Buying a business is a little like playing poker.
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In poker, you are up against an opponent and you don't know what cards he has in his hand. You have to make educated guesses about whether you can beat those unknown cards in his hand.
When buying a business, one of your opponents is the changing market environment.
Changes in the market environment can defeat you. You cannot predict them explicitly but, as in poker, you can think through the possibilities. Based on that analysis, you can decide whether to fold or keep playing. In other words, you can decide if you want to buy a business or walk away and move on to buy a different business.
So how do you evaluate markets when buying a business?
There is no simple answer to that question. The key is to get as informed as possible on how the markets are changing or might change in ways that might affect your decision to buy a business. Train yourself to think about worst-case scenarios and best-case scenarios for any given market.
To get you in that mode of thinking, we have a simple example for you to think through.
Drycleaning Industry Example
Market Trends Should Impact Business Buying Decisions
A new immigrant bought a drycleaning business around the corner from us. The valuation was based in large part on the historic numbers for the business, such as how many shirts the drycleaning business processed each month.
The new business owner later told me that he had not considered a few market trends that would have led him to pay less for the business. For example, he noted the growing popularity of no-iron shirts that don't require drycleaning. He also noted that the economy was fading when he bought the business and he should have factored that decline into his projected revenues. When people lose their jobs or have diminished purchasing power, they cut back on drycleaning expenses, and the drycleaning industry sees reduced piececounts.
Other market factors for a drycleaning business might include physical changes in the neighborhood or changes in the surrounding demographic. For example, is the city about to start a massive construction project on the street where the drycleaner is located? That will certainly slow down business. Is the neighborhood slowly shifting to more of a blue collar population that might require less drycleaning?
Another factor might be the growing population of folks that want to do well by the environment. Right or wrong, drycleaning has a reputation for not being environmentally-friendly. If more people in a neighborhood suddenly decide to be more green-friendly, they may do so in part by bringing fewer shirts to the local laundry.
Market Analysis Isn't Rocket Science
That's all there is to market analysis, as it pertains to buying a business. You just have to think through cause and effect while looking at market trends and market possibilities.
Nobody has a crystal ball per se, but you have to be able to make educated guesses about the future of your market based on what's happening now.
None of these things we've discussed above in our drycleaning example is necessarily a deal killer, but the point is that business buyers may in fact find a few deal killers if they properly evaluate market trends.
For example, you don't want to be buying a retail video rental store with a huge inventory of VCR tapes right before everybody converts over to DVD or right before the local cable company or a large online company starts offering instant access to online movies, do you? You get the idea.
At a minimum, doing your homework on market trends may allow you to negotiate a better price. My drycleaner friend wishes he had paid less when buying his drycleaning business. Had he presented a thorough analysis of the market when he was buying the business and explained why he thought the future was more bleak than the seller was suggesting, he might have been able to negotiate a better price with the seller.