Step 1 Valuation Benchmark
A man wanted to sell his services business and retire, simple enough. My client had the cash and was eager to buy it. No agreement had been reached yet, so I went with my client to visit the seller to work out some details of the purchase. As we sat in the seller’s conference room and started discussions, I noticed the seller was extremely motivated to get a cash deal done quickly. Red flag #1.
However, the terms of the deal kept changing every time he opened his mouth. At first, he would offer to sell the business for X dollars, then Y dollars, then Z dollars. It was a moving target, red flag #2.
I suggested we structure the deal as an asset sale, but the seller was adamant that it be a stock sale. Red flag #3. As we talked more, I discovered there had been a law suit, some time ago of course, but the seller said it had been resolved. It was a sexual harassment suit by a former employee. There are certainly situations where a stock sale makes sense, but generally I try to structure deals as asset sales, primarily to limit potential liabilities. (See your attorney for legal advice.)
The seller offered to indemnify my client from any potential liabilities. My client was eager to buy the business since it offered a good return on investment. He was satisfied with the indemnification, but I was not.
I recommended to my client that he “just say no” to this opportunity and look for something else. I explained my reasoning as follows:
- If the law suit was indeed settled, then the seller should not care if it was an asset sale. (See your tax advisor for tax advice.)
- The seller’s indemnification was only as good as his personal financial ability to pay for any damages. Of course, we did not have a copy of his personal financial statement, but I would not have moved forward under these conditions anyway.
- Finally, I learned the seller was planning to move to another country in Central America to retire (true story). So, I advised my client that not only was his indemnification shaky, but he would have to chase the seller to a foreign country to get money if there was an issue, which could prove time consuming, difficult, and expensive.
We passed on the deal. We later learned the seller sold the business and moved to a foreign country. We also learned the sexual harassment suit had not been resolved and was still active. Crisis averted.
The terms of the deal are as important as the price, sometimes more so.
Also, if it looks too good and easy to be true, then it probably is.