Property problem killed the sale of this ecommerce business for me

On Saturday afternoon, I received a call from a former client of one of my trading companies. He had been in protracted negotiations to buy a small e-commerce business from his so-called ‘friendly rival’ and the negotiations had been dragging on for some time. He now felt under pressure to quickly conclude a deal and just wanted to get a second opinion.

It immediately became clear that if he managed to close the deal and purchase the business, then the main driver for my client was to sell off its stock between now and Christmas and get his money back.  Seasonal inventory in a small business is notoriously difficult to value, but he had agreed to buy it “at cost”. While a detailed stock check had not yet been undertaken, it was envisaged that it would be valued at around £150k.

I spent an hour-and-a-half on the phone playing devil’s advocate with him, putting forward a number of arguments as to why he should think again about purchasing the business.

My client is an internet retailer, who sells stock on marketplaces such as eBay and Amazon, and he was now buying another internet retailer that basically did the same thing. According to him, the acquisition would allow him to almost double his turnover and, in theory, increase his profitability. In practice, however, he was buying a limited company and taking on a workforce and a rundown warehouse at the other end of town.

Tip from Shaf: When acquiring a company, don’t appear desperate to purchase. The more desperate you are, the less leverage you will have to strike a favourable bargain.

What was he buying?

I have previously blogged about how business can be valued - have a look here. What was my client buying? If you stripped away the veneer, he was buying a marketplace seller. As far as I am concerned, a marketplace seller has no value in terms of goodwill. It’s not as if they own a website - Amazon and eBay have the pleasure of owning that. Fundamentally, my view is that when someone is buying from Amazon, then they are buying from Amazon; they don’t think that they are buying from a specific Amazon seller.

In other words, my former client was buying a customer database of people who had previously purchased from marketplace, but they still effectively belonged to Amazon and eBay. Some types of customers are more valuable than others, but in my opinion, these customers had no value – so essentially, the only assets he was really acquiring were the stock and anything else which was on the asset register.

Tip from Shaf: During the negotiating process always focus on the weakness and vulnerabilities of the company you are acquiring. By focusing on these, you will be able to drive a better deal.

What’s the real price?

My client felt the best part of the deal for him was that he was paying for the stock at value and everything else was free! Basically, the deal he had agreed was that the shares in the company would change hands for the value of the stock. He had become so fixated on the price he thought he was paying that nothing else mattered.

In reality though, he wasn’t just paying for the stock; he was paying a lot more. It was clear that the real purchase price he was paying was considerably more once he took the hidden liabilities into consideration. Post-Christmas, he planned to relocate the business that he was acquiring to his own premises, and invariably he would have to cut the workforce – which would result in cost. A further cost he hadn’t factored in was the fact that by acquiring the shares in the company, he would be taking on a lease. The worrying thing about this lease was that the business he was buying was in a rundown warehouse in a non-too exclusive part of the city.

Tip from Shaf: If you are buying a marketplace seller, then ask a property expert to consider any leases you take on. With all due respect, most of today’s large marketplace sellers started their business in their garage or bedroom. When they eventually took on leases, most landlords didn’t want to rent to them due to their covenant so they ended up taking properties that no one else wanted – rundown buildings often in disrepair. They moved in with little professional advice and certainly no schedule of conditions, leaving them open to substantial schedules of dilatations at the end of the lease. The schedule of dilapidations can often wipe out all value in the Assets of the business.

Abortive costs

My client was fixated on the time that he had sunk into the project so far. He had been discussing the purchase since August, had developed tunnel vision and simply wanted to do a deal - he just needed someone to tell him it was a great move and that he should go for it. There was no way he wanted this one to get away.

Tip from Shaf: There is a saying when it comes to sales and trading in inventory: “the first loss is the best loss” and clearly this was the case here. I felt he would be better off accepting the abortive costs rather than doing this deal in its current format as that would be the least of his worries!

The DIY test

This is a very simple test that I have used many times over the years. I ask myself, ‘What would it cost to set this business up from scratch?’ If you can put together a new business that is similar to the one being sold and do it in a more cost-effective, efficient manner, then it’s probably not worth bothering. As soon as I ran through the numbers with my client, his rose-tinted spectacles fell off.

Let’s consider this further by looking more closely at the process of starting a similar business, and any potential challenges.

Barriers to entry: Absolutely none. You can open an eBay and Amazon seller account within an hour!

Developing a customer database: No investment required. The business sells goods on a marketplace, so the customers are already there. To gain traction you just need to be competitively priced. To build a good reputation on a marketplace, it’s a case of offering excellent customer service, and it won’t take long for the positive feedback to arrive.

Recruiting and training staff: No investment required – my former client already had the resource in-house. In fact, his plan was that once the peak season of October to December was finished, he would close the acquired warehouse and make the vast majority of the acquired staff redundant.

Stock: Fair enough, he was getting £150k worth of stock which, if things went to plan, he could sell for £300k. However, if they didn’t go to plan, he would be left with a lot of seasonal stock which he would then have to hold onto for nine months until he could sell it the following year. As the only real asset that he was buying was stock and he just wanted £150k worth of complimentary stock at cost, then surely he could just go and buy it from a wholesaler?

By setting up the business himself, or in his case, expanding his product range to the same level as his friendly rival’s, he wouldn’t have any of the hidden liabilities I have mentioned. It’s important to remember that those hidden liabilities could be as much as the consideration for the purchase.

Note from Shaf: On Sunday 16 October, I sent this blog to my client before publishing it. He called me within 10 minutes of reading the blog, asking me to remove a couple of his personal details that could have identified him as the purchaser. Once I had agreed to do this, he went on to admit: “When I saw it in black and white, it’s ridiculous that I was actually going to buy that business. I think the only reason I wanted to buy it was because it would make me feel good.”