How To Buy A Business
This is a slightly edited email we recently sent to a prospective business buyer recapping our conversation on the business purchase process. Namely, how to buy a business, business sales price multiples, and how we can assist.
For a PDF Download of this article, click here: HOW TO BUY A BUSINESS AND BUSINESS PURCHASE PRICE MULTIPLES
Start With A Search
What makes the most sense for most individuals is to do the initial search on your own. The most popular websites for this are: www.bizbuysell.com, www.bizquest.com, www.mergerplace.com, and www.Business broker.net. In our Mid-Atlantic business sale market, Biz Buy Sell is probably the most consulted.
Your first step is to contact the business you see on the websites that might interest you. By looking at a lot of businesses you get a sense of the market and what businesses/industries you might be interested in. Also, if certain franchises interest you call the franchisor. Sometimes they have new areas for sale and sometimes they assist their franchisees in selling operating units.
Normally, it will take you three to four months to get comfortable with or decide to withdraw from the process. This is like looking for a job: Lots of distractions for a few lookers. Expect to be somewhat frustrated by the brokers responses and most of the businesses you ask about. If you find an industry that really might work for you do not hesitate to call business owners directly.
If the business broker involved strikes you as someone with whom you can work, you might want to call them regarding other listings or listings that are not public. Remember, business brokers represent the Seller and are obligated to get the Seller the highest price. Of course, at some point no buyer will pay the price and good brokers know that too. Also, many business brokers do not co-broke on their better businesses. If they co-broke they often will not split commissions with the other broker. They sell their better listings themselves, which is why you need to call many business brokers directly. The next best thing if you want to be represented by a broker is to pay your broker directly.
Once you have decided on a business, plan on signing one sided non-disclosure agreements (NDA) to protect the seller. In addition, you will be asked to submit a summary financial statement or provide a letter from your CPA or financial planner stating you can buy.
After you have signed and returned the NDA and financial disclosure to the seller or the seller’s broker, you will usually receive a seller’s confidential information package. This should outline important information about the business and assist you in determining if you wish to go forward. The larger the business, the more information. Small businesses costing under $500,000 may just have a single page tear sheet with summary information. Larger businesses will have some indication of markets served, products, key people who will stay, and financial summaries of the business.
Review the Cash Flow
Most small businesses are valued on Discretionary Earnings (DE). Usually, the information package will include the calculations to determine DE. This figure is (or should be) the total of every way an individual owner makes money. Personal expenses benefiting the owner, such as health care and auto expense, are added to profits, salary, and any other earnings that are attributable to the owner. You also add depreciation and interest. If there are multiple owners, you need to adjust for the labor value of the work performed by other owners as you will need to replace the person. Most small businesses with DE over $100,000 and below $400,000 will sell for 1.5 to 3.5 times DE depending on the level of interest in the buyer community, the level of difficulty inherent in running the business, etc. The nice thing about DE is you can take your living expenses or other concerns and work with that number to see if the business cash flow makes sense for your goals
Key Things to Consider When Buying a Business
- Will you enjoy doing the day-to-day tasks? Some businesses have a sales focus, others have a human resource focus, and still other take a production focus. Does the focus of this business work for you day in and day out? By tasks I mean what you will actually do each day. A good friend of mine said he wanted to buy a bar because bars have music and he liked music. I suggested he follow a bar owner around for one weekend and see how much music the owner could enjoy. He quickly saw what being a bar owner really meant in terms of daily tasks and looked for another type of business.
- Will the cash flow support you? Some businesses can grow rapidly but many will only grow modestly. Can you pay the note, the taxes on earnings, invest in new equipment, people, and growth, and make a living wage for yourself?
- Does the business have growth potential? If so how much time or capital will it require to grow. Is the investment and effort consistent with your plans?
- How might you get out of the business if it does not work for you or when you are ready to retire or move on?
Once You Decide to Pursue the Purchase of a Business
If the business looks like it might be interesting, the next step is to set up a meeting with the seller. You will also want to review tax returns, the lease and any other major agreements. Make sure the tax returns tie into the summary. Adjust the seller’s DE to reflect what you think it should be. In the seller interview ask and learn about how the business runs. Make sure it makes sense for you. Who is staying that knows how things run? How will customers transition? Finally, make sure you are comfortable with the seller. If you do not trust the seller do not buy the business. Life is short.
Somewhere around this point (maybe earlier for the first seller interview), you may want to hire an advisor to help you review the pricing, cash flow, industry problem areas, and put together questions for the seller interview. If all looks good, the advisor can help you craft a non-binding letter of intent outlining major business terms of an offer. They will then stay involved to assist with questions, and if you get stuck in negotiations. Sometimes, an advisor will directly negotiate. This continues to closing on the transaction.
Finalizing the Transaction
Most business purchases today are either bought with purchaser cash or a combination of purchaser cash and a SBA 7(a) loan. SBA loans take 60 to 180 days to obtain. We find about 120 days is the normal time. Sellers either do not provide financing or typically provide about 10-20% of the purchase price in financing. Sometimes this amount and the timing of the payment is tied into performance of post-sale transition services and/or the continuation of revenues after closing. Do not forget you cannot separate price and terms. Terms to protect you tend to come with higher prices. But, for a buyer a low price solves many contingencies and problems.
Negotiations around a letter of intent offer often take four to eight weeks to get to an agreement. If the letter of intent is accepted, you will want to retain quality legal counsel for the final binding contract and a good CPA to review the seller’s books. You will find a problem or two in due diligence. Generally, if everyone is being forthright (which is not always the case keep your guard up) the problems will get solved and you will go to closing.
Typically for small businesses, the seller will assist for two weeks to transition the business. For larger businesses ($1 M to $5 M in price) the time increases. Often it extends for one to three months full time then some sort of part-time support for up to a year. Typically, after a few weeks to a month the seller is paid as an employee for their time.
How We Can Help
If you decide to do your own search, we are available to step in where needed. We charge an hourly rate. Because we only do this type of work, our time is generally quite short, which keeps the total fee reasonable. Usually, for a small business purchase, our total fee is less than $5,000. The total fee depends on the amount of work we do for you. We usually obtain a retainer for the work in advance. This allows us to keep our costs down by simplifying receivables.
If you do not want to search for a business, we are available to do the search for you. However, that can be expensive for individuals as the cost starts at about $3,000 per month. That fee includes a definition of search parameters both for the companies being looked for and the search methods to be used. Search methods include:
- direct mail
- cold calling
- internet searches
- searches of non-public databases and related follow up
There is a commission or success fee should we identify and you close on a business.
Obviously, there are a more details involved in buying a business. But, this is a useful outline of the buying process. The process should take you between nine months to a year. In some cases, a bit longer.
What I would suggest is you work closely with us or another advisor on the first real opportunity or two. By the end of the process, you will understand basic pricing and calculating DE. Then, come back in when you find a business and think you might like to write a letter of intent. We will review the situation closely and help you prepare a letter of intent. We will then stay with you through the closing process. We will assist you, but you should plan on obtaining an attorney and CPA to do the detailed work we do not do. They are also likely to stay with you once the business is purchased.
Let me know if we can be of further assistance. If so, we will prepare a simple engagement agreement and get it in place so we are ready to go when you find a business that interests you.
Greg Caruso, JD, CPA, CVA