Consequences of Over Paying for a Business
March 11, 2025
by a searcher from Morehouse College in Washington, DC, USA
I wanted to share a post because I just met a third business owner in the last 2 months (one of which is a close friend) that is experiencing major headaches, pain, and depression from overpaying for a business. I love entrepreneurship and believe it is the best way for an ambitious person to become wealthy. Buying a business isn't easy and sometimes it feels like you just have to take the Band-Aid off and hop into it. I understand and have been there myself. I've jumped into the deep end and had sleepless nights thinking about how I would cover my $12K payroll, or consistently make a $10K lease payment for the next 10 years or consistently attract customers to sustain the business. We took the plunge swam through the deep end and are now on the other side. (FYI now my payroll is $90K a month and lease obligations are $40K a month, but with that being said I sleep better now than I ever did LOL). I don't want to discourage anyone with this post but I also want everyone to have their eyes wide open. Take the rose-colored glasses off. Forget about how nice it will be when the business is running like a well-oiled machine and you're off looking at the next venture to scale your empire. Be logical when purchasing a business. Know your numbers and walk away if the seller won't budge. There is always another business for you to buy. No business is perfect and buying the wrong business can completely derail you.
The biggest challenge we face as searchers is finding a good deal that maximizes the upside while also limiting the downside. When looking to acquire a business the bank, the broker, and the seller want to close the deal and will create a sense of urgency that you need to close quickly. My friends I say to you, to take your time and be patient. Search for a good deal and don't overpay with the hope of growth in the future. Stick to your numbers and plan for the worst while hoping for the best. I'm seeing more and more deals where the business valuations are so inflated that the net income they currently generate will all go towards debt service following the acquisition. As a searcher you don't have the luxury of big funds that can throw money at a business and hope it sticks. We are putting our names, houses, and credit on the line for a shot at becoming millionaires. We are not here to play the lottery or hope that we hit it big. As buyers we need to know where that cash flow is coming from week after week, month after month, year after year. If you don't know where that Cashflow is coming from or are thinking you can generate it yourself through strategy and marketing than I say is the risk of being wrong worth it?
Please don't let this post discourage you. Look at this post as a reminder to think twice. Trust your judgement. Scrutinize the seller. And know where your cash is coming from your first day in business. Message from an unbiased Entrepeneur that wants to see us all succeed.
from The University of Chicago in Chicago, IL, USA
Whether you pay 3x or 4x, one would have challenges mentioned in the post, which I totally agree, if one has not done proper homework of annual, monthly and weekly cash flows. Higher price only reduces ROI, it does not create the challenges mentioned in the post. The problem is magnified when D/E is high., which occurs when equity is low. Prior to Searcher class, deals were getting done with 20% PURE equity plus, shareholder having some dry powder Today, capital stack consists of 5-10% equity including preferred. A DSCR of 1,5 DOES NOT MEAN you can service the debt. A buyer must calculate after-debt-service cash flow. That requires doing pro-forma with transaction structure, price allocation, and more. Even when one does all this, one has to look into monthly/weekly swings, payroll cycle, etc. It is unfortunate that ETA is focused on becoming wealthy with no money (or little) out of pocket.
There is a max debt (for given terms) that a business can support. As equity reduces the ROI goes up big time but the risks to absorb shock goes up exponentially. Such high ROI creates the room to share the ROI with preferred which further increases the risk to absorb unknowns.
I agree with the end result that ^redacted is mentioning but not with the primary cause being overvaluation. 3x is more expensive than 4x when buyer is driven more by the price than the fundamentals of the business. It is my observation that post-searcher era valuation is lower than pre-searcher era valuation.
from Keller Graduate School of Management of DeVry University in Tampa, FL, USA