Fred Dunayer: Welcome to the SCORE Small Business Success Podcast – Been There, Done That! To get free mentoring services as well as to see the wide variety of resources available for small businesses visit our website at www.score.org or call 1-800-634-0245. Now, here’s your host Dennis Zink.
Dennis Zink: I’m joined by Fred Dunayer in our studio as co-host, SCORE mentor, and audio engineer.
The first episode is Buying A Business. I’d like to introduce Norm Silverstein whose primary expertise is assisting buyers and sellers of small to mid-sized businesses. Norm has owned his own business brokerage company for 10 years and merged with another company in 2006. Having completed hundreds of business sales and transactions, Norm is experienced in mergers and acquisitions, business valuations, performing due diligence, determining the real cash flow of a business, and everything that it takes to bring buyers and sellers to the closing table. Norm has been a SCORE certified mentor since 2012.
Norm, welcome to Been There, Done That!
Norm Silverstein: Thank you and good morning.
Dennis Zink: Good morning.
Fred Dunayer: Good morning.
Dennis Zink: Good morning, Fred.
I’d like to start by asking, many entrepreneurs choose to buy a business, an existing business, as opposed to starting from scratch. What are some of the reasons that someone would want to do that?
Norm Silverstein: Basically buying a business or owning a business has always been the American dream and there are three ways of going into business. I’ll touch upon buying an existing business as number three but number one, the most difficult way of getting into a business is starting from scratch. That’s the highest risk however it gives the highest rewards if you’re a true entrepreneur. Basically you’re starting off with no customers and no business, so that’s difficult. That’s something you have to overcome.
The second way of going into a business is buying a franchise and there are good franchises and there are bad franchises. You have to really differentiate and do your homework to find out what is a good franchise. You will not get any current numbers or numbers of existing franchises as far as what volume they’re doing, what profits they’re making. They’re not allowed to do that so you have to do your due diligence by contacting different franchisees of that franchise to determine whether this is something you really want to go into. Also one of the disadvantages of owning a franchise is that they take a piece of your total sales whether you’re making money or not and they do this every month. They charge you a franchise fee, an advertising fee, and usually it runs around 7% or 8% of your total volume so you got to pay that upfront. Another disadvantage is if you’re a true entrepreneur you really can’t do everything you want to do if it doesn’t fit into their system. Buying a franchise can be advantageous if you need that kind of help, that background, that support that a good franchise will give you but you got to pay for it in the long run.
Buying an existing business is probably the least risky if you buy the right business and do it properly because you have immediate cash flow. That’s number one. Buying a franchise or starting from scratch you don’t have that advantage so you have immediate cash flow. All of the bugs of the business have probably been ironed out and all of the problems that the business has encountered at the early stage of their development have been resolved. Basically, most of the dirty work has been done when you buy an existing business. To me that’s the most advantageous way of doing it and the least risky. Again, if you do it properly.
Dennis Zink: Do you also think it may be the least expensive?
Norm Silverstein: It could be but maybe not. It depends on the size of the business and it depends on how you buy it. You can buy a business for all cash which I don’t recommend or you can buy a business with a down payment and most business owners will do financing. If the business owner does financing a bank will also come aboard if you need additional financing. It really depends on the size of the business. Again, it could be expensive but maybe not because again you’re getting that instant cash flow. That’s what you have to determine whether you want to do that or not.
Dennis Zink: Who typically are the buyers? Where do they come from? What are they looking for?
Norm Silverstein: Buyers, there are people who have always dreamed of owning their own business and that’s a select group. They may be working right now or they’re not working but they’ve always dreamed of owning their own business. They can be employed or they could be a displaced executive who based on the economy today there’s a lot of them who are looking for jobs and can’t find them and the other option of course is to try to find a business that they can afford to buy. Some former business owners will also look for other opportunities. Sometimes they’re burned out in their existing business and are looking for new challenges and they’re looking for another business to buy.
There are turnaround specialists who look for businesses with problems and if they find a business that they can buy based on their economic needs that they feel they can turn that business around. They’re looking for that challenge and that’s fine. There’s a strategic buyer which is usually a company looking for a business that will fit in with their overall business plan. There are foreigners looking to move to this country, live in this country, and they need a Visa to stay in this country. One of the best ways of doing that is to buy a business and that will fit their needs too. We have a lot of business owners, small business owners, in this country. If they have enough employees to satisfy the immigration authorities of our country they could become and they are potential buyers.
Dennis Zink: Let’s assume that you’re ready to buy a business. How do you find the right business to buy? Where do you look? Who do you go to?
Norm Silverstein: That’s pretty difficult. There are ways of finding an existing business. There are websites. For example BizBuySell and BusinessesForSale.com where you can just type in or punch in a state, a city, a town and the type of business and some of these existing businesses will pop up and you can take a look at those. I think the best way of doing it is to contact a business intermediary, a business broker, who has specific listings who can help you in the process of buying a business and some of the due diligence has been done by this business broker already so you got some basic information that you can deal with. You can look at the newspapers. Some businesses advertise. You can certainly do that but I think again as a former business owner I think the best way of doing it is to hire an experienced business intermediary who knows exactly what your needs are, who can match your needs with an existing business that’s for sale.
Dennis Zink: You go through an intermediary. What are the major steps that you go through in buying a business?
Norm Silverstein: The first thing to do is to find a business that as far as the price of the business is concerned and with the requirements, the down payments and terms, fit your needs. That’s most important.
Dennis Zink: Basically, let’s say you find a business. You like the business. It looks like it makes sense for you. How do you make an offer?
Norm Silverstein: Before you make an offer you certainly want some financial information. Then usually, a broker will have that information on hand which will give you an idea as to what the gross sales have been over the past few years, what the net profit has been over the past few years. This could be very helpful before you make an offer. To make an offer usually you would come up with an offer to purchase which would have to be contingent upon you doing due diligence. Contingent upon getting and accepting an acceptable lease, because not finding a lease that will be acceptable to you is a deal killer.
Landlords, they don’t like to give leases to people they don’t know especially if they’ve been getting paid every month by the current owner. You have to find the landlord and the business owner usually will put you in touch with the landlord. You get to know the landlord. If you don’t have a lease that’s acceptable to you, you have the right of null and voiding the contract. That’s very important. Plus you have to do your due diligence. You need a few weeks to do that. If the due diligence doesn’t prove the numbers that you have been given, you also have the right to back out. You’re not at risk until you get to the closing table.
Dennis Zink: Let’s get back to the lease for a moment. If the lease is assignable you’re saying that a landlord won’t automatically allow you to take it over but then again would they possibly renegotiate the lease or in your experience most of the time do they let it be taken over as an assignment?
Norm Silverstein: Most of the time if they feel comfortable with the buyer, they will let the buyer assume that lease because the lease will probably say that it’s assumable but again the landlord has the final say in that, otherwise it will be negotiable. Then the negotiations have to be to your advantage otherwise it’s not going to work. If you’re going to be paying hundreds of dollars more a month and you’re projecting your cash flow on the previous lease payments that’s not going to work. Again, that could be a deal killer if you have a landlord who’s not going to cooperate. He’ll ask for a personal financial statement so he’ll know something about you and again, with a meeting. If you have a meeting of the minds with the landlord it should work but again that’s an unknown factor and that’s why it’s always a condition before closing that it has to be acceptable to the buyer.
Dennis Zink: I use the word assignable as opposed to assumable. Is there a difference? Did I use the wrong term?
Norm Silverstein: It’s pretty much the same. It means the same.
Dennis Zink: Going through the due diligence process which you mentioned. What does that involve?
Norm Silverstein: It involves a lot of things. Number one you will probably have been given a projected financial statement for the following year, for the previous years. These are profit and loss statements that you can look at to determine what the profit of the business is but you want to verify that. You want to look at, at least the last three years of tax returns to see what has been reported to the government. That’s the most important thing. What’s on the P&L that’s provided by the owner, that’s okay, however you want to see what his total sales are, what he reports to the government, so that’s number one.
You should be looking at bank statements. You should be looking at canceled checks. You want to know everything that that business has done. You want to look at the customer list and you have the right of doing that. If you don’t have that information, again, you’re going to back out, so you want to verify everything that’s been represented to you by the business broker, if you’re working with a broker, or that’s been represented to you by the seller. You want to make sure that everything is exactly as it’s been reported to you.
Fred Dunayer: Norm, given that most of us haven’t been through that process is there somewhere in this sequence where you should go ahead and bring in your accountant, your attorney, some other resources to help you do that evaluation?
Norm Silverstein: Absolutely. When I was in that business I always recommended to have your attorney certainly draw up the contract and also have your accountant look at all of the information with you. You’re going to make the final decision but your accountant is going to certainly advise you as to what he thinks but business is more than numbers. Not that numbers aren’t important but you want to make sure the numbers check out. Then you also, as a business person, want to make sure that from a marketing standpoint, from an employee standpoint, there’s other things you want to make sure that are in place.
Fred Dunayer: When you’re doing that is your regular accountant and your regular attorney, for lack of a better term, the folks you use for that or should go out and find specialists in business acquisition. Do they have special CPAs that have that as a specialty, those kinds of evaluations and things?
Norm Silverstein: Yes, there are and there are CPAs and there are attorneys who specialize in closing businesses. As far as using an attorney, you want an attorney who knows how to draw up a proper contract. Not every attorney can do that but there are a lot of business attorneys here in town that do that as well. If you have an accountant who just does taxes that’s not going to work but there are accountants who are familiar with the due diligence process, who can be very helpful and at least verifying with you the books and records of the company.
Dennis Zink: How do you account for a business owner that has a car through the business? Goes out to restaurants every day of the week and takes his wife out in the evening. How do you account for the amount of profit, of true profit, in a company that is hidden?
Norm Silverstein: Great question. I think all of the things that you just mentioned are some of the advantages of owning your own business. You can do that and it’s certainly legitimate however you have to prove that to the prospective buyer. In other words if you have a car that you’re using for business or even not using it for business. If it’s on your expense statement, if it shows as a cost of business, that’s part of the owner benefits. In other words when you’re looking at what the business is truly earning for you, you want to take that bottom line in the tax return and add back to that, what the seller is really taking out of the business, which could be a car. He could have his son in college listed as an expense on his business statement but again you may not want to do that but that’s money in your pocket.
If there’s $20,000 of depreciation on the profit and loss statement or on a tax return you don’t write a check for depreciation, but that’s money. The government gives you that money so that’s part of your total owner benefits. Going to lunch or taking a vacation where you’re charging part of your vacation to your business, as long as you can prove that to the buyer, that’s part of your total owner benefits. Not just the profits of the business.
Dennis Zink: What are typically other than the ones you just mentioned and that I mentioned about cars and restaurants and your kid in college. What are some of the other areas where the amounts are recast or added back to the bottom line to show the true profit?
Norm Silverstein: Sometimes a business, some businesses, get a lot of cash for their services and cash sometimes is reported and sometimes it’s not reported. If a seller tells a buyer that look I’m taking cash out of the business but I’m not reporting all of it that’s not your concern, okay. He’s already been paid for it.
Dennis Zink: IRS won’t like that.
Norm Silverstein: There are restaurants like that, coin laundries, things like that. They’re all cash businesses. Again, at that point the owner has to prove by bank statements and things like that that he really did take the cash and was part of the business. If he can’t, forget about it. That’s not part of the income. That’s not part of the sales. It’s nothing.
Dennis Zink: I’ve heard stories where a prospective buyer will actually hang out with the current owner and just visually see what goes in the cash register in a given week. Is that a common occurence?
Norm Silverstein: It’s not common but I’ve had situations like that, especially restaurants. I’ve had a prospective buyer, with the owner’s permission, who swore up and down he was making all this money in cash, credit cards, and all that stuff. He allowed the buyer to stand behind, at the register, for about two weeks to verify what he actually did and guess what, he bought the business. I also had a situation where somebody was buying a bar and grill and the prospective buyer who’s familiar with the business said if I can sit at the bar and grill for about a week or so, because the owner couldn’t prove anything, I’ll know what’s going on. He did that and he came back to my office. He said, Norm, I want to buy the business. I know exactly how much the bartender is stealing. I know exactly what is going through the register and I’m going to buy it. Again, it’s not typical. It’s not in the books, but again, with a knowledgeable buyer it’ll work.
Fred Dunayer: The buyer got to sit there and eat and drink for a week.
Norm Silverstein: That’s right.
Fred Dunayer: It worked out really well for him.
Norm Silverstein: Again, the bartender didn’t report some of that stuff.
Dennis Zink: What typically happens after the closing, can you explain that?
Norm Silverstein: There’s two ways of closing the business. If you’re buying the assets of the business versus the stock of the corporation you have two different scenarios. I always recommend to buy the assets of the corporation because if you buy the stock of the corporation, which is advantageous to the seller, you don’t know what skeletons are in the closet. There could be lawsuits pending. There could have been all kinds of problems in the past.
Dennis Zink: Tax issues.
Norm Silverstein: Once you take over, you are the corporation. You’re responsible. I don’t recommend ever buying the stock of the corporation. I’m talking about small to medium sized businesses. When you buy the assets of the corporation, at the day of the closing, whatever expenses or whatever bills have not been paid are still owed by the former seller. You’re responsible from the day of the closing forward and he’s responsible for everything prior to the day of the closing. For the first few weeks you’re going to be sitting and working with the seller as bills come in and he’s got to pay his responsibilities and you have to pay yours. It’s a process that you have to work with.
Fred Dunayer: Norm, how common is it that the previous owners stays on for some period of time to help transition the business to the new owner?
Norm Silverstein: It’s very common. In most small businesses the owner will agree to stay on for about 30 days. That’s always negotiable but that’s a typical 30-45 days. That’s about it. Usually beyond that if the buyer requires that he would have to pay the owner some kind of a salary or consulting fee for periods beyond that but in most cases 30 days is sufficient depending on the complexity of the business. Again, that’s always negotiable but usually at least 30 days as part of the business contract.
Dennis Zink: Can you explain the concept of goodwill and what a buyer is getting other than the actual inventory, if there is inventory? What is goodwill?
Norm Silverstein: Goodwill, is the total owner benefits that the company is producing. Whatever the owner puts in his pocket at the end of the year, that’s goodwill. It’s not blue sky.
Dennis Zink: If his name is Will it’s really good for Will.
Norm Silverstein: That’s correct. That’s goodwill. Some people confuse goodwill with blue sky. Blue sky is like buying the potential, pay for potential, of the business. You have to make the potential not the seller so that’s blue sky but goodwill is what the business is producing as far as income is concerned.
Fred Dunayer: Is there a rule of thumb? Going back you talked about the value. It’s more than just the profit of the business. It’s the profit plus all those benefits added back in. I’ll just use the word profit to make it simple. Is there some multiplier of the profit that a buyer should consider in terms of how much he should pay for that business?
Norm Silverstein: Yes, there are. That’s called rules of thumb. Now some people say rules of thumb are dumb however in most small businesses the purchase price of the business is really based on some multiplier, as you indicated, of the total benefits that the business is throwing off. Typically, it’ll run anywhere from one time to five times the total owner benefits plus any inventory at cost, plus furniture, fixtures and equipment. Furnitures and fixtures and equipment is also part of the assets and the other questions raised and I’ll go back to your question.
When you’re putting a value on furniture, fixtures, and equipment it’s not based on what the depreciated value is. It’s not based on what it costs new but what is the value of the equipment today if you had to sell it. It’s somewhere in between the new price and the depreciated price and inventory is always at cost.
Fred Dunayer: You said it could be one to five times. There’s a big variance in there.
Norm Silverstein: Big variance. Here’s the variance. It depends on whether the business numbers have been going up or down. It depends on how profitable the business has been over the past couple years, recent years. It depends on how unique the business might be. Typically, as far as an average is concerned, through my experience, most businesses will sell around 2.5 times the total owner benefits plus inventory at cost, plus the value of the furniture and fixtures. Again, that’s a rule of thumb.
Dennis Zink: That depends on the industry too. It’s different by industries.
Norm Silverstein: It depends on the industry, yes.
Dennis Zink: Are there ever any times when the multiple is a multiple of sales or is it always cash flow?
Norm Silverstein: Multiple of sales means nothing. I’ll tell you why. You can have a business that the income of the business is $5 million let’s say, but the total owner benefits is $100,000. What’s the value of the business? or the business could be breaking even but the owner will say well, look at all the equipment I have. I’ve got $3 million of equipment but the $3 million of equipment is only producing $100,000 in net income. What good is that? I’d rather have equipment of $50,000 producing $5 million worth of profits. A lot of sellers think that the value of their business is based on the gross volume. It’s not because the buyers are not going to look at it that way and no sensible person is going to look at it that way.
Dennis Zink: I’ve often heard that a business is worth exactly what a willing buyer will pay without there being a gun to his head. Can you comment on that?
Norm Silverstein: We’re always talking.
Dennis Zink: The seller will accept. The buyer will pay and the seller will accept.
Norm Silverstein: Again, there’s always negotiation. The buyer is going to have an asking price which is usually a top line price, usually. The seller is going to look at it somewhat differently. The seller will make an offer. If it’s accepted that’s great. If not he’ll make a counteroffer if he wishes to do that if they’re close. Again, it’s always negotiation and again if the seller is smart and the seller is really motivated to sell the business he’s not going to ask for a price that’s outlandish. If he asks for a reasonable price it will be negotiated.
Fred Dunayer: You’ve been listening to the SCORE Small Business Success Podcast – Been There, Done That! The opinions of the hosts and guests are theirs and do not necessarily reflect those of SCORE. If you would like to hear more podcasts, get a free mentor, view a transcript of this podcast, or would like more information about the services we provide you can call SCORE at 800-634-0245 or visit our website at www.score.org. Again, that’s 800-634-0245 or visit the website at www.score.org.