News Back FOR WHAT ITS WORTH Peter J. Butler and Keith A. Pinkerton Idaho Business Review Plan Now To Earn A Return Before you enter a deal, it's critical to plan how you'll earn a return on the investment. Consider the following real situation: Mary and Sam were enjoying retirement. After many years of hard work and sacrifice, they finally were taking time to relax and enjoy themselves. They had just sold their movie and video game rental business for an amount that was more than sufficient to fund their retirement. In fact, the transaction closed for $40,000 more than the closest competing offer. Several years earlier Mary and Sam had committed the business to a long-term lease in a prime shopping mall near a large residential complex. The large number of nearby homes allowed them to compete successfully with chain stores. However, the relatively high rent forced them to carefully manage the other operating expenses to maintain profitability. Thirteen months after the transacting, a ringing telephone heralded the vent that forever changed their retirement plans. The buyers' monthly installment check on the loan from Mary and Sam bounced. Their call to the business revealed a disconnected telephone. Much to their dismay, their old business had failed. Although Mary and Sam knew the buyers had limited resources, their confidence in the transaction was buoyed by the fact that the buyers had personally guaranteed the promissory note backed with the stock of the business. They knew that if the buyers defaulted they could always step back into the business and sell it to the next-highest bidder. Still, Mary and Sam had not counted on re-assuming control of a business that had changed drastically from the thriving operation they sold just over a year before. Three months after the sale, and upon expiration of the existing lease, the buyers relocated to a less expensive location. However, the new location came at a price. The buyers' sales plummeted as the supposed "loyal" customers switched to the now more-convenient chain stores near their homes. Within three months, revenues at the new location had dropped by more than 50 percent from previous levels. At the reduced sales levels, even the lower rent payments did not make the business profitable. The buyers then attempted to lower their costs by ordering fewer copies of first-run movies. However, this course of action led them to increase late fees to avoid continual out-of-stock situations on popular titles. A little more than a year after the transaction, Mary and Sam were the proud owners of a now-worthless stock in a failed video rental store. Among numerous other problems, the lease signed by the buyers had a five-year term. Cleaning up the mess occupied the next three years of Mary and Sam's lives and forced them to completely re-evaluate their retirement plans. Start planning with the prize in mind. This means analyzing not only the amount you will receive from a particular exit strategy, but also its attendant risks. In the case of Mary and Sam, with the benefit of hindsight, the best choice would have been to accept the all-cash offer - even though it was $40,000 less. Cash always eliminates the risk of default. As Mary and Sam would attest, payment details of the outright sale are paramount to whether the transaction is a success or a failure. An important common denominator for all exit strategies is that successful ones do not happen overnight or without planning. Peter J. Butler, CFA, ASA and Keith A. Pinkerton, CFA, ASA at Hooper Cornell, PLLC specialize in the valuation of privately held companies and assist owners in maximizing the value of their businesses they can be reached at 344-2527. Back |