Losing Focus – Business Decline During the Pharmacy Sale Process
On lists of deal-killers, this obstacle is often near the very top. Nothing is more important than keeping your focus on maintaining the operations and profitability of your business while you are involved in the sale process.
Owners losing focus happens often for two reasons: (1) after going through the emotional decision of making the decision to sell, some owners mentally check out and spend significant time focusing on their after-sale life; (2) some owners become too focused on the sale process at the expense of maintaining their business.
This is a huge obstacle and here’s why. Your business’ value is primarily based on it’s profit. Buyers, their advisors and their lenders assign more importance to the most recent fiscal year’s profit than previous fiscal year’s profit. If your recent earnings are less than previous earnings, the recent earnings will depress the value of your business.
An example of declining SDE with a $135,000 negative effect
Let’s look at an example using three years of the same EBIDA numbers, but in a different order. Let’s assume increasing annual EBIDA as follows: Year 1 EBIDA = $250,000, Year 2 EBIDA = $300,000 and Year 3 EBIDA = $315,000. The three-year average of EBIDA is $295,000, and at a multiple of 3.0, the business is valued at $885,000 (3.0 x $295,000).
Now let’s assume the same numbers in decreasing order: Year 1 EBIDA = $315,000, Year 2 EBIDA = $300,000 and Year 3 EBIDA = $250,000. Because the most recent year is substantially less than the previous two years, the buyer, his advisors and lenders are only going to value the business based on the most recent years EBIDA ($250,000), not the three-year average EBIDA ($295,000). Valuing the business at a multiple of 3.0 on the $250,000 of EBIDA yields a valuation of $750,000. That’s $135,000 less because the current year’s EBIDA was less than the previous two years’ EBIDA. It is a very important concept to understand.
The same concept applies to your interim earnings in the year of your attempt to sell the business. Buyers, their advisors and lenders will always request to see a comparison of your current year-to-date earnings vs. previous year-to-date earnings for the same period of time.
Continuing the example, but with a 33% reduction in value
Again, let’s look at an example. Let’s make the same previous assumptions where the business was valued at $750,000 based on the most recent year’s EBIDA of $250,000. Let’s assume you file tax returns on a calendar year ending December 31 and you receive an offer for $750,000 on June 15 with closing scheduled for August 15. The buyer, his advisors and lenders are going to request to see your financial statements for the six months ending June 30 of the current year (Year 4) and will want to compare those results with the first six months of Year 3. If we assume your business is not seasonal and earnings occur pretty much on a straight-line basis, as of June 30 of Year 3, the earnings would be $125,000 (1/2 of the $250,000 EBIDA of Year 3). If you provide six-month financial statements for Year 4 that show less year-to-date EBIDA than Year 3, there’s going to be a big problem, resulting in either termination of the transaction or a downward adjustment to the purchase price.
Let’s continue the example. If you have a six-month Year 4 EBIDA of $90,000 vs. the $125,000 EBIDA of Year 3, it appears your projected EBIDA for Year 4 would only be $180,000 (2 X $90,000) vs. the $250,000 EBIDA of Year 3. Now a buyer can legitimately argue, at a multiple of 3.0, the business is only worth $540,000 (3 x $180,000). In addition, at a level of $180,000 of EBIDA, the threshold for achieving a 3.0 multiple may no longer be valid. At a multiple of 2.8 times the Year 4 projected EBIDA of $180,000, now the business values at $504,000. That would be $246,000 less than the $750,000 offer you accepted, a 33% reduction in value!
Maintaining focus is extremely important
Until due diligence is completed, including the buyer’s review of your interim operating results, the buyer can usually escape the transaction or attempt to renegotiate the offer. Can you see how difficult it would be to successfully resolve the situation created in the example above? After seeing the interim results, the lender will not finance the transaction at an acquisition price of $750,000. The buyer and his advisors will want to renegotiate to a level of about $500,000 to $550,000. The seller will not want to accept 25 – 33% less than the original offer. Unless the seller gives in, this deal is likely to fall apart and the seller will likely have to take the business off the market if he is unwilling to settle for less than his original asking price.
The example above is a painful scenario, but it happens – way too often. As a result of the seller not maintaining the profitability of the business during the sale period, he’s wasted his time, the buyer’s time, the broker’s time, the advisors’ and lender’s time. In addition, by this time, significant dollars have likely been spent by both parties on professional advisory fees. It’s a shame.
Two things to learn
1) Keep your focus on the profitability of the business, especially during the sale process; and 2) If the new fiscal year has already started before you decide to sell, and you know the results are down, take that fact into account when setting the asking price.
Lesson two above parallels the advice to disclose issues upfront. If you know your interim operating results are going to be down versus the previous fiscal year, disclose it and position it the best you can. But don’t ignore it. It’s not possible to conceal it. Your interim results will be examined and will be a deal-killer if you are not prepared to consider them in your negotiations.