owners falling in the third category who have not accumulated enough cash to weather the shutdown/slow down and the struggle to return to success and profitability, they may want to think about selling now for two reasons:

    1. Timing is everything.  Soon, there is likely to be a lot of businesses in your industry on the market.  The sooner you decide to sell, the less competition you will have for your business.  The laws of supply and demand say that you will be able to receive some value for your business now then after the glut of distressed businesses hit the market.
    2. Value will continue to decrease.  If the restart is prolonged, buyers will begin to account for the decreased revenues and owner benefit when valuing your business.  At the moment, your business has only been affected for a few months where financials are easily explainable and a buyer may be more willing to forgive the past few months.  Will a buyer be more forgiving of six or nine months of depressed revenues and owner benefit?  I doubt it.

    So, what exactly is a “distressed” business?

    We define a distressed business as any business where either:

    1. In a smaller operation, e.g., owner/operator business, the owner benefit is not sufficient to pay the owner a fair market wage for their time and effort operating the business.  For example, if you owned a vacation rental company that normally provided $100K annual owner benefit and you worked the business 40 hours per week you might expect to be paid at least $60,000 per year to manage the business.  If the business during COVID was shut down and the prospects for post COVID are only expected to generate about $2,500 per month ($30k/year) in owner benefit due to numerous cancellations and on-going fear of travel, you are a distressed business.  $2,500 per month normally isn't enough owner benefit to attract a buyer.
    2. In a larger operation where a buyer would expect to finance the purchase, after paying the owner a fair market wage for their time and effort, the business cannot support debt service payments.  For example, if you are a large fitness gym with month-to-month memberships and you were doing about $300K per year in owner benefit before COVID, you earned zero revenue during the shutdown, and are now seeing only a very slow trickle in of past customers.  It may take a year or two to return to that $300K, or it may never happen again.  A typical valuation on that $300K owner benefit would be $750K.  If you bought with an SBA Loan, your debt service would be about $85K.  Let's say again that a fair market wage for a fitness center manager is $60K.  If the business is not producing $145K ($85K + $60K) in owner benefit post COVID, it is a distressed business.

    What Does This Mean for a Buyer?

    There are three primary considerations for a Buyer:

    1. Depressed Valuations.  Depressed revenues and owner benefit translate to lower valuations.  Businesses meeting the definitions of a distressed business will be hit even harder.
    2. Leverage to Negotiate.  As mentioned earlier, as more similar businesses become available in the marketplace, supply and demand dictate the Buyer is more likely to have the upper hand in negotiations.  
    3. Higher Risk.  The one downfall for a buyer is that buying a business that is distressed is riskier than buying a healthy business.  What if the customers do not return?  What if the downturn creates a competing product or service?  

    What Does This Mean for a Seller?

    There are five primary considerations for a Seller:

    • Something is better than nothing.  How long can you keep the lights on?  How long can you work for a significantly reduced income?  It is better to sell now when there is still some perceived goodwill vs. selling later when all you can obtain for the business is the sale of the assets.
    • Walk away with no debt.  If you have any outstanding debt, you may be able to cover that debt or negotiate a partial release with a quick sale. 
    • Save jobs.  A sale to a better-capitalized buyer may save your employees' jobs.  A buyer that has the capital to operate the business while the business and economy recovers is more likely to keep your people on payroll.
    • Low valuation.  In a perfect world, you would be selling a healthy, profitable business.  Unfortunately, that is not the present situation.
    • Low leverage.  A distressed Seller, who is working for a reduced income, or possibly even working for free, is in a poor position to dictate terms and conditions of a sale.

    If your business fits the definition of a distressed business, there may be options.  Contact us today for a complimentary review of your business and an assessment of your business's present value in today's market.

    Eric J. Gall
    [email protected]