Buying Blue Sky

Jim is a small business owner, and a competitor is retiring. Jim wants to know what Dave's thoughts are on "blue sky." His competitor isn't very profitable, but Jim likes his customer base.

QUESTION: Jim in Los Angeles is a small business owner, and a competitor is retiring. Jim isn’t interested in any of his hard assets. Jim wants to know what Dave’s thoughts are on “blue sky.” His competitor isn’t very profitable, but Jim likes his customer base. Dave thinks Jim needs to be able to get about a 20% return on his money to buy it.

ANSWER: The only question is the value. If we took out a manager’s salary at $35,000—which would be really cheap—this thing nets $10,000. That’s what the investor’s making on his money. That’s what you would capitalize. The business is worth somewhere around five times that. That’s a 20% rate of return on my money. If I invested $50,000 on it and I made $10,000 on it, I’d be making 20% on my money. Why would I want to make that high of a rate of return? Because it’s a small business; it’s high risk. I can buy real estate and make close to that and not have anywhere near that much risk. I could buy mutual funds and make 10 or 12% and not have anywhere near that kind of risk. Since it’s a higher risk and higher hassle investment, as an investor, I would capitalize the net profits as an absentee investor at about 20%. If I want to make 20% on my money, the thing’s making $10,000, it’s worth $50,000. He’s probably in about the right range. That’s what I come up with. That’s one way to value the business.

What is his database worth? It’s only worth what it creates. What’s his name worth? It’s only worth what it creates. The name has no value unless you’re monetizing the name.

You just don’t want to create something that’s complicated. He wants $60,000, and if you offered him $20,000—and the equivalent of $20,000 would be 50% of the net profits the thing creates the first year—I’d give him that. I’m trying to create a formula to effectively give him $40,000. You could do $20,000 cash and $20,000 out of profits. Figure it out. But do it fast. Don’t do this thing where you’re constantly talking about it and this thing goes on for five years. There’s no need to. This is a clean deal. I’d rather give him $30,000 cash and be done with it.

Tell him to maintain the social media push for one year to your benefit for his retirement. He wants to retire; let him play on Twitter for you. That’ll increase the profits that he gets during that year. During that year, you might learn to love social media. If it gives you results, you’ll like it. Let him play with it for a year since he’s kind of got that thing going on, and let him impact his own profits and impact the quality of the transition of the database. Just tell him since he’s getting a percentage of the profits, for that reason, you want him to maintain Twitter and Facebook to help you with the transition of his customers to become yours. He can tinker around with something that’s fun from his retirement, impact your bottom line, help him get a bigger check, and everybody’s winning here.