Hey everyone it is David Barnett once again and this week I am answering the viewer question: Is it a wise move to buy a failing business and turn it around? In my opinion, no it is not wise at all. Here is why, there are industry associations of turn around experts and they are successful less than half the time. My advice to everyone out there when they go looking to buy a business is to find a business that is profitable number one and number two does have problems that you know how to solve. What does this do for you? It creates an opportunity where you have a positive cash flow from day one but you are able to employ your knowledge and skills to fix the problems and improve the business. And it is in improving the business and expanding the cash flow that you make your big gain or profit as a business owner.
Businesses are valued on multiples of cash flow, so if you can buy a business that has a cash flow of $100,000 you get in there and you fix it so that your cash flow is $250,000. Your gain is $150,000 a year while you own the business but your real gain is that you have increased the businesses value many fold over by that increase in profitability. So if you bought the business for 3 times cash flow, you bought it for $300,000 and now you have increased that cash flow to $250,000 now it is worth $750,000, more than double the price you paid for it. So, buy a business that is profitable that has problems that you know how to solve. So that you can improve it, this is the safest course of action.
he only scenario that I can think of where it might make sense to buy a failing business would be in a strategic acquisition. So, let’s say you own a business, let’s say it is a paving business or a roofing business or something like this maybe commercial glass. So you own this business already and another failing competitor is going to close if they can't find a buyer and you look at that business and you say. If I had their customers and I got rid of all their overhead and administrative staff because my staff can do the work and I got rid of their facility and I got rid of whatever expenses that you can look at that you can get rid of and add their sales to your existing business. Then perhaps there is an opportunity for you to buy that failing business and do well with it, by doing a consolidation between the two companies.
But that is the only kind of scenario I can imagine where I would actually recommend someone buy a failing business. And in that case it would be very clear that this failing business would have no good will and you would simply be paying for whatever tangible goods that you are acquiring; equipment, machinery and inventory and on top of that you would probably be buying it at a discount. Because, if you didn't buy it they would probably end up closing and going out of business and you could just buy all of that stuff from the auctioneer later on anyway. So, and you empathize to buying it before close would be to get the customer list obviously and try to maintain those relations and not have a disruption in service to the customers.
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