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Common Pitfalls in Buying a Business - Buyer Overpays

Written by: Dennis Gerschick

Article Overview: This article explains the reasons why buyers often overpay for a business.

Common Pitfalls in Buying a Business - Buyer Overpays

This is the second in a series of articles that will address the mistakes that are commonly made by purchasers of a business. Buyers often act hastily, and they often overpay for a business. Buyers of a business would be well advised to listen to Warren Buffett and apply the lessons that he teaches so well. Mr. Buffett has noted that it does not make sense to buy a single share of stock at a specific price, unless you would be prepared to buy the entire business at that same price per share. Mr. Buffett carefully considers the intrinsic value of the business and compares it to the company’s market capitalization (the number of shares outstanding multiplied by its current stock price). Mr. Buffett understands that at one price a stock may be attractive but at a higher price it may not. He has the intelligence to understand the difference. More importantly, he has the discipline to act accordingly. Mr. Buffett looks at many potential deals but walks away from the vast majority of them.

Buyers overpay for numerous reasons including:

1. They are too anxious to do a deal.

2. They don’t see any potential problems, or when they discover a problem, they downplay it.

3. They believe that the seller’s management team and/or employees were incompetent, but with the buyer’s intelligence and experience, the business will be very different. That is not always the case.

4. The buyer falls in love with the idea of owning a business. They make an emotional decision, rather than a rational one. They just have to have it, regardless of the price.

5. The buyer is buying a perceived competitor out of fear.

I’ve had clients acknowledge that they were overpaying, but they are quick to spout off several reasons to justify their decision. Mr. Buffett is also known for making witty remarks that contain a lot of wisdom. One is, “When you match an individual known for his brilliance with a business with poor economic fundamentals, it is usually the individual’s reputation that suffers.”

In short, no matter how smart the executive, if the business is in a bad industry, it is hard to make money. Experienced executives in the airline industry struggle to generate profits. This is not because they are stupid or lazy. It is because the airline industry has serious shortcomings. An airline ticket is a commodity. Commodity businesses typically have small profit margins. The way to profitability is thru volume and expense control. Not every executive has been successful managing a commodity business.

How does a buyer know if it is overpaying for a business or is paying a fair price? I’ll address this question in a future article.


© 2007 Dennis J. Gerschick All Rights Reserved

Related Articles
  Common Pitfalls In Buying a Business - An Introduction
  Common Pitfalls in Buying a Business – Structure of the Deal ©
  Common Pitfalls in Buying a Business – Inadequate Due Diligence ©
  You have a buying process problem, not a selling problem
  5 tips to successfully sell your business

Article Tags: brilliance, business buyers, competitor, current stock price, discipline, economic fundamentals, emotional decision, intelligence and experience, intrinsic value, management team, market capitalization, mr buffett, owning a business, reputation, s market, spout off, walks, warren buffett, wisdom, witty remarks



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