[fortysix]

Hey guys -- I was browsing different blogs and found these series of articles very informative -- its a guy describing how to find businesses for sale, how to value, and then how to purchase. Its an interesting read, especially for those of us who would like to eventually work for ourselves, but want to skip the initial start-up stages of business ownership, or for those who don't have the ideas or skills to start their own business.

http://www.coyoteblog.com/coyote_blog/20...ompay.html

Quote:

Buying a Company Part 1 (or how I got into this)

September 29, 2004, 8:56 pm


When I describe what I do, the most common reaction is for people to ask "So how did you get into that?" The answer, as they used to say in the old electric razor commercials, is that it interested me so much, I bought the company.

Now, at some level, corporate acquisitions were not new to me -- I had worked with acquisitions and acquisition analysis in many of my corporate jobs. But these were large acquisitions - at least $20-$40 million in sales, and it was funded out of a large corporation's cash flow.

One fateful day, I decided that A) I hated working for other people and B) I had no groundbreaking entrepreneurial ideas of my own so that C) if I wanted to own a decent sized business, I would have to buy one.

Unfortunately, I had NO CLUE how to go find companies that were for sale and that I could afford. In fact, I was not sure at that point such opportunities even existed (again, when the rubber met the road, my Harvard MBA let me down). And, if the questions I get asked all the time are any indication, I was not the only one who didn't know how any of this worked.

So, let me share how it all worked for me. This is part 1. Also see part 2 and part 3.



First Step
OK, the first step was relatively straight forward, and may be one you have already tried. I went to Google, and plugged in "business for sale arizona". Now, that looks encouraging - pages of results (actually, a lot more comes back today than when I first did it). Now, start clicking the links. Hmm, kind of thin, huh. That's because most of the stuff that ever makes these web sites is either out of date (ie sold or off the market) or the dregs that have been listed for years and months.

This did not necessarily daunt me - the same issue often exists with Internet home listings. But these listings do give you a very good lead on who are the brokers selling companies in your area.

Who are these brokers?
Business brokers are like real estate brokers in that they generally get paid by the seller based on a percentage of sales (8-12% is not uncommon). The buyer can (and should) have a broker representing them, and, again like home sales, the buyer's broker is usually (but not always) paid out of the seller's commission. Brokers, in terms of their skills and outlook, tend to fall along a continuum. At the low end, selling smaller businesses like retail shops, they look and act a lot like real estate agents, and in fact many are both. These brokers tend to handles smaller sales up to a few hundred thousand dollars. At the other end of the scale are full fledged investment bankers, who tend to handle sales of $20 million or so and up. In between are the dedicated business brokers, who really specialize in mid-sized transactions.

Why is no one returning my call?
So, based on my web searches, I started writing and calling and emailing various brokers. Nothing. No answer. If you grew up watching Loony Toons, think Daffy Duck on stage with the crickets chirping. I could not for the life of me figure this out - if I had called real estate agents, they would be pestering me every 5 minutes.

It turns out that business brokers are inundated with what they consider unqualified buyers. People apparently read one of these "nothing down" get rich quick investment books and start calling brokers, trying to buy large companies with no down payment, no relevant experience, and no real liquid assets. No matter what is written in any book, its not going to happen. To buy a small company, you need AT LEAST one and preferably both of these:


1) available, liquid assets or home equity value equal to a substantial percentage of the purchase price or
2) vast, directly relevant experience and history of success in the exact industry of the target company

Without #1, you will need a loan, and no one, including the SBA, will make any kind of substantial loan without #2

So, inundated with twenty hopelessly unqualified buyers for every one good one, brokers seldom return calls. Finally, one broker took the time to at least explain the above to me. I then sent a new set of letters to brokers. In these letters, I was more precise about the target company I was seeking, I explained, in the same detail I would for a job interview, my experience in these industries, and I even included a detailed balance sheet to show my financial capability to buy something.

Finding a Company

The approach above was ultimately successful. Once I had a broker, we starting going through the lists of what was available. Most communities have what amounts to an MLS for companies, though it is much less developed than its real estate equivalent. If you want a restaurant or a micro-brewery or a craft store, you are probably in luck. Every time I have looked, our local listings were dominated by these type businesses (though if you are smart, you might want to try to learn something from the fact that so many are up for sale). I was looking for a manufacturing or industrial products distribution company in a certain price range. Sometimes, the right company is available, and sometimes you may wait for years for one to come up. In my case, I was lucky, and something likely was already on the list.

Valuation

You could write a book on corporate valuation, and in fact many people have. There are many ways to value a company, and I spent a lot of time with big spreadsheets at large companies doing sophisticated cash flow analyses. You can do these for small companies, but most brokers and sellers will stare in confusion at your work. Do these analyses anyway, if you know how, but no matter what, you need to understand how the seller and broker are valuing the company. The good news is that the standard approach tends to yield some pretty attractive valuations.

First, you need to get to a number known as the annual cash flow to owner. To get to this number, you begin with the company's stated profits from the previous years, hopefully arrived at by some acceptable accounting method. You then adjust this number as follows:


1) add back non-cash expenses (such as depreciation)
2) subtract out cash expenditures that aren't booked as expenses - generally capital investments
3) add back the salary or other compensation the owners took for themselves
4) add back any one-time expenses that aren't expected to recur in the future and subtract one-time revenues that won't recur

Number four is where sellers get especially creative. They will claim all kinds of things are unusual one-time expenses that won't recur. Take these with a grain of salt (or two). Also, in number 4, depending on the owner, you may start finding odd stuff. For example, I was looking at a security alarm company, and the owner had an add back of $100,000 in cost of goods sold. That was very odd - I had never seen an ad-back in COGS, since ad-backs are usually overhead items (e.g. cost of special insurance policy that covers the owners). It turns out that the owner had the company purchase $100,000 of materials for his vacation home construction and had slipped these personal expenses into COGS so that he could write off the cost of his 2nd home. Once verified, I agreed that it was a valid ad-back, but for me, it was also a huge flashing red light that caused me to lose trust in the sellers and their business. If they were cutting legal corners here, where else were they cutting them? I could probably shelter myself from liability for their past actions, but what if I had to raise costs to get in compliance - e.g. if, as actually happened in the business I ended up buying, I had to raise labor costs to come into compliance with wage and overtime laws.

To this cash flow, owners and brokers will apply a multiple to arrive at a sales price. These multiples usually range from 3 to 6 times the annual cash flow to owners. So, if a company has a cash flow to owners of $100,000, they might try to sell it for anything from $300,000 to $600,000. Note that many large companies can pay 8 or 10 or even more times cash flow when they acquire companies. When you buy stocks in the stock market, you might be paying 15 or 20 times cash flow.

This makes small companies potentially attractive acquisitions. But there is a reason for the low multiples. Much more can go wrong with small companies, and small companies are much more likely to have hidden problems, falsified financial statements, etc. Companies without much performance history and dodgy accounting statements will trade at the low end, while companies with very clean financials and solid performance history will trade at the higher end.

Of course, this value analysis is only a starting point. Far more important will be your estimates of future earnings and cash flows, but we will save this for part 2.

http://www.coyoteblog.com/coyote_blog/20...ompay.html

[jamaicabound]

Thanks for posting, this is an awesome thread and topic. A few months back I had an offer to buy my business. Due to my business being strictly online and no brick and mortar it would basically be buying my inventory which maybe comes to 30k-50k but aside from that I had no real assets, basically they would be buying a domain name, my website even thoug they planend to throw their own up, and my customers lists and supplier contacts. A big part of why someone wanted to buy my business was my paypal had no limits or holds and my ebay account because I continually uppedit for years I'm able to sell up to like 6 million dollars worth of goods on ebay every month. My business wasn't only ebay but at the time ebay was making up a good chunk of my income.

I got a very low valuation from this buyer because for the previous year or two I was doing 3k-5k a month in profit, howeve rthe month prior to him inquiring about buying us we did 20k in profit so kind of hard for both parties myself and them to judge a value. I wound up being offered 250K. I considered taking it as I though the one good month we had may have been a fluke. Even with our previous numbers though the valuation was kind of low, especially since it was a competitor who was buying me and I knew he had a more solid foundation and could do more with my business and my customers than I coudl at the time.

After a lot of back and forth we got hungup because of the paypal and ebay element of our business. Your not allowed to transfer paypal or ebay accounts. Buyer wanted us to keep our name on accounts but hell if I'm gonna be responsible and have my name on something I'm not a part of and have no control over.

Really glad we didn't sell as the good month wasn't a fluke and are consistantly doing 15k-20k a month, hell just closes a sale earlier today I made $4600 on took all of about 5 minutes. Eventually I'd like to sell but I'l never get what the business is worth. I know typical valuation is like 5 years of profits but due to my business being all online and not really getting anything tangible, mainly name, brand, and customer lists. Also doesn't help that my business is dependent on third parties like Paypal for payment processing and ebay for a good chunk of our sales. Evetually I'll get out when I make enough and just don't want to deal with the hassle of the day to day but will probbly go for some kind of revenue sharing deal since nobody will pay what its worht upfront due to risks of it not being a longterm biz. I can't share industry or products or anything sorry.

[Flavius Aetius]

Completely agree with #4 on the list. It can set off numerous red flags when the owner brags about screwing the IRS and state out of taxes. Cant trust a crook.

Another red flag is when the owner refuses to let you interview employees. I almost made an offer on a small business in LA, but the owner refused to let me meet the employees because he did not "want them to know he was selling the company." I found it very suspicious considering the business relied on two key employees whose clients were more loyal to them personally and not to the company. Where there is smoke there is fire--usually.