Should I buy a business to give me a salary?
I recently spent three months in constant contact with a client advising him on a management buy out.
Not so unusual….except this time I was trying to talk him out of it!
Here’s the situation, my client is an engineer, and has been an engineer all his adult life. He rose through the ranks of the company he has worked for since he left university until he became General Manager reporting to the CEO who was also the owner. During his career with this (small) company, he helped to draft procedures manuals and develop their internal systems; he got to know the clients and while not in sales, he helped develop relations through his work and his network with the customers was excellent.
Then, the family owners decided to sell out to a publicly listed company. My client stayed with the company and started reporting to a new CEO appointed by the public company. He can’t say that his relations with the CEO and the new owners, represented by the Chairman, were bad. Indeed they were courteous, but simply different.
Of course it would be. He had gone from direct relationships with people he had known since he was a young man 20 years ago to corporate relationships with people he hardly saw. As friendly as these new relationships were, they had to be different.
After a few years, the market turned. The specialist engineering services provided by his company started to lose demand, and the business results plummeted. The public company held on for as long as it could but then had to make the commercial decision – it had to sell the company and asked if my client wanted to enter into a management buy out.
I won’t detail the financial structure as that’s not the point of this article. Suffice to say that the company was not worth anything after the last couple of years’ bad results.
However my client believed he could revive its fortunes and turn it around – in the last couple of years, the CEO and the Chairman had not listened to his warnings about how to conduct operations and how to market their services and he felt they were starting to lose contact with his network. However he had kept contact and felt that he could bring their business back, as well as make the operations more efficient.
The point was, how much would this cost him? Since the business was worthless, and closing it would cost the public company hundreds of thousands in redundancies and other costs of closure, I felt he was in the best bargaining position. We worked out scrap value for the plant and equipment, agreed that we would not take over any liabilities, and decided that was our bottom line. I discussed with him in detail how it was simply not worth more since there was no “goodwill” in a loss-making company, and any up-side would have to be put in by himself after the takeover.
That was the context – it should have been a short negotiation. Either the public company would negotiate a little then accept, realising that this was the best offer, as otherwise they would not receive any money but would have to pay out a lot of closing costs, or they would refuse and my client needed to walk away.
So why did it take three months?
The Chairman negotiated with my client personally. The Chairman was a self-made businessman, full of huff and vigour, and true enough he came back with a ridiculous figure valuing the plant and equipment at full written down value, include taking over all liabilities, and included a calculation of goodwill based on a business plan that showed future profits worked out by my client as the GM!
We had rehearsed this and had decided to be firm and go back with take it or leave it. But instead, my client started negotiating. He negotiated on the scrap value, from $500,000 to $600,000 (“overall what’s another $100,000?”). He began negotiating on what liabilities he might take on (“I can see his point of view”).
When I queried him on it, his justifications were quite telling to me:-
“I know this business, I know I can make it work.”
“The people can be kept together – we’re a good team.”
“I know this business – I’ve been working in it all my life.”
“If we don’t do this so many people will lose their jobs.”
“I know this business, and it pays my salary.”
Do you see what I do? My client was feeling things beyond the calculable value of the business. In short he was too close, and he was not only worried about his colleagues on staff, he was also afraid of leaving this environment he had been his entire working life and having to go out and work somewhere else unfamiliar.
In the end I had to ask him a clear question: “Are you buying the business to secure your salary?”
That was the crux of it and at least he had the sense to realise what I was asking and admit to it. So I took him through the logic of the situation – was he willing to put at risk nearly $1 million after buying the business at full value, and taking on the liabilities which if everything went pear-shaped would be additional cost to him? After admitting he was not, I then took him through his options, including working somewhere else as the good engineer, and good manager that he was, and including the option to buy an unrelated business that he might enjoy to manage and run, but at the right value and risk-profile.
I’m glad to say that he finally saw sense and withdrew from the MBO discussions.
When you are looking to buy a business the first filter you have to apply is one of value. It is never justifiable to spend more than the value of the business, no matter what the emotional justifications are. It is true that you cannot remove emotions from a major decision like buying a business – you have to like doing what you have to do in it, you have to like working in it, you have to like the relationships you will or have built in it, you have to be or capable of being proud of it. However you must not let any of these emotional filters cloud the value filter.
At times, it may be acceptable to buy a business to provide you with a salary – the return on investment may not be as good as in another option – but if the risks are small you could consider it, and that’s where the emotion is allowed to colour the hard numbers but only after the numbers and the risks are considered. However on most occasions the risks of running a business are greater than the benefits of buying a business just to earn a salary – you want the premium that comes from risk otherwise you’d simply put the money in the bank and live on the interest.
I’m interested in how you entrepreneurs out there see this issue? Is it ever alright to buy a business just to secure your salary? Come on over to the website teikoh.com and start a discussion!
While you’re there, check out the other articles and video advice on creating strategy, providing leadership, and growing your business.
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