Rose colored glasses

[jonmulzer]

As I have mentioned a time or two in passing here on the forums, I have recently been looking into buying a local business. The purchase would be from a man that I is not close enough to be called a friend, and not distant enough to be called an acquaintance. Just a person I know and have worked with on occasion. To say the man views his business through rose colored glasses, now that I see the big picture, would be an understatement.

The initial discussion talked about some rough figures on his sales, profit margin, overall profits, etc. Based upon that I said that his $350,000 asking price would be within negotiation range most likely. I got the P&L, AvL and balance sheet this week. Not even in the ballpark. This year is the first year, out of five being in business, that it has turned a profit. Of an entire $15,000 on $213,000 in sales. In those five years, he has not drawn a single paycheck. The $65K he told me he paid out in payroll, is actually $35K. From a cashflow basis, the business has a negative value.

Looking at assets, he purchased approximately $65K in equipment, spent $30K on the buildout of the space he leases (that is horrendously laid out) and roughly $5K on office, POS and such. He also spent $37K on a franchise agreement that also costs him 5% of gross per year. The franchise agreement has zero value to anyone, it costs him every year more than it saves him and there is zero brand name recognition.

So that equals $100K in assets worth purchasing, when they were new. Discounted 50% (going rate for used equipment in this field) and we are down to $50K. He holds about $20K in inventory so the actual value of the business is roughly $70,000. Two accountant friends with years of experience came up with figures within a grand of my actual numbers along with a half dozen business owner friends of mine. Another friend who has spent the last ten years working in mergers and acquisitions for a Fortune 100 company agreed with myself and everyone else. So I have no doubt about the value unless there is another half million in equipment somewhere in the 3,000 sq ft retail space, lol.

I am supposed to meet with him tomorrow afternoon to discuss this. I am not sure how to approach him about it. Looking at the balance sheet and ledger he probably has $300K or better in it. But also looking at the ledger it appears that most of that went to poor business decisions. I also have no doubt that the business could thrive, under different management. The last two years advertising has been around 1% of gross profit. It is rather hard to get people to do business with you unless you invite them. I can also get great advertising at bargain prices right now through friends in media. The major problem with the business overall is simply that he puts no effort into it. He is in his sixties and he has sank all of his retirement into it and failed. He is looking for some way to make that back, but no one is going to pay the price he asks.

I am torn between just saying I cannot commit myself to that much right now and walking away with no hard feelings, or taking the chance and pointing out to him that you can't get to his asking price without multiplication. I know the guy who looked into purchasing this business two years ago and he chose option one, to walk away. I feel like after putting in this sort of effort that I should at least show him the value that I and several professionals (much more knowledgeable than I) came up with.

Rose colored glasses. NEVER listen to what a franchiser tells you.

Just needed to rant!

[gsmittle]

Wow. Let me summarize the parts of the above I understand: 1. He's asking wayyyyyyy too much. 2. The business might, someday, actually make some money.

My experience with human nature leads me to believe that even if you show him all the numbers and how everybody arrived at the final value, he won't hear you. People get pretty invested in their stuff (how many used cars have you looked at that the seller was asking far too much?) and it's hard to cash the reality check. I looked at a FSBO once where the seller took pains to tell me that he paid over $1000 for the butt-ugly chandelier in the dining room and how he wanted to get that back. It was worth nothing to me, because I would have to replace it with something a little more sane. If we'd gotten down to talking turkey, I would have told him to dismount the chandelier and take it with him.

I wish I knew what to tell you.... Maybe offer a little more than the calculated value, paid over a number of years. That way, he'd have some retirement income and you'd have a chance to make a go of the business. This is all WAY out of my area of expertise, so I have no idea what I'm talking about.

[LCHIEN]

Not a friend, I don't think you need to worry about alienating him
Be Brutaly honest with your valuation to him, make a reasonable offer, you owe him nothing from what I read.

If he is offended then no loss, he's beyond reason, He may come to realize how you are right, that may be a buyer or two too late or it may be right away.

Good luck.

[billwmeyer]

Spell it out

In my opinion, you would be doing him a favor to tell him what your research has turned up. Of course, it is a very rare business that does not have room for an intangible element called blue sky or on the books it is shown as good will. This is the difference between what the business is worth, or more often sells for and the actual value of it's assets. I do not believe he has over $200,000 of blue sky built in. If you want the business, figure how much it is worth to you, but also what you can reasonably expect in profits. Make this estimate brutally honest to you. It is too easy to dream numbers. Find a number that works for you and be sure you do not exceed that number. If you decide you do not want this business, I would still show him your research. He needs some reality to make his future business decisions. I would suspect that he already has his doubts to what it is worth. Either way, good luck!

Bill

[cabinetman]

The $65K he told me he paid out in payroll, is actually $35K.

This should be your first clue of how upfront your "friend" really is. It's so easy to doctor up paperwork. I would do some hard thinking on the viability of this business being profitable, with the times being as they are, or will be.

If it's a liquor store, or a funeral parlor, it should survive.
.

[Uncle Cracker]

Would you want to be given a business that doesn't make money? Then why on earth would you want to buy one? Forget about what he might think. I wouldn't do this deal if it were my mother. If you wanna piss your money away, send it to me instead. At least then you would be assured at least one person was grateful...

[cgallery]

Buying a small business where you'll actually be working on-site is about purchasing a job. The purchase price depends on what the job pays (profits). How much would you be willing to spend to purchase a job that, in the last five years, only paid $17.5k ONCE?

I've had friends purchase businesses thinking they were going to turn them around by advertising and better management. Almost universally, they have pretty much discovered that it is much harder than it looks.

50% on five year old equipment is too high. Based on your numbers, I wouldn't touch the business with a ten foot pole unless I had clearly identified several areas that could be improved that would bring-up that bottom line.

And even then, I wouldn't negotiate as you might. I would say, "Frank, this business has turned a measly profit one year out of five. And we're likely headed into a deeper recession. Maybe I can make it work, maybe I can't. If you want out I'd be happy to assume the lease and perhaps make a small, goodwill payment so you don't walk away with nothing. But I'm afraid the business, as is, isn't even worth $25k."

Now, if the seller needs (because he has spent his life's savings) more, you're done. You'll never see eye to eye. Maybe he will continue operating it while working for free. Perhaps he will have a bad year and run out of the ability to finance it through whatever means he used those first four years.

But don't get caught-up in the moment and offer too much.

[bruce hylton]

Without knowing what type of business this is, I would say it is a good story. If it is a bar or restaurant, there may be more than meets the eye. Without knowing your background as well, I would't know that you could succeed. What is your history with this type business?

[kevincan]

Walk away.

From your information the value he has put on his business is not even in the same ballpark as what you have come up with. On top of that he has not been very up front on some things. It sounds like he wants to get back what he has put into the business.

If this is something that you really have an interest in just play the waiting game. If he is that overpriced and not making much profit it is only a matter of time before he goes out of business. Then you can pick up a bargain .

[SARGE..g-47]

Would you want to be given a business that doesn't make money? Then why on earth would you want to buy one? Forget about what he might think. I wouldn't do this deal if it were my mother. If you wanna piss your money away, send it to me instead. At least then you would be assured at least one person was grateful...

Yep.. numbers don't jive.. he's getting OUT and wants to re-cover his investment and make a profit for a business that didn't return one. And last but certainly not least.. take a closer look at the economy at the moment. People aren't spending period as they have run up debt and suddenly.. it has come home to haunt them in many cases.

At this moment.. I would be reluctant to purchase a business even if it showed a profit yesterday... as yesterday was yesterday but today people are pulling in their reins and not spending. Owning your own business is a 24/7 proposition. Owning one that has a negative return is a 24/7 head-ache.

Good luck...

[jonmulzer]

[QUOTE=billwmeyer;396780Of course, it is a very rare business that does not have room for an intangible element called blue sky or on the books it is shown as good will.
Bill[/QUOTE]

I have never believed in that since the people who taught me to value businesses over the years did not either. I was always taught that there are two ways to price a business. Cashflow basis and book value. Cashflow is easy, it takes care of all tangible and intangible elements at once, if the business is making a profit, this one is not. If it is not making a healthy profit, then it is worth what the equipment and assets are used and not a dime more.

This should be your first clue of how upfront your "friend" really is. It's so easy to doctor up paperwork. I would do some hard thinking on the viability of this business being profitable, with the times being as they are, or will be.

If it's a liquor store, or a funeral parlor, it should survive.
.

To be fair, I truly think this is more of an illustration of how little he knows about the goings-on of his business instead of his dishonesty. When I asked him about this detail he told me, "I was wrong, whatever is on the P&L is what I paid out."

Buying a small business where you'll actually be working on-site is about purchasing a job. The purchase price depends on what the job pays (profits). How much would you be willing to spend to purchase a job that, in the last five years, only paid $17.5k ONCE?

I've had friends purchase businesses thinking they were going to turn them around by advertising and better management. Almost universally, they have pretty much discovered that it is much harder than it looks.

50% on five year old equipment is too high. Based on your numbers, I wouldn't touch the business with a ten foot pole unless I had clearly identified several areas that could be improved that would bring-up that bottom line.

And even then, I wouldn't negotiate as you might. I would say, "Frank, this business has turned a measly profit one year out of five. And we're likely headed into a deeper recession. Maybe I can make it work, maybe I can't. If you want out I'd be happy to assume the lease and perhaps make a small, goodwill payment so you don't walk away with nothing. But I'm afraid the business, as is, isn't even worth $25k."

Now, if the seller needs (because he has spent his life's savings) more, you're done. You'll never see eye to eye. Maybe he will continue operating it while working for free. Perhaps he will have a bad year and run out of the ability to finance it through whatever means he used those first four years.

But don't get caught-up in the moment and offer too much.

I agree with the first part. But it does have value, and that is the equipment and build out. It is capable of making money though. Getting rid of the franchise agreement and it would have made another $17K last year, which is why I said the franchise agreement is a loss. Being willing and able to work more than two days a week would add in another $15K+, there is no sense in paying someone to work on the slowest days. Advertising well adds more, if done properly. The problem is, these are things I bring to the table. Value I can add, not value that is there at the time of transaction.

Without knowing what type of business this is, I would say it is a good story. If it is a bar or restaurant, there may be more than meets the eye. Without knowing your background as well, I would't know that you could succeed. What is your history with this type business?

I have close to ten years, off and on, of business management experience. This is a winery, of which I have ~2 years of hobby experience. The last year and a half I have spent with learning all I can from winery owners and winemakers in this market and others. I spent my vacation last year working for free in a winery in another market for one of the most knowledgeable people I have ever met in the field, who has agreed to do the same for me if I buy the business to help it turn around. I have no doubt that my chances are pretty good for turning it around. Not 100%, but nothing is.

Walk away.

From your information the value he has put on his business is not even in the same ballpark as what you have come up with. On top of that he has not been very up front on some things. It sounds like he wants to get back what he has put into the business.

If this is something that you really have an interest in just play the waiting game. If he is that overpriced and not making much profit it is only a matter of time before he goes out of business. Then you can pick up a bargain .

If negotiation doesn't work, that is probably my next choice. Either that or open up next door with a better product and cheaper prices! Just kidding, I could never be that ruthless.

[jonmulzer]

Yep.. numbers don't jive.. he's getting OUT and wants to re-cover his investment and make a profit for a business that didn't return one. And last but certainly not least.. take a closer look at the economy at the moment. People aren't spending period as they have run up debt and suddenly.. it has come home to haunt them in many cases.

At this moment.. I would be reluctant to purchase a business even if it showed a profit yesterday... as yesterday was yesterday but today people are pulling in their reins and not spending. Owning your own business is a 24/7 proposition. Owning one that has a negative return is a 24/7 head-ache.

Good luck...

I agree with what you guys have said. But the business does have value. Let's put it in woodworking terms. You know someone who is selling a custom furniture and cabinet business. After looking, you realize it is not making money. The business still has value since you would be buying the table saws, jointers, planers, molding machines, routers, shapers, bandsaws, sanders, etc. But on that same notion, you are not going to pay full retail price for them.

That would be a bad analogy though. People have quit building and improving homes. They have not however, quit getting drunk! If they quit buying high-end reds I can start making my own versions of Thunderbird and Mad Dog 20/20!

[LCHIEN]

if you do buy, the thing to do is to have him declare bankruptcy and buy the pieces. or otherwise dissolve the business and get out of the franchise agreement - saves at least 5% gross a year... if it is as you say no use. If you buy the business as an entity then you also pick up the contract for the franchise. If there's significant money in the Build-out you have to make sure you do get a continuation of the lease (make that separate agreement with the leaseholder) or if that can't be done you may have to buy the businesses and its contracs and put up with the franchise expenses.

[jonmulzer]

The franchise is on 5 year renewals. Supposedly, he put in a stipulation in the contract when he renewed that whomever purchases the business has the ability to opt-out. I will have to go over that contract with a fine tooth comb to make sure for myself. I trust nothing he says at this point, so it all has to be verified. The other odd thing I noticed about their franchise agreement, the franchiser owns the rights to the telephone number. That is also supposedly changed. But supposedly before the last negotiation, if you left the franchise agreement after five years, they would keep the phone number and you have to let old clientele know of the new number somehow. Kinda dirty.

[LCHIEN]

The franchise is on 5 year renewals. Supposedly, he put in a stipulation in the contract when he renewed that whomever purchases the business has the ability to opt-out. I will have to go over that contract with a fine tooth comb to make sure for myself. I trust nothing he says at this point, so it all has to be verified. The other odd thing I noticed about their franchise agreement, the franchiser owns the rights to the telephone number. That is also supposedly changed. But supposedly before the last negotiation, if you left the franchise agreement after five years, they would keep the phone number and you have to let old clientele know of the new number somehow. Kinda dirty.

Actually that's pretty clever on their part about keeping the number so that all ol an previous advertisements still reach their franchisee if they have one -- assumes the franchise has value. I wouldn't really call it dirty but smart business, like all things, I guess it could have been negotiated at the inception.