Buyers need to be very careful about giving away future profits.
First-timers often are tempted to give a seller extra money in a purchase price based on the hope that the new owner will be more successful. The wastefulness of this type of thinking should be obvious. First, the new buyer should question why he or she thinks the company could be more successful under their leadership than under a person who has built the business from scratch, and who knows every aspect of that company, including all the customers and employees by name. Secondly, why should a seller be entitled to a piece of future profits?
The future belongs to the owner at that period in time. The past successes or sins of the past belong to the seller. A buyer might, however, offer something called an “earn-out”. In such a case, the buyer may offer a lower multiple of EBITDA, but than counter with an upside profit split for a short period of years ( 1 to 5 years) after the new owner takes over. An earn-out effectively ties the buyer and seller together towards a common goal, which is increased profit and success of the company.
Rule 5 means that no business fits into a standard valuation model.
Each deal stands on its own merits, and no two deals are the same.
Finally, Rule 6: The great lie.
One of the most delusional comments ever uttered by a business owner is “Small businesses are expected to lose money in the first three years”. This is often the words of a person who either owns a failing company or one who is trying to justify in his or her own mind that a failing business is worth buying. The first sign of a successful business is that it makes recurring profits. Profit and cash-flow are the engine by which a buyer gets money to pay a seller. Never forget the phrase that attempts to justify failure by masking it as the norm. That is a falsehood , and failure should not be expected or accepted by the SBE, its owners and its potential buyers.