Why invest in an unprofitable business?

“Do not be fooled by its commonplace appearance. Like so many things, it is not what is outside, but what is inside that counts. This is no ordinary lamp. It once changed the course of a young man’s life; a young man who, like this lamp, was more than what he seemed: a Diamond in the Rough. Perhaps you would like to hear the tale?” – Aladdin 

A new franchise owner approached me one deep dark hallowed night… OK, well maybe it was actually by phone on a weekday afternoon…. Anyway, this owner, who will be representative of dozens of owners I have worked this in this area, had opened his new franchise less than two years prior. He was in an agitated state. He had invested in a reputable franchise, beautiful buildout, and massive initial marketing. He hired and trained 12 employees and began operations. Unfortunately, he bled his working capital in less than 4 months, and break-even was not projected until 12 months. This owner borrowed what he could, cut out marketing, and tried to stay on top. Rather than be terminated, he came to me to find a buyer.

The phrase “Diamond in the Rough” pertains to a person or an item that has potential, that to the untrained eye, is over- looked or missed completely. The Japanese have a saying that is not dissimilar to the phrase “Diamond in the Rough” – a jewel, unless polished, will not sparkle. This business fell squarely in the category of a ‘Diamond in the Rough’.

I have clients who sign acquistion agreements with Zarian for the sole purpose of engaging in the acquisition of one or more ‘Diamond in the Rough’ businesses. These often, cash buyers, seek to gamble on buying a failing business, use their skills to turn it around, and then ultimately sell it for a very high return on their investments.

Think about this mindset for a minute. A franchise owner invested upwards of a half million dollars in the buildout, hired and trained all the employees, invested in marketing and growth, only to find that in the first few years, for one reason or another, they couldn’t sustain the business into profitability. Now they want to get out fast. So, what’s the answer?

Well rather than terminate or relinquish the business to the franchisor, an owner can often come out with their shirt on by selling to a buyer with a higher risk tolerance.

Advantage to the Seller? They get out with more than they would by relinquishing the business. 

Advantage to the Buyer? They have a much lower investment with a higher return for the risk they are willing to take. 

Franchise owners, whose businesses are struggling, have options. Taking a strong hard look at the business with a detailed analysis will illuminate the truths of the enterprise. Only then can the business be optimized. The owner should begin with a current, conservative valuation and then review and analyze each factor of distinction to develop a projected value based on several forecasted scenarios. This can be very empowering for owners who can now have the option to continue the business or sell, rather than terminate.

For owners who are out of time, developing this projected forecast can assist in engaging buyers that are intrigued with this ‘Diamond in the Rough’ and have the means and knowledge to cut and polish the business into profitability.