As a would be entrepreneur you are looking for the perfect business opportunity. After several discussions with your accountant, banker, lawyer and relatives, you have developed a list of acquisition criteria: low risk, high return, short hours, great location, good growth potential, and most importantly, a large asset base. Being pragmatic, you realize you can’t satisfy all the criteria, especially since the majority of available businesses are service businesses inherently light on assets. How can you overcome this problem?
Over the years, business buyers have evaluated acquisitions by the worth of their assets. Many business advisors, most notably bankers and CPAs, have also rallied around the “buy assets” banner, citing both tax advantages and liquidation potential. These were valid arguments in the past, but are they valid today?
When America’s economic system switched from a manufacturing base, with its large capital outlays, to a service base, with its comparatively inexpensive information gathering assets, more Americans became employed in the service industry than in manufacturing. It is time to take note of this important transition.
The following illustration points out the difference between an asset intensive business and a service business, and is intended to remove this obstacle to a sale.
These two businesses are available for purchase:
Business A Business B
$100,000 Selling Price $100,000
$ 30,000 Down Payment $ 30,000
$ 40,000 Cash Flow $ 40,000
$ 80,000 ASSETS $ 8,000
In the above illustration, both businesses possess identical growth potential and other key characteristics. Business A, however, has ten times the hard asset value of Business B. If your first inclination is to buy Business A, here are some important considerations:
• Although $80,000 worth of assets will provide a tax benefit in the form of depreciation, at some point in the future, as these assets become physically or functionally obsolete, they will have to be replaced. You should understand you won’t be able to replace them for $80,000. You should also realize the tax laws could no longer favor hard asset businesses with write-offs like accelerated depreciation and the investment tax credit.
• The liquidation argument is only marginally valid once you consider the negligible value of used assets in a distress sale. More importantly, if the liquidation of a business is one of your overriding concerns in purchasing a business, you should remain secure in your present job and leave entrepreneurship to those with a more positive outlook.
• On the other hand, the owner of Business B doesn’t have to fret over replacing costly, vital assets to maintain his cash flow. A business light on assets is also light on its feet. It has the flexibility to adapt to changing economic conditions and consumer demands without costly retooling or restructuring.
Instead of hard assets, your primary consideration should be cash flow. It is cash flow that funds debt service, all operating expenses, and your living wage. Is the cash flow of Business A worth more than Business B? Hardly!
It is no secret that the colossal business failures of the past decade have been companies laded with hard assets. You might remind your banker that the primary cause of bank failures has been their lending policy favoring hard asset industries.
So the next time you hear the cry, “Buy Assets,” ask the person how much stock he owned in the above mentioned firms. Then look at a good janitorial service.
