27 Mar Buying a Business
The big has arrived – you want to step out and become a business owner. The very first thing that needs to be said, “There is no business that produces endless amounts of money, with no competition at zero risk”. Starting with a reality check is the best place to start from. Everything that you are going to look at will have some nuances, little quirks and industry related challenges. Every successful business requires lots of hard work, dedication and a talented owner that is capable of finding that competitive edge over the competition. Unfortunately most of the learning comes after college – in the classroom of life.
“OK I hear you say – so where do I start?” Begin with writing down what it is you are seeking. Be as specific as possible. This is a really important thing to do. I can’t tell you how many prospective buyers have come to me asking me to find them a business – with no idea of what it is that they really want. I get comments like, “Oh you know it must be a solid business, making a good return, have growth potential, be sustainable and not cost a lot”. Yeah right.
A question that needs to be asked at this stage – are you buying a job or a business? This needs to be thought through. People often miss this one. It is important because this will determine what level you are going to purchase at? If you are buying a job be careful that you are not going to become a bank employee.
Think of the discretionary income you want as an owner. Are you sure that is the amount you want to bank every year? Now take that and multiply it by three. That roughly is what the business you want will cost to buy.
The next thing now that we have sorted what the expected cost of the business is going to be – do you have the money to buy it? “Oh I can borrow it from the bank – not a problem”. Can you? Will the bank lend it to you just like that? The banks always ask for security. They want to be preferential creditors – that means when the money is called in they get it first – before anyone else. Especially post recession the banks are being real careful about who they lend money to. Now a really important part of the overall equation that most people forget – in your calculations of how much money you need you should factor in the amount of money you will need as working capital. Once you have bought the company you will need money to service the business – to pay your creditors on time. You cannot grow a business if you are cash strapped. It just doesn’t work. Creditors quickly learn that you are a risk and they then shorten your credit line.
In the first unit I mentioned a number of things that a seller needs to have in place in order to sell a business. Let’s look from the other side now – from your perspective, that of the buyer. Look at the business – how does it present? What is its position in the industry? Who do you benchmark it with? How long has it been in existence? How long has the current owner run the business? Why is he selling? I cannot stress enough – find the real reason the owner is selling their business. Is it a good sound reason – like they would like to retire, or is it because they are trying to get out before the latest market threat wipes the business out? Has the business run its course or is it only in its infancy in its lifecycle?
Go straight to the Profit and Loss Statement for the last year. What profit is the business making, before tax, interest, depreciation and amortisation. This is the discretionary income or cash surplus to the working owner. There are a few fundamentals that you need to understand at this point. If you are buying a managed business insure that you have calculated sufficient funds to pay the manager. The more talented and effective managers cost more – don’t calculate on average industry earnings. You will then employ average performers who will produce average results.
Look at the industry – does the business require high cost stock? How much capital is tied up in non earning entities? Can this be changed? You don’t want to buy dead wood – by that I mean you want your money to work effectively, efficiently and constantly for you. You want a business that produces more than if you were to invest at the highest interest rate possible in a money generating fund. Otherwise what’s the point – you would be better off putting your money in that fund – you would certainly have a whole lot less stress for zero effort.
Work with your broker through all the financial details. There are obviously a number of key issues that need to be considered. Your business broker will be able to point out the implications of the various entries and what may be the best way forward. For example there may be costs that are one off and these would be added back to the income stream – providing the buyer with additional resources. The past performance also needs to be tracked to see if the company has grown and what areas require attention. My first comment – there is no business without risk – at this point in the buying process you will be able to ascertain the level of risk – based on the financial performance of the entity. One obviously wants to limit your exposure, but at the same time you also want to take advantage of going into the purchase with your eyes wide open. If there are areas that require attention they may work to your advantage and these could assist your negotiation when it comes time to put in an offer. These so called grey areas could also be areas of advantage by being areas that if put right they could add additional sales, or reduce costs. If your flair is to turn thing around sometimes there are poorly managed companies that are for sale at low prices because the vendors are selling before they loose their shirts. This is turn can result in large profits for the buyer – as once “fixed” you will then be able to see the business at a much higher price.
Throughout the buying process the key element to clarify is: what is my return on investment going to be and what is the associated risk. Once you have that ironed out you will be able to confidently proceed and make an offer.