Entrepreneurship & Small Business

Take-over/Buying a new business - what to do?

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Take-over/Buying a new business - what to do?

I am thinking of taking over a small business, that's already established, instead of start-up a new one with so much and so many costs to get it up and running. The main goal is to generate some cash-flow. We already have some other investments, but would like to expand the portfolio a bit.

Other than the normal regular questions that you ask sellers/broker, financial statements, lease copy, etc., what else do you ask? ask yourself, and ask the seller?

The big/major gripe I have is the financial statements provided would never really show anything fully "truthful". And if you own a business, I assume that you know what I am talking about.

Example:
If a business is listed for $200k, i would expect some profits close to $80-100k (maybe before taxes). So 2 - 2.5 years would be a rough estimate for ROI. But financial statements would be somewhere in the low tens ($10,000-$15,000) or even at times, negatives. Obviously, no one wants to buy a losing business and think they'd bring it up, might as well start a new one. Or, no one would buy a business and wait 20 years to make back the investment. And I know the sellers would agree to this.
There has to be some hidden numbers that sellers can't show or won't show. How do I get them to show me these numbers? Or what other ways to see these numbers? And even when they do, how do I validate these numbers?
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I don't think you are going to get a business owner to show you the 'hidden numbers' if they are using fraudulent numbers in their financial statements they use to reconcile their income tax return. However, they may show you numbers that 'normalize' the statements for salaries and other amounts they may be paying to connected parties that are above the norm but are above-board expenses.

I would be sitting down with them and going through the statement of income and expenses line-by-line for the last 3 years and current and asking them to discuss with you any that look out of line. Do your own reasonability test too.

A business can be valued at anywhere from less than 1x normalized profits and up depending on the business and its size, rate of growth, competitive environment, whether the owner is staying and other factors. What factors are present here. Of what magnitude are the profits?
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For small businesses, often the financial statements are not audited. You need to take the numbers with a grain of salt and use your own common sense. It's like buying a 2nd hand car. The seller knows the condition of the car much better than you. It's harder than a 2nd hand car because at least you can hire a mechanic to check. If you want to valuate the company, chances are good the seller would not agree.

What kind of business are you buying? If it has a physical location, go stalk the store and see what the customer traffic is like. Come up with your own sales estimates. Count the number of employees there if possible. You should be prepared to ask a lot of questions to the owner(s).

Another issue with small business financial statements is that owners often pay themselves salaries. Basically you can pay yourself enough salaries such that corporate income tax is $0. There is nothing wrong with this. The owner is just choosing to pay tax at the personal level rather than through the corporate level. Furthermore, what is defined in accounting as "assets" could mean nothing in reality. If you are buying a restaurant for example, the renovations would be capitalized as leasehold improvements. If you are planning to rebuild, you would probably be more interested in whether any of the equipment can be redeployed. The book value of the leaseholds are often meaningless to you.

My persona advice is to focus on the FUTURE potential. History can only tell you so much and there is a lot of room for fudging with the numbers. There isn't really an exact science to this. Some guy in a suit is probably happy to walk you through their valuation method but at the end of the day, you need to make your own assessment of the sales and operations. The best thing to do is to buy a business with potential but run by incompetent management. This way you can use your skills to turn it around.

The type of business also matters. Buying a franchise food store is going to be very different from buying an online business.

What you see as the list price you are probably better to interpret the cost as the cost to buy someone out. I live in the GTA. You could be paying $100-200k just to take over the location without consideration of the corporation's assets. The seller often doesn't even provide any financial statements. In a lot of cases, the new owner is buying the business to renovate into another business. Like buying out a convenience store and rebuild a restaurant.

Lastly, think about why someone is selling. Are they looking for someone to take over? Are they losing money and want to get out? Short of personal reasons, if the business is making money, the owner wouldn't be selling. If it's too much work, you can simply sell a stake to someone you trust to manage and pay this person a salary.
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First of all, thank you for such a great insight
BananaHunter wrote: For small businesses, often the financial statements are not audited. You need to take the numbers with a grain of salt and use your own common sense. It's like buying a 2nd hand car. The seller knows the condition of the car much better than you. It's harder than a 2nd hand car because at least you can hire a mechanic to check. If you want to valuate the company, chances are good the seller would not agree.

Another issue with small business financial statements is that owners often pay themselves salaries. Basically you can pay yourself enough salaries such that corporate income tax is $0. There is nothing wrong with this. The owner is just choosing to pay tax at the personal level rather than through the corporate level.
I understand this part. And thus, very low net income to the business.
My question then would be: is there a body to "audit"/"verify" small businesses like this? As in, if the business keeps on running for a few years, making very little to $0 profit, or even negative, would someone at some point say "you are not making money, you can't own this business anymore". I assume this would be true with Franchising?
BananaHunter wrote: My persona advice is to focus on the FUTURE potential. History can only tell you so much and there is a lot of room for fudging with the numbers... The best thing to do is to buy a business with potential but run by incompetent management. This way you can use your skills to turn it around.

The type of business also matters. Buying a franchise food store is going to be very different from buying an online business.
We are looking at a few businesses, franchise and non-franchise.
And from what the way it looks, franchise would be something with little to no growth, but slightly more stable, relatively, of course.
Non-franchise would be something with potential. And to reach the potential, it's a lot of hard work.
At the moment, I think franchise business, more likely than not, is better for me. Less income, but also less work.
BananaHunter wrote: What you see as the list price you are probably better to interpret the cost as the cost to buy someone out. In a lot of cases, the new owner is buying the business to renovate into another business.
I see, if this is the case to the businesses I am looking at, it might not be for me. I am planning to keep things as it is for now. Low profit, little work.
BananaHunter wrote: Lastly, think about why someone is selling. Are they looking for someone to take over? Are they losing money and want to get out? Short of personal reasons, if the business is making money, the owner wouldn't be selling. If it's too much work, you can simply sell a stake to someone you trust to manage and pay this person a salary.
I was thinking of this. But I tried to put myself in the situation, and I can probably take it this way:
After a few years running this place, I'd probably getting tired of it, net income is roughly the same throughout, enough to survive, but nothing big. And maybe I've made back the money I've invested. Maybe I should sell it and put the money into something bigger, etc.
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There is no government body that says you must turn a profit. However, if your cash flow is so problematic that you can't pay your payroll deductions and remit any sales tax collected, then the government will be on your case. Directors (which will be the owners for a small business) are personally liable for such liabilities to the government. Basically the government doesn't care about your losses as long as you are square with government filings.

There is no business association to police performance. The real bottom neck is obviously going to be how much cash you can invest into the business. You are welcome to keep operating at a loss. But you have rent, staff, and suppliers to pay. There is nothing in accounting to stop this. The owner can contribute funds indefinitely to keep things running even at a loss. That is your choice. But you would be wise to wake up at some point to shut things down and reach a settlement with your debtors and landlord.

Franchisors often don't fundamentally give a damn whether you make money or not. They make money on royalty and often on the supplies they resell to you. As long as you pay up, they don't have a legal liability to care about your bottom line. Though some of them may be curious and some newer frachisors might "try" to care about your bottom line in order to attract more franchisees to join. All large franchisors are basically existing to suck money out of you while you take the risk of running the business. So therefore they have no reason to shut you down if you are losing money...in general. One thing they COULD do is perhaps resell your location to a new franchisee if they feel you are managing things poorly. And managing poorly COULD be a reason for your poor performance. It's really case by case.

You seem to be debating franchise vs non-franchise. In my opinion it all depends on the opportunity. The people who joined Tim Hortons early are probably really happy. After opening so many stores, they have good amount of statistics to assess how much franchise fee they should charge and how much markup they should charge on supplies resale. Basically if you join a well developed franchise, there probably isn't much room to actually make money as the large franchisors would have already calculated everything in a way that would be beneficial to them and not for you. They need to make the opportunity just attractive enough that you would fork over money to invest.

Running a business is always a very serious commitment and you should give it a lot of thought. If you talk about low risk and less work, I personally recommend you don't bother and stick with a 9-5 job. A 9-5 job does not require investment. Starting a small business often means signing on various personal guarantees and many young owners are in over their heads. By the time s*** hits the fan, it's too late and their life is ruined.
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My advice is never buy a business in an industry you are not intimately familiar with, because the financials will not make any sense to you. When analyzing financials you should be able to tell if certain ratios make sense in that industry and for the size of that business. You have to know how the numbers for that sector work. If you for example discover very high OPEX in an industry that is normally low OPEX, then you can drill down to see the reason why and how much time it will take to rectify the issue - thereby, getting a more realistic price analysis. You need to be able to price an acquisition accurately - that is what will make or break you. The story behind the numbers can only come from industry experience.

If you have to overcome a huge learning curve, then just start a business from scratch - at least not a lot of capital investment for imaginary goodwill. Once you know your sector, you could then go and buy out competitors. In my wife's line of business we have become so adept at the numbers and operations, such that when I see a similar business being advertised for sale, just based on the description, I can pretty much tell you what their client mix is like, workforce size, rough margins.
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BananaHunter wrote: Running a business is always a very serious commitment and you should give it a lot of thought. If you talk about low risk and less work, I personally recommend you don't bother and stick with a 9-5 job. A 9-5 job does not require investment. Starting a small business often means signing on various personal guarantees and many young owners are in over their heads. By the time s*** hits the fan, it's too late and their life is ruined.
I do take this to heart.
Truth is, I am not really "starting" a business. The business is already operational, and has been for a few year. and generating incomes. Current owner does very little work at the moment, they own quite a few other businesses. I hope it's a smooth transition in the background and not so much disrupting the current flow.
From what I understand, selling this business give them some cash to put into another business that generates more profit.
It does seem like if I take over, I can pretty much work the same way the current owner is operating the business. Of course I'd need a lawyer and accountant to verify all financial details.
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canuckstorm wrote: My advice is never buy a business in an industry you are not intimately familiar with, because the financials will not make any sense to you. When analyzing financials you should be able to tell if certain ratios make sense in that industry and for the size of that business. You have to know how the numbers for that sector work. If you for example discover very high OPEX in an industry that is normally low OPEX, then you can drill down to see the reason why and how much time it will take to rectify the issue - thereby, getting a more realistic price analysis. You need to be able to price an acquisition accurately - that is what will make or break you. The story behind the numbers can only come from industry experience.

If you have to overcome a huge learning curve, then just start a business from scratch - at least not a lot of capital investment for imaginary goodwill. Once you know your sector, you could then go and buy out competitors. In my wife's line of business we have become so adept at the numbers and operations, such that when I see a similar business being advertised for sale, just based on the description, I can pretty much tell you what their client mix is like, workforce size, rough margins.
Thanks. That is what I am thinking. It definitely will be a huge learning curve on anything you have not been familiar with. It's why we choose to take over something that's already running okay, instead of starting up a business that might not even work. It's a way to get to start learning while things are already in place. Of course there will be other nags, but still better than starting from scratch.
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konsensei wrote: Thanks. That is what I am thinking. It definitely will be a huge learning curve on anything you have not been familiar with. It's why we choose to take over something that's already running okay, instead of starting up a business that might not even work. It's a way to get to start learning while things are already in place. Of course there will be other nags, but still better than starting from scratch.
Depends on the person. Some people are quick studies and some are not. Some people do enough research before buying and some don't. I've bought and started many businesses that I didn't have a clue about but did my due diligence and have been successful most of the time (ok I had a couple duds). Telling someone it's better to start from scratch, or always buy a business that's already in operation for that matter, is nonsense. People are always doing both and being successful. Sometimes a business that fails, whether you start from scratch or not, is simply bad luck. Black swans can show up in any business.
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eonibm wrote: Depends on the person. Some people are quick studies and some are not. Some people do enough research before buying and some don't. I've bought and started many businesses that I didn't have a clue about but did my due diligence and have been successful most of the time (ok I had a couple duds). Telling someone it's better to start from scratch, or always buy a business that's already in operation for that matter, is nonsense. People are always doing both and being successful. Sometimes a business that fails, whether you start from scratch or not, is simply bad luck. Black swans can show up in any business.
We have other investments, which I have also learnt, and very fortunately they are doing ok.
It would be our first time stepping into "businesses". We want to expand. We are willing to learn. We don't want to jump in something that we would need to learn so much in such a short time, that might generate too much losses. We are willing to lose a little bit here and there while learning, thus taking over a business that's doing "okay" might not be as bad.
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Have you actually sat there outside and watched how many customers go in ? We had a few businesses " back in the day " and that's what one of the buyers did. He sat there for about 4-5 hours, just watching the foot traffic, sales, etc.
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tkl wrote: Have you actually sat there outside and watched how many customers go in ? We had a few businesses " back in the day " and that's what one of the buyers did. He sat there for about 4-5 hours, just watching the foot traffic, sales, etc.
We did. numbers are similar to what provided to us.
Do you still your businesses? Or what changed the path?
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konsensei wrote: Thanks. That is what I am thinking. It definitely will be a huge learning curve on anything you have not been familiar with. It's why we choose to take over something that's already running okay, instead of starting up a business that might not even work. It's a way to get to start learning while things are already in place. Of course there will be other nags, but still better than starting from scratch.
My point was that without intimate industry knowledge, you will almost always overpay for a business as you do not know how to impute a proper valuation. You could end up paying twice what the business is really worth. Not only will you overpay, but the burn rate of trying to sustain so called business will leave you cashflow negative every month. Been down that road in my youth.

While it might sound counter intuitive that starting from scratch is easier than buying a going concern, there is a strong reason for such rationale:

You can minimize the start up capital outlay. For example, you want to buy a going concern retail business that sells bicycles for $250k - yet you do not know how to properly value and optimize such a business. You could easily pay $250k for a business that is really worth $100k. On top of that you do not have enough cash flow to sustain it and end up in debt. Now, let's say you were to start in the bike resale business from scratch - you would maybe start off selling a few bikes online while learning the business stuff that is not reflected on financial statements (e.g. consumer tastes, which SKUs have better contribution margins, supply chain and inventory issues). This online start up can all be done at a cost of $5k out of your garage. Once you have outgrown your online sales channel, you might want to explore other sales channels like retail and you could start off by selling at flea markets and trade shows to build brand awareness. If the proof of concept is working good, then you open an actual store front for the cost of first and last month's rent vs paying someone $250k to buy their bike store.
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canuckstorm wrote: My point was that without intimate industry knowledge, you will almost always overpay for a business as you do not know how to impute a proper valuation. You could end up paying twice what the business is really worth. Not only will you overpay, but the burn rate of trying to sustain so called business will leave you cashflow negative every month. Been down that road in my youth.

While it might sound counter intuitive that starting from scratch is easier than buying a going concern, there is a strong reason for such rationale:

You can minimize the start up capital outlay. For example, you want to buy a going concern retail business that sells bicycles for $250k - yet you do not know how to properly value and optimize such a business. You could easily pay $250k for a business that is really worth $100k. On top of that you do not have enough cash flow to sustain it and end up in debt. Now, let's say you were to start in the bike resale business from scratch - you would maybe start off selling a few bikes online while learning the business stuff that is not reflected on financial statements (e.g. consumer tastes, which SKUs have better contribution margins, supply chain and inventory issues). This online start up can all be done at a cost of $5k out of your garage. Once you have outgrown your online sales channel, you might want to explore other sales channels like retail and you could start off by selling at flea markets and trade shows to build brand awareness. If the proof of concept is working good, then you open an actual store front for the cost of first and last month's rent vs paying someone $250k to buy their bike store.
I believe part of the buying as a job of a buyer, I should really do my due diligence to verify the $250k store before I put down the money, no?

I really think of how and how long does it take for me to get back my $250k.
Putting down 250k, I would really need to pocket at least 100k/year. How is the business in the past 3-4 years, is it generating anywhere close to $100k/year for the current owner? Does it look like it's going to make another 100k next year? If it is indeed 100k/year, why is the owner selling?

That's been my way of thinking going into this so far. Any other thoughts on how to approach it?

When I think of starting from scratch, especially anything retails, that needs a physical store, I think putting down $250k store and I might not be able to make any money at the end, that scares me more.

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