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Every business owner dreams of creating a profitable and successful business that will last for decades and build a better life for the owner’s family. Unfortunately, thousands of businesses fail to make a profit every year. Owners may try to sell an unprofitable business in an attempt to recoup some of their costs.
How To Sell An Unprofitable Business
Living in Houston, Gerald Hanks has been a writer since 2008. He has contributed to several national trade publications. Before starting his writing career, Gerald was a web programmer and database developer for 12 years.
Alternatives to Business Bankruptcy Shareholder and Sole Proprietorship What are some of the constraints businesses face in maximizing their economic benefits? The Tangible and Intangible Benefits of Negotiations The Benefits of Buying an Ongoing Company Why companies tend to be cautious when investing What happens when a shareholder leaves a company? Right of first offer vs. Right of first refusal When is a merger or acquisition more appropriate than an IPO? What is the difference between a sole proprietorship and an LLC? Why do companies go public? Explaining Profit and Negative Cash Flow in the Same Accounting Period Sometimes we work on a valuation engagement where the company in question has a history of losing money. We are hired by a shareholder of the company owner as he is looking to cut his losses and sell. So what is a business worth with negative profits?
In most cases, the value of an ongoing business is based on income. There are many (many!) ways to create value, but for the most part, profit generates value. Due to? Think of yourself as the buyer of a fictional widget maker. The history of WidgetCo, Inc. it has very, very nice machines. Top of the line. State of the art Large office space too. But when you buy the business, do you care more about the machines and the office space, or the ability to use both for profit? In most cases, the answer is “profit” – these assets can be good…but they have to generate profits for you.
All right. WidgetCo makes a profit, we do magic and voila! Are you going to sell WidgetCo. But what if Widget has a loss history? What if all those machines in fancy offices weren’t making widgets? The situation got complicated. In these cases, we considered a number of factors:
It turns out that in many cases it is possible to restructure a company to make a profit. Sure, it’s hard work, but there’s no doubt that it happens all the time. (In fact, there is a cottage industry that focuses solely on this type of work.) To set a price, one of the first steps then is to rework the financial statements to present a “pro forma” indication of how WidgetCo might make a profit. To raise prices? Unprofitable “Fire” Customers? Eliminate excessive costs and expenses? While there is an art to this process, the ideal outcome to justify it is to make a profit from WidgetCo… which forms the basis of value.
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Let’s say you’ve worked through the numbers, maybe even have a plan to make changes, but WidgetCo isn’t profitable yet. For you. The existing business. Then, another consideration to take into account is the potential value for an acquirer. Do you have certain certifications that are valuable to a competitor? Perhaps you have excess machine capacity that could be utilized by a buyer (thus increasing utilization rates and ROI)? Or maybe in combination with a buyer service offer, the buyer could sell more to your existing customers.
There are many scenarios here, but the most important consideration is understanding what your WidgetCo has for a specific buyer.
Once you’ve exhausted your other options, it’s time to consider the dreaded “fire sale”. In this case, the business is worth the sum of its parts (minus liquidation costs). From a valuation perspective, this often means reducing intangible assets to zero. Rental improvements? Basically, it cannot be sold. Franchise fees? Probably not transferable. While “carrying value” is often the valued “out” in most situations, in a liquidation scenario, certain adjustments must be made to reduce each asset (or liability) to its ultimate value.
Selling an unprofitable business is difficult. Heck, valuing an unprofitable business is tough. This often means investing in the help of your CPA or consultant to get the most out of it. The other option is liquidation, and that’s never a good option. We always advise clients to think long and hard before reinvesting in a reversal scenario (which requires additional liquidity) before settling for a liquidation (for a small amount of money).
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Dan Doran Dan is the founder of Quantive and Value Scout. He has two decades of experience leading M&A transactions. Additionally, he oversees Quantive’s valuation practice and has performed thousands of business valuations. A call strategy involves selling a product or service at a price that is not profitable but is sold to attract new customers or to sell additional products and services to those customers. Loss leadership is common practice when a company first enters the market. A lead product introduces new customers to a service or product in hopes of building a customer base and securing future recurring revenue.
Loss lead can be a successful strategy if executed correctly. A classic example is razors. Gillette, for example, often gives away its razors for free or at a low price, knowing that customers will have to buy replacement blades, and that’s where the company makes its profit.
Another example is Microsoft’s Xbox One video game console. The product sold with a low margin per unit, but Microsoft knew there was potential to benefit from increased video game sales and subscriptions to the company’s Xbox Live service. Call strategy is common in the video game industry, and in most cases consoles are sold for less than they cost to build.
Call strategy is also known as penetration pricing because the manufacturer tries to penetrate the market by setting low prices for their products.
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Opponents of loss-making practices argue that the strategy is predatory in nature and designed to force competitors out of business.
Both physical stores and online stores use loss-making price strategies. These companies usually price certain items so low that they are not profitable. The hope is that when the customer purchases the product in the store or on the website, the customer will purchase other products and become loyal to the brand. Unfortunately for businesses, consumers sometimes leave without purchasing other products or signing up to the brand. This consumer practice of jumping from store to store and picking up items at a loss is called cherry picking.
Some retailers put losses in the back of their stores, so consumers have to skip other more expensive products to access them. One of the most practiced examples is the sale of milk. Milk, a common household item, is often placed in the back of any grocery store, requiring a person to browse through almost every other item in a grocery store.
Even if the shopper has just entered the store to buy milk, he is very likely to buy additional items as he passes them on the way to the milk section and then back at checkout, which will lead to increased sales for store results. .
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Starting prices can also be a loss leader. For example, a credit card company may offer a low introductory rate to entice customers to use a card or transfer their existing balances. Then, after hooking up the customer, the company raises its interest rates. Similarly, cable companies often offer low rates, sometimes at a loss, for an initial period to attract new customers or draw them away from competitors.
For businesses using a call strategy, the greatest risk is that customers may only benefit from the price of the call product and not use any of the company’s other products and services. Additionally, some small business owners complain that they cannot compete with large companies that absorb the losses implicit in this strategy.
Finally, suppliers to companies following a loss-making strategy may be pressured to keep their own prices low so that the company with a loss-making strategy can continue to generate profits.
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