14 Dec 11 Key Points to Think About When Buying a Business
You’ve started to explore the option of buying an existing business but you have a lot of questions and aren’t really sure where to start looking for information or answers!
Well, let us help you get started.
This post contains 11 key points that that you should pay attention to whenever you look at a new business that is for sale. These 11 points are just the beginning though, there are often many other factors beyond the ones highlighted below that you must think about along the way.
As we explore these key points, it’s important to highlight that each individual business advertiser organizes their information in different ways on their respective websites. At the end of this blog post, we’ve included an example of how the Business Brokers of Florida – Multiple Listing Service (BBF-MLS) provides their information. We’ve highlighted these key points right on this sample listing! If you want to test yourself and see if you can locate the key points we’ve highlighted on a live listing, visit BuyBizFL.com (or any other Florida MLS page) to search for a listing that interests you.
Whether the Owner / Seller offers this information to you at first or not, make sure you request to see this information. In an ideal world, you might want to see every tax return, sales report and employer record, but often many of the detailed reports are only shared to a prospective Buyer as part of Due Diligence once an Asset Purchase Agreement (APA) or Letter of Intent (LOI) has been agreed to by both parties. This will at least get you to a point where you can decide to look more closely at the business. (We have used a fictional listing for an example.)
Below are some terms that you will see mentioned in the points below:
- SDE – Seller’s Discretionary Earning or Owner’s Benefit
- EBITDA – Earning Before Interest, Tax, Depreciation, and Amortization
1. Is Price to SDE reasonable?
There is no single way to determine the price of every business but there are guidelines that we use within the industry. Many businesses sell for between 2 to 3 times SDE or 3.5 to 4.5 times EBITDA but the actual multiple varies.
Always bring in professional, experienced help to look over the earnings. It’s okay to pay on the high end of a reasonable price range for a business that is performing well and that is right for you but look at what others have paid for similar businesses before you make your final offer.
For calculation and greater explanation of SDE, visit: http://buybizusa.com/for-owners/selling-tutorial/much-business-owner-earning-calculating-sde/
2. Does ratio of SDE to Gross make sense?
Owners have lots of ways of calculating SDE but we offer a particular calculation guideline used by most reputable brokers. Since Owners want to sell their business, they may do their best to make this look as attractive as possible. You must do your best to verify figures and determine if the SDE is reasonable.
We have seen, as an example, where a restaurant claimed to have Gross Sales of $500K and the Owner claims he is taking home $250K, when Rent was $150K. This may be the truth but since most restaurants have an SDE between 10% to 15% of Gross Sales, the claim seems overly optimistic. Always verify, and trust instinct when the money seems too good to be true.
3. Does the stated reason for selling make sense?
People sell for all sorts of reasons, and many sell their businesses because they want to retire, but others want out for reasons that would make you uncomfortable if you knew the truth.
4. Does Owner work reasonable hours?
- Will you be replacing owner?
- Can you work the same schedule?
- Does the owner have spouse or other family working there?
- Will they stay after you buy the business?
- Are they on payroll or is part of the owner benefit (SDE) calculated to show you will be replacing more than one person?
NOTE: SDE is a calculation to account for only one person. If a spouse is also working, the owner benefit should be calculated to pay for all workers except for ONE WORKING OWNER, and only one.
5. Business Owner been around a while?
It is always a red flag to see business being offered for sale after owner has had for just a short while. Highly investigate any time period under three years. There are legitimate reasons for quick turnaround sales but often this is a sign that something is challenging about the business. It could be something you can live with that the current owner cannot. Just be sure to verify why. One additional tip is to have Owner/Seller complete and sign a Seller’s Disclosure Document.
6. Training and non-compete reasonable?
The right amount of time for training, as well as the distance and time for non-compete vary from business to business and Buyer to Buyer. Get advice to discover what works best for you. If customers are closely tied to Owner / Seller, it might take months, a year, or more to successfully transfer business.
Regarding the non-compete time requirements, always understand why an Owner / Seller might ask for a short period and why asking for too long of a period might be difficult to defend. In terms of distance for a non-compete, a convenience store might need only a few miles for non-compete but an online business might need to be global.
7. Will you need a special license?
Make sure you know the legal requirements to own and operate the business. Do not rely on the Owner / Seller to be up to date. We recently worked with a Dental Lab and the Owner was shocked to learn that the number of years of experience needed to obtain a license had more than doubled! Even if you don’t know the industry, you can often, over time and with support, get licensed in many fields. Check with the state and county. Speak with someone who knows. Get the facts and make sure you can live with them.
8. Source of Financial Records good?
Some business records match with what the Owner / Seller claims while others have multiple records, or have hardly any records at all. Unless you absolutely know the business and can get a good idea of how the business is financially performing, be very cautious. Often a business losing money will be reported as profitable when offered for sale. It can be hard to tell the difference between someone who is hiding profits and someone who is hiding losses. If the sources are Taxes, or even Profit & Loss Statements, that can be encouraging. People will also report Projection, Owner Estimate, pure guesses and worse.
NOTE: Even taxes can be faked so trust but verify by having Owner / Seller sign and submit IRS form 4506T.
9. Reasonable expenses and adjustments.
Read the details on calculating SDE. Only accept reasonable, verifiable adjustments. It might be right to add the expense for the owner’s expensive car written off to the business. However, Owner / Seller cannot add back money given to employees that are given as a bonus each year. If that has been the tradition, employees work hard for and will likely expect it to continue, so you need to be prepared for that situation.
10 . Rent reasonable, compare to Revenues.
Rents that are too high compared to the Gross Revenues destroy business profitability. Learn the industry norm and determine if price the rent for business you are considering is in line with the norm. Landlords are very often unlikely to sympathize with someone who bought a business and now hopes that rent will decline so that the new owner can make, some, or any, money.
11. Business has lender financing.
Few businesses qualify for SBA lending. Less than 10% of the businesses advertised on the internet today are lender. Pay close attention to these.
Hopefully, you are ready to examine business listings a little more closely and you can find these 11 key points on any business that interests you! Take a few minutes and look at image below where we’ve provided an example listing from the BBF-MLS (not a real business). We’ve highlighted in RED the 11 key points we’ve talked about today and how to find them on this listing source. As mentioned before, each unique advertising website, will list this information in different ways, but these are the absolute key pieces of information you should look at for any listing you are interested in.
One thing to keep in mind though, every business and business owner is unique and while these 11 key points are extremely important in the evaluation process, you will likely find that there are many other factors that you must consider along the way. Happy hunting and if we can assist you in anyway, please give us a call at 1-833-BuyBiz1 (1-833-289-2491).