Occasionally, we run into what I call “Battling Assets.” That is when an owner is drawing a comfortable income from the business, but it is arranged in a way that denigrates the business value, the value of the asset, or both.
Here are three true case studies for examples.
Under-optimized Real Estate
Two partners operated a beautiful campground. The acreage was along a river, and despite rapid suburbanization in the area, the bluff on the opposite bank prevented any visual encroachment. Like many such facilities, it had been a destination for the same families year after year.
The owners were ageing, and sought a buyer who would continue the tradition for their “family” of campers. In our interview they were emphatic about not selling to a developer who would cut up the land into lots for expensive homes.
I assessed the business, and found that their Seller’s Discretionary Earnings (SDE) was roughly $100,000 plus a modest salary for the partner who ran day-to-day operations. I told them that a presumed owner-operator seeking a lifestyle business and possessing substantial cash might pay as much as $1,000,000 in a deed-restricted sale.
They were enraged and accused me vehemently of being some type of grifter. They had already talked with an interested buyer who said he would pay them $4,000,000 for the property.
I asked about the identity of buyer. They said it was a developer who wanted to chop it up into lots for high-end homes. They only wanted a “fair” price for the land from someone who wouldn’t use it in that way.
I’m in Love with My Car
A contractor with an excavating-based business hated to see his workers idle. To make certain they were fully occupied at all times, he maintained duplicate inventory of his heavy equipment.
He would use his flatbed trailers to deliver a backhoe loader, bulldozer, rock saw and dump truck to the next scheduled job a few days in advance. The laborers would be picked up from a completed site (even if it was midday) and delivered to their new workplace promptly. A few days later he sent flatbeds to transfer the equipment from the finished job.
With two sets of equipment, the chances of any one being out of service were pretty high. To be safe, he kept a third set as spares. He was also proud of his substantial knowledge about used equipment values, and usually had a one or two “deals” that he had just purchased and a few others listed for sale.
His business had been good to him. He had a beach house, a ranch, and was essentially debt free. He rewarded his management well, and was perfectly happy with a nominal salary from the business. We estimated that his cash flow would justify a sale price of about $2,000,000.
He was shocked. “I have more than that just in equipment!”
The truth was, he could sell most of the equipment, sell the business to his managers for a note, include just one set of working tools, and still be better off financially.
The Battling Assets
This owner had a large building fronting on a busy highway. He had paid it off years before, and took the substantial rental payments as his principle income.
He occupied the premises with his business, a wholesale distributor of construction supplies. His wife took a salary for her administrative work, and the company paid health insurance for the two of them. Otherwise the business was at break-even.
At first, I found it difficult to understand why he even bothered with the business. In his eyes, it had little purpose other than as a triple-net renter for his building, although he worked more than 40 hours a week running it. It paid the rent plus all the expenses of maintenance and taxes.
When we looked at “normal” rents as a percentage of revenue for his industry, his costs were double the average. When we compared rents for the area, what he paid for his building was about one-third less than the market rate.
We ran the numbers. I could show him how much more profitable the business would be if it paid thousands of dollars a month less in rent. I also showed that without his business there, the building could be charging thousands of dollars a month more to a tenant who wanted the highway visibility.
The practical results would be almost a doubling of his current income, as well as making the distribution business saleable.
Sometimes business owners become focused on a comfortable lifestyle at the expense of maximizing their investments. Pointing out battling assets can be both eye-opening and (usually) much appreciated.
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Any examples provided are hypothetical and for illustrative purposes only. Examples include fictitious names and do not represent any particular person or entity.