Almost every business owner is faced with the pros?pect of buying or selling a business at some point in time. Whether you are just getting started in business, or already own a successful operation and want to expand, buying an existing business can present some real opportunities and advantages. On the other hand, if you are already in business, but are ready to call it quits and want cash-out, then selling your business can bring up some serious considerations.
The biggest advantages of buying an existing business are, it can potentially save you a lot of money, and you’ll know what you are getting in advance. If you can trust the owners financial statements, you’ll understand how much the business is making or losing. Even buying a business that is losing $2,000 a month might be better than creating a new one, and suffering a $10K to $15K loss during its first month of operation. Plus, a business that isn’t profitable will usually sell for only pennies on the dollar, so you can save a small fortune in start-up costs. And, if an existing business you are considering is profitable, then you can probably be assured that if you buy it, it will make money for you as well, even though it will cost more.
Determining a fair price:
Whether you are looking to buy or sell a business, you must first be able to identify a fair value. If the business isn’t making a profit, then in reality it’s only worth the depreciated value of its equipment and furnishings. In addition to that, some consideration might be given for a portion of the expense that was incurred for such things as cabinets, modifications made to plumbing, electrical, etc. But, beyond that, there is really no other value in the business. This means you might be able to buy or sell a distressed business for only 10￠ to 50￠ on the dollar of what it cost to open when it was new. Paying a deeply dis?counted price to take over an existing operation is far less risky than investing $200K to $300K to develop a new one. Especially when there is no guarantee that a new business will ever make money.
On the other hand, if you are considering a business with a long history of healthy profitability, then it might sell for far more than the cost of starting a new business from scratch. This can still be well worth the investment, especially if risking your entire life savings to start a new business is unthinkable. Formulas for determining the value of an existing profitable business are numerous. 1 X last year’s annual gross sales is one. 2 X annual net profit + depreciated value of assets is another. But, in reality, any business is only worth what someone is will?ing to pay for it.
Validating the numbers:
Being able to verify the financial performance of an existing business, before you make an offer, is crucial! While the owner’s books for the business might provide you with the information you are seeking, you’ll have to determine if you can trust their numbers. It’s not uncommon for a seller to reveal that they have sheltered some income; did not report all of it to the government so they could pay less in taxes. The problem is, how do you verify how much additional income they actually made? After all, by telling you that they didn’t reported their income in full, they’re basically admitting they don’t have any problem with lying about it. So, are you just supposed to trust what they say? Another problem with believing the owner’s books is that they may have changed some numbers, or created an entire second set of books, to make the business look more profitable than it actually is.
For these reasons, the only documentation of income you should trust is the owner’s personal Income-Tax Return. Think about it, have you ever seen anyone declare more income on their tax return than what they actually made, and then pay taxes on it? If they are unwilling to show you their personal in?come tax return, then “buyer-beware!” They either made their money by shorting what they declared in sales and not paying taxes on it, or they reported all of it, paid their taxes, and can now substantiate a greater sales price for their business; it’s one or the other… they can’t have it both ways!
Debts and encumbrances:
Anyone buying an existing business will want to make sure that they will not be responsible for any past debts or en?cumbrances created by the previous owner. A title search should be conducted to make sure there aren’t any liens or legal actions filed against the business. The existing owner of the business should be required to pay off any debts owed to vendors, contractors, the government, their landlord or employees. If it will require the proceeds from the sale to settle these debts, then your attorney should get involved to craft an agreement to set aside the necessary funds for payment.
Determine their reasons for selling:
An important factor to consider when buying a busi?ness, is why does the current owner wants to sell it? If they want to sell their business because they’re out of cash, or because the business required greater effort to run than they ever imagined, then the business may be worth considering. However, if the business has been unsuccessful because of a poor location, or because it’s hidden away, or difficult to get to, then these may be problems you can’t fix.
You can improve a store’s ambiance, product quality, and customer service, but you can’t move it to a more vibrant, visible, and easier to access location. Don’t buy a business with problems that can’t be easily or affordably fixed!
Access to a reasonable lease:
Anyone who might be considering buying an existing business will want to make sure that they will have access to a reasonable, long-term lease. Hopefully the current owner’s lease will be “assumable” by the buyer, (usually, with the land?Ed Arvidson has been a leading consultant to the Specialty Coffee Industry for over 20 years. His company, E&C Con?sulting, can be found at www.coffeebizconsultant.comlords approval). If the current owner doesn’t have an assumable lease, or the buyer is not acceptable to the landlord, then the current owner may ultimately remain on the hook for lease pay?ments if their buyer fails to make payments in a timely fashion.
If the current lease period is almost over (1 year left or less), and an option to renew for an additional period is avail?able, then the new buyer of the business should negotiate the terms of that extension directly with the landlord. The selling owner should never bare responsibility for any future options.
Selling your business:
If you are looking to sell your business, then there are some important things to realize. First, understand that your business will always be worth more to a potential buyer if it is still operating. The fact that it is generating sales, and has a staff in place that can maintain those sales, can be invaluable to a buyer. This will give the buyer time to develop a management routine, evaluate what they want to do with the business, and make desired changes. However, if the business has shut, you may realistically only get a “fire-sale” value for your assets. Also, shuttering your business won’t relieve you from your obligation of paying the monthly rent.
Second, if you are selling your business, it must look its best and be running like a well-oiled machine! Just like a home or car that’s for sale, spiffing-up your asset will generate more interest, increase the chances for a sale, and justify a higher price!
Third, get “real” about the value of your business. We already talked about how to go about valuing a business, but un?derstandably most sellers will think that their business is worth more. Be careful here; I’ve seen sellers turn down reasonable offers for their business, only to wish later that they had taken one of those offers when they had the chance. Remember, a bird in the hand is worth more than two in the bush!
Finally, a potential buyer that doesn’t have the ability to cash you out isn’t a qualified buyer! You do not want to take payments from your buyer. You do not want to play the role of the “Bank.” Experience tells us that most buyers who are mak?ing payments will end up defaulting before they can pay for the business in full. When this happens, you end up with your unwanted business again, probably run into the ground, and you may not even have the ability to sell it, or even operate it again, if it’s tied up by legal constraints.
So, if you are looking to buy or sell a business, proceed carefully, conduct thorough research, don’t become over?whelmed by your emotions, and make good business decisions.
Written by Ed Arvidson