Last month I wrote about escaping economic strangulation resulting from the purchase of an overpriced business. This month I will talk about how to avoid the problem in the first place.
As an accounting professional, I have been a party to numerous transactions involving the purchase and sale of a business. Most have worked pretty well. A few haven't. While not all the failures involved over valuation, many, if not most, did. Sometimes it is immediately obvious, sometimes it is not. In any case, value is a very subjective thing and often not consistent. A business that has been very successful in the hands of one person can be a dismal failure in the hands of another. There are simple formulas, however in my opinion they are not reliable.
Having said that, I'll try to shed some useful light on the subject.
If there is a constant in the over valuation equation, it is over confidence on the part of the buyer, often coupled with an unwillingness to take an objective look at known and probable obstacles. In a frantic effort to close the deal, the buyer simply does not look. This attitude can affect anyone, including sophisticated people who should know better. This process has been well demonstrated in the last ten years thorough various mergers, acquisitions and leveraged buy outs and numerous resulting failures. Many old and well established companies have been destroyed in the process. When you are looking - take your time. If you have been there, you know the frustration of losing a deal is insignificant compared to the very real pain of being trapped in a doomed business. If you haven't been there, take my word for it, or learn it from a book.
Hire your own experts. This sounds basic, and it is, but I have seen buyers risk everything they own while relying on the sellers experts. While the experts may the most honorable people in town, they are working for the seller and are bound by that commitment. They cannot help you, regardless of how much they might want to. Despite all the wining, dining, and nice words, business deals do have an adversarial element. Ultimately you have to get down to the tedium of paying for the purchase.
Talk to your spouse and friends, particularly your spouse. If you cannot win your spouse's support it probably isn't going to work anyway. Running a small business is not a nine to five situation. It is intense. It involves long hours. Everyone sacrifices, particularly the spouse. If you must face a disgruntled spouse every time you go home the cost quickly becomes more than the purchase price.
It is the responsibility of your experts to advise you and make certain you understand the consequences of what you are doing, not make your decision for you. Listen to them. If they are telling you not to do it, or that the price is to high, there are reasons. Ask questions. Understand the reasons. Once you understand the reasons you may consider the problems relatively insignificant and want to proceed anyway.
If in doubt - don't.