I’d like to share a story about two small business owners I recently met who took different routes to get to where they are today.
Sally owns a small specialty retail franchise. She’s had the store for 3+ years and wants to slow down and retire. Tim owns a similar store on the other end of town. They are competitors in a sense, although it would be unlikely that they would view each other as competitors as they are not close enough geographically to affect each other’s business.
What I want to illustrate is the difference between buying a profitable existing business and starting a new business.
Sally started her business. She worked in the corporate world for 20+ years and like many entrepreneurs always wanted to be out on her own. Plus, she always wanted to get into this particular type of business. She had fresh ideas. A handful of years ago she did some research, created a budget and business plan; found a really good location and began her new venture:
· $30,000 – Franchise Fee
· $100,000 – Leasehold Improvements
· $40,000 – Furniture, Fixtures and Equipment
· $30,000 – Start-up Supplies, Professional Fees
· $50,000 – Inventory
· $50,000 – Working Capital to pay for staff, rent, telephone, etc. to get started
$300,000 – Total Investment
Sally earned a cash flow of about $20,000 last year. Not great. Not uncommon 3 years into many start-up ventures.
Tim, 10 years into his venture, and with a strikingly similar business model (size, types of goods, target market, location demographics) is earning a cash flow of about $65,000. Tim bought his business originally, for $150,000. It was slightly smaller back then; cash flows have improved over the years, since he inserted his own product and service twists. Some failed, some didn’t.
Over the years Tim earned about $500,000 in cash flow earnings. Today, he’s considering retirement and may want to pass the torch to a new owner. We’ve spent some time together, done all the appropriate analysis, and I have recommended that the value of his business is in the neighbourhood of $175,000.
Sally is also thinking about spending more time with the grandkids. Similarly, we’ve reviewed all the margins, operating expenses, discretionary expenses and cash flows. The picture is not as rosy. I’m not sure I can help Sally, at least not based on where she needs to be. The challenge is she still has about $260,000 remaining on her personal investment. By adding up the cash she brought to the table and debt she incurred, if she doesn’t sell for $260,000+ she will walk away in the hole.
At the end of the day, whose shoes would you want to be in, Tim’s or Sally’s?
If you’re in Sally shoes:
· You made a $300,000 investment that earned you less than $40,000 over 3 years and only $20,000 last year;
· You can sell today, but know you cannot recover what you invested into the business; and
· Comparatively speaking it will take you many years to build a size of business large enough to break-even, plus you really should consider the opportunity you lost by not doing what Tim did at half the cost.
If you’re in Tim’s shoes:
· You know, despite a tough local economy, if you sold today, it’s likely you can recover your original investment;
· You were able to make a comfortable living from day one till 10 years later, there were ups and downs along the way, but never had to ‘pay your dues’; and
· You have choices, today could be your time to pass the torch. You can make the decision on your terms; continue building your business or sell.
There are no perfect business purchases or start-ups. And, there are business start-ups and business purchases out there that have been extremely successful. However, if you could reduce the potential pitfalls, dramatically reduce the risks associated with a brand new business, and make money on day one… wouldn’t you?
Do you have small business questions you would like answered about this article or others? Please visit www.VRWindsor.com or call 519-903-7807.
William Sivell is a sales representative of VR Windsor Inc., Business Brokerage; his blog appears every Tuesday.
Interesting scenarios Bill. A real eye opener. I'm curious though, the ledgers didn't appear to show any marketing costs? How did they promote themselves.
ReplyDeleteIn your valuations, do you ever calculate brand values?
Hi Ed;
ReplyDeleteThe start-up supplies at $30,000 and the $50,000 in working capital included their marketing and advertising efforts. She didn’t do a tremendously great job, in my opinion, in finding cost effective ways to drive traffic to her doors. She used some newsprint, and some direct mail, as well as the usual yellow pages, but never really established a quality marketing plan. I would suggest she may have been able to improve her top line sales had she been better in this area.
As for calculating brand value, the short answer is yes, but requires an explanation. There are a number of value drivers that will affect a business’ value. Things like customer diversity, management depth, competition, location, proprietary products/technology, brand, etc. Most of which are anecdotal in nature, and the degree they impact value depends on factors specific to that business, the market, and the industry.
In Sally’s case, unfortunately brand had no impact. In fact, Tim’s brand has more power because of some of his efforts locally in promoting his business.