Why buy a failing business?

Aug. 8, 2009, 1:41AM

Q: A friend has suggested that we consider buying a business that is failing. Why would we ever want to do that?

A: A failing business might present an attractive investment opportunity for any number of reasons. When businesses for sale are failing, i.e., they have low or negative cash flow to the owner, you need to look under the cover to see what's really going on in the business.

The reasons the business is struggling could be correctable by the right buyer. And, if that's the case, you need to make sure that what you are buying, with the necessary adjustments, will fit into a business plan that you believe will be successful.

Actually, the evaluation you should conduct is not much different than if you were considering buying a business that is profitable. You may find that the strong earnings of a successful business are based on factors that are temporary or depend on skills that you don't have or are difficult to acquire.

A business may be failing because of owner mismanagement. Perhaps the owner doesn't have the marketing skills needed to boost sales or maybe is not managing inventory in a cost-effective way.This could create an opportunity for a motivated buyer with the capability to properly manage the business.

The owner may just be burned out and may not have the energy to make the adjustments needed to improve the business.

For instance, an owner I visited recently has been running his business for a long time. His market has changed, but he doesn't want to make the investment in time and money to advertise and take orders over the Internet even though the rest of his business infrastructure will support this. Again, this could be a good opportunity for the right buyer.

Sometimes early-stage businesses fail because they run out of cash and can‘t raise more capital. This can happen even though their sales volume is growing nicely and can reasonably be expected to continue to grow. But a seller may have a long-term lease or a loan payment that he or she can't support any longer.

A buyer with the financial resources and the know-how can treat the business as a startup but with a head start, thereby avoiding many of the headaches entrepreneurs normally encounter when starting from scratch.

Of course, your evaluation may discover that a business is failing for reasons that can't be easily resolved. In this case, you just keep looking for that good investment opportunity. There are many of them out there.