How do you manage capital costs and sell a business?
Almost without exception, a business is sold for its Fair Market Value (FMV).
FMV is recognized in law as meaning that a business will only sell once the buyer and seller have exchanged complete information. This includes not only the business and its operations, but also key information essential to each party. This allows them to make an informed final decision.
FMV also means that neither party has to or must do the deal. That is, neither party is subject to outside pressure forcing them to make a decision.
For example, suppose the seller owns a business in California and owes a third party, such as a lender or the IRS, money.
In that case, this may be seen as an outside pressure that’s forcing the seller to sell the business in California. Consequently, it affects their decision to the point that the business is not being sold for FMV.
Buyers Look for Value when Buying a Business
Recently, I’ve seen three sellers trying to sell their businesses in California, but have been unable to reach their expected price due to decisions they made regarding their businesses.
The first example concerns a grocery store that the owners have owned for just 14 years. As part of owning the business in California, it also included the real estate. One of the challenges in trying to sell their business was that during their 14 years of ownership, they had done very few capital improvements. This meant they had not upgraded the lighting, flooring, heating, or air conditioning. Nor had they made other capital investments to present the business as an attractive place to potential buyers to conduct business.
The business’s financial performance was strong, generating well over $250,000 per year. The business had no direct competition, or the location of the nearest competitor was over 2 hours away. The business had well-trained and qualified employees, which was another valuable asset. However, the only negative factor prevented the business from selling. It required a series of capital investments to upgrade the business’s appearance and overall look. This had been delayed too long. What was frustrating to the sellers was that there was good buyer interest. Yet no buyer was willing to offer close to what the seller wanted. This was because they would have had to make the capital investment improvements. Buyers felt that the seller should be willing to cover part of the cost, as it had been delayed too long, and a significant amount was required.
A similar situation occurred with a pizza restaurant I was asked to sell. The business had been under the same ownership for over 38 years. Although it was closed on Mondays, it had a very loyal clientele that came back year after year.
The Importance of a Business Valuation and Guiding the Sale of a Business
When the business valuation was compiled, it totaled over $725,000. However, the market was not willing to pay that price, as little to no capital improvements had been made. Moreover, they were well overdue.
In this case, the seller was highly motivated to sell, as they were in their early 70s. Thus, they accepted an offer that was approximately $225,000 lower than the valuation, allowing them to retire.
Part of the complication in this transaction was that the business owner in California and the landlord were unable to agree on who should pay for all the capital improvements.
The seller wanted the landlord to cover some of the costs, but since a new lease was in place with several years remaining before it was due to be renewed, the seller had no bargaining power.
Importance of Making Capital Improvements
The cost of capital improvements is comparable to other costs associated with owning and operating a business.
It’s tempting for the business owner in California to delay the work, as it requires a lot of time and effort. Also, it generally costs more than expected and serves as a distraction from the day-to-day operations of the business.
A valuable lesson can be learned from larger companies, as it is simply part of their business.
Where I live in California, it’s easy to see Starbucks in full swing, making capital improvements and investments. Even though it often doesn’t seem that this work is necessary.
Planning for Capital Improvements
If you adopt the right approach, making capital improvements can be a win/win/win.
If you lease the property, you will know when your lease is up for renewal.
Plan to discuss capital improvements with the landlord and see if they are willing to contribute to part of the cost. Most landlords are motivated to keep the building as presentable as possible, as ignoring it would lower the rent they can charge and the price they can get if they try to sell it.
Some capital improvements, such as solar or renewable energy upgrades, can be eligible for subsidies or incentives from utilities or government programs.
Benefits of Capital Improvements
Making capital improvements also provides an opportunity to engage in conversations with your customers and gather their feedback.
Bella Bru is a coffee shop I frequent in Carmichael, CA, where I live.
The business is open 7 days per week, and I rarely see the owners, but I talk to their employees every time.
The business is currently undergoing a significant upgrade that’s taking several months to complete. Rather than being overly pessimistic, the employees explain what’s happening and why, and present it in the most positive light possible. That is, they are handling the disruption very well.
Strategies for When Unable to Do Capital Improvements
Capital improvements typically follow the business cycle. If you are unable to undertake capital improvements, consider the following strategies.
- The first strategy is to acknowledge that they are necessary and not simply ignore the need. If you plan to sell your business and it is not yet complete, inform the buyer accordingly. If you pretend it doesn’t exist, what else will you pretend doesn’t exist?
- Capital improvements cost money. Be prepared to provide the buyer with a discount on your asking price if they spend their time managing and organizing the capital improvements. Encourage the buyer by suggesting that this is a good idea, as they can complete the capital improvements at their own pace. This way, the buyer can choose the design, colors, and materials.
- Some capital improvements will need to be depreciated, and others can be written off in the year of purchase to reduce the amount of tax the business pays. Highlight these benefits to the buyer.
- Inform the buyer that implementing capital improvements will attract new customers and encourage existing customers to increase their spending. Customers love a new environment for doing business.
- If you wish to be brave and have an interest, suggest to the buyer that they purchase the business, and you’ll organize and manage the capital improvements as a separate project after the business sale closes.
Capital Costs are Critical
Capital improvements are a necessary part of being in business. They are too frequently avoided or delayed too long, as I’ve mentioned above, to the point where it hurts the business.
This negative impact is evident in the amount a buyer is willing to pay. Particularly if they are willing to negotiate to buy the business in the first place, it influences the amount they are willing to pay as Fair Market Value.
Are you considering selling your business and taking on your next challenge? Would you like to know the value of your business? For more information, please visit my website, Business Valuation.
For more immediate assistance with purchasing a business for sale, you are welcome to contact Andrew Rogerson, a certified business broker based in Sacramento, California. He services the entire state. Call Toll-Free at (844) 414-9700 or email him at support@rogersonbusinessservices.com.
Further reading
Sell a California Small Business: How Much Tax I Need to Pay?
Accurate Financial Statements When Selling a California Businesss