A buyer is usually looking for a company whose cash flow can cover its current operating expenses plusthree other numbers: 1) the salary that the new owner hopes to earn or plans to pay an on-sitemanager, 2) projected annual financing costs to cover the amount he or she must borrow to make thepurchase, and 3) an annual investment return on whatever cash the new owner puts into the deal.
Savvy buyers probably realize they could earn at least 10% a year just by putting their savings in amutual-fund portfolio. Most hope to better that performance, with an investment return that covers theadditional risk associated with buying a business.
That formula sets a high standard for any company's cash flow. After all, the current business ownermay be drawing a below-market salary or may not need to pay any financing costs at all after startingthe company from scratch. The notion of investment return has probably never entered into his or herthinking, at least not until it comes time to price the company for sale.
And there's the rub: If the company's cash flow can't meet the standard described above, its sellingprice will have to drop until it reaches a point at which lower projected financing costs help close thedeal. And in some cases--especially for those companies in obscure niches or industries without anyconsolidation activity to help spark a bidding war--the numbers won't ever pan out to support a sale.