So You Want to Buy a Business: Protect Your Investment Before You Buy
by Joey Young | March 29, 2021
Editor’s Note: This is the last article of a four-part series. Access the entire series at the bottom of this article.
In the previous three articles of this series, we studied a health club’s financial statements and arrived at a reasonable estimation of the earnings before interest, depreciation, taxation and amortization (EBIDTA) of $135,000 and an adjusted owner’s cash flow (OCF) of $154,000. Furthermore, we decided that the predictions of the future cash flows warranted a price of 3x that OCF for a final offering price of $462,000 for the business.
Before you give the seller a sense that the deal is settled, you need to consider some important things that will protect your investment. It should go without saying that an experienced attorney should be involved by this point, but the following items are some of the things that you’ll need to consider in your final negotiations:
- Can this business afford to make the loan payments required to finance it? If you decide to borrow money from a bank or use owner financing to purchase the business, you’ll have to see whether those payments are even affordable to the business in the first place. This is one of the reasons you think before you offer. Your business will need cash for all of your new ideas so keep the safety of your investment in mind at all times.
Example: If the business costs $462,000, the debt payments would be approximately $89,000 annually if a 7-year SBA loan were used. That leaves $65,000 per year of leftover cash flow to the owner. A reduced cash flow like that might even inspire the buyer to lower the multiple of OCF back down to the industry average of 2.3x OCF.
- Debt load, liabilities, lawsuits, back taxes/program licenses/accounts payable/unpaid liquor licenses: Always make sure that an attorney is involved with the final sale contract so that hidden liabilities do not become the responsibility of the new owner, because they will if you don’t protect yourself.
- Lease issues: Is the current property lease assignable to a new owner? Does it require a personal guarantee? Will the landlord give you a long enough lease to pay off the business loan? (SBA loans like these are usually 10-year terms). Are there affordable and explicit extension options in the lease? Do not assume that a landlord is on your side. They will make money at every opportunity, so protect yourself before the purchase of the business is finalized. Do not obligate yourself to debts or other financial situations until after the lease is signed. If a landlord knows you have committed to debt early, he can charge you whatever he wants in rent because you’re now financially committed to follow through.
- Does the landlord grant “non-competes” in the same shopping center? Disclaimer: People say that you can only count on two things in life: death and taxes. I say that you can only count on three things in life: death, taxes, and competition. So, don’t underestimate the reality of a competitor nearby soon after the purchase regardless of your rent protections.
- Don’t be desperate. Protect yourself and remain calm and assertive. Too many first-time buyers get excited and feel like the owner is doing them a favor by allowing them to buy the business. Stay cool. Stay confident. You’d be surprised how many opportunities come your way when you aren’t acting desperate. If you are inexperienced, this would be a good time to try the “fake it ‘til you make it” method.
- Training time: Make sure you include some training time (three to six months) from the seller in your purchase contract. You will need help getting going on items that aren’t immediately clear to a new owner.
- Non-competes from seller: There should always be an agreement for the seller not to compete within a certain number of years and distance from the business after a sale. Some customers are loyal to an owner and will follow him/her to a new location, so protect your investment with a non-compete clause.
This series is not exhaustive, but it does give you a sense of the kinds of things that are important beyond simply a selling price. Remember that when you buy a business it’s more than an investment, it’s a life you’re choosing. So be careful and thoughtful about that choice because it’s a big one.
Florida SBDC at USF, Tampa
Specialty: Accounting, Cash Flow Management, Taxes, Startup
Joey Young has 22 years of experience in start-up and business development as an owner and business consultant. He holds a bachelor’s degree in economics from Auburn University, a master’s degree in entrepreneurship from Oklahoma State University, and a master’s degree in music business from the Berklee College of Music. He is also a veteran of the U.S. Air Force. Young was involved in the start-up, expansion, and sale of five of his own businesses that range from health clubs and construction companies, to live music event planning. Through those endeavors, he maintained professional relationships with large corporations such as IKEA, World Gym International, and FabLocal. He has experience in accounting, finance, business valuation, tax implications, cash flow management, strategic planning for growth, and e-commerce.