Assessing the viability of a business purchase
The American Dream is to own your own business. It gives freedom to apply your personal values to your work, and it has no upper limit on how big you can make it. Starting a new business is risky. The opportunity to take over the existing business from your boss can be a much quicker and certain path to becoming an owner.
This is a great opportunity, but before you jump into buying your boss’s business, consider these 7 things:
1. Gut check the critical aspects of ownership.
Do you know enough about how the business will make money for you? Do you want to manage employees? Are you willing to work extra hours to succeed? Are you ready to risk putting your own money into the business, buying it, and running it? What does your family think about their investment in money and your time?
Buying a business is a major life decision. It’s better to pass up what appears to be a good opportunity if gut questions are unanswered.
2. Control the timing, don’t let it control you.
Your boss may appear to be in a hurry to sell you the company. That’s his issue, not yours. Go slow. Make sure that you take enough time to dig deep, understand the business you are buying, and get comfortable that it is the right decision for you and your family.
If the seller pressures for a quick sale, it may be a warning sign that something is not right.
3. Get the facts about the business.
The owner needs to share their financial statements, customer relationships, suppliers, competition, and external factors that may affect the company’s health. Is the company dependent on just a few big customers, is it dependent on a few key suppliers? Is it exposed to international competition or supply? Is it at risk of labor shortages, materials shortages, seasonality (like winter & summer), or cyclicality (like housing, automotive, or energy costs)?
This process is known as “due diligence.” Spend time studying financial statements and tax returns (with an accountant if necessary), supply chain, marketing, sales, and legal issues.
4. Determine your own value for the business.
The seller may have an asking price based on his wants and ideas. His “asking price” doesn’t matter to you. Your key question is what the business is worth to you if you buy it? The real value of a business is the stream of future profits that go to the owner. And this means profits after you have paid yourself for your work at the company. Most businesses with $2,000,000 or less values are sold for 3 to 5 times net (after owner’s salary) profit.
It is a mistake to pay money upfront to “buy a job” for yourself because you can get a job somewhere else without the up-front payment and the everyday risks of ownership.
5. Plan how the business will work when you own it.
“Business Plan” is a scary topic for many company owners, but it is necessary. You need to plan how you will make a salary and profits from this company. You need to plan for generating sales and controlling costs, hiring employees, and investing in assets to support the company. This is your roadmap to success, and it serves as a guide for your decision-making as the owner of the company.
Your business plan doesn’t have to be fancy, but it must be realistic. It needs to include a description of the business, its customers, suppliers, competitors, and the risks of something happening to those critical components of the economy. It needs to have financial estimates about monthly profits and working capital required for success.
6. Create a business payment plan that sets you up for success
Every company owner who sells wishes for a big fat check at the closing. That’s not realistic for most employees who are buying the business. Asking the seller to help with the financing is a common way of putting together a buyout that works for both parties. A typical method is for you to make part of the payments to the seller over time. This seller financing often bridges the gap between the price the seller wants and the capital the buyer can raise.
A representative payment plan might look like the table to the right:
This example shows a company earning $200,000/year and a value negotiated at four times earnings for a price of $800,000. The buyer puts in $75,000 from savings or a second mortgage on his home. A bank loans $325,000, and the seller agrees to take half the purchase price in a payout over five years.
The payment to the seller is $80,000, which is less than half of the $200,000 annual earnings. In this way, the seller is committing to the buyer that he believes that the company will be profitable. It also gives the bank comfort that their $325,000 loan can be paid first before the seller’s $400,000 is completely paid out.
7. Visit the bank at the end of the process, not the beginning.
You will likely have to borrow some of the purchase price from a bank. Bankers are always interested in talking with borrowers. The bankers’ job is to lend money to businesses. They will turn away from a borrower who does not have a clear plan about how much is needed and how it will be paid back.
Walking into a bank saying, “my credit score is 700, how much will you lend me to buy a company?” is an amateur move. You need to show the banker what the business is, how much money it makes, how much debt you need to make it work, and how you will repay the loan. The bank will also want to know about collateral and guarantees that will assure their loan gets repaid. Wait until you know how all the terms of the purchase work and how the company will make money to repay the loans, then go to the bank. Showing a payment plan like above should be a reasonable proposal to them.
Buying your boss’s business is a great opportunity. If it passes your gut check, then pursue it objectively with due diligence, and work out the price and terms that suit both you and your boss. It can be an excellent thing for you and the seller. You can become part of the American Dream.