I wonder if business owners who are willing to purchase a business take the same sort of view as when they are buying stock in the stock market. Let’s think about the way Warrant Buffet looks at a business and decide if we could be using those similar successful strategies. Those strategies tend to be summed up in a very concise manner: ensure the industry prospects are favorable, and make sure you understand what you are buying.
Many owners I meet want to buy businesses, or franchises, in an industry that they do not understand at all. If you cannot completely feel good about knowing the real sales potential, expenses, the cash flow cycle of the business, then you should not purchase that business.
Many business owners like to focus on buying a business that has been either poorly managed or abandoned by its earlier owners. While there are obviously some nice turn around stories out there, more often than not these kind of transactions become huge challenges and financial nightmares. Simply speaking: The business was cheap to buy for a reason!
The people aspect of purchasing a business is also vital, and great investors such as Buffet place a large emphasis on management. Clearly the business purchaser has the focus of either replacing management or keeping management. Logically, management that focused on the bottom line and long-term growth are to be extremely valued.
Then, it gets down to ‘price’. Business acquirers should focus as much on net income and return on equity. That is the key area in a Buffet type purchase decision.
Our legendary investor, Buffet creates a formula which he calls owner earnings – the formula is:
Net profit + deprecation – Capital assets needed
We would agree that this is a great way to look at profit potential in any business being acquired.
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