Real Stories from the Front Lines

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.

Buy – Don’t Start – New Business

Many have felt the desire to do something entrepreneurial. The allure of being one’s own boss can be tantalizing. The opportunity to be the master of your own destiny, and your investments, can be very rewarding.
But it can also be very frightening. We’ve all read about the high failure rates for new start-up businesses. Less than half of new start-ups make it through the first three years and 23% won’t even make it past their first birthday.

There are reasons for this, such as insufficient operating capital, bad management, strong competition, weak customer base, poor business concept or even just plain bad luck. Owners of brand new businesses need to manage a multitude of details, such as product and service positioning, branding, marketing, employee hiring and training, site location, choosing vendors and establishing terms, etc. Even when all the stars are aligned and the correct decisions are made; it can be months or even years before they begin to see positive cash flow.

Imagine if these potential pitfalls could be significantly reduced for you as a business operator? They can.

By purchasing an existing business instead of trying to start one from scratch, a buyer can dramatically minimize the risks associated with starting a brand new business.

Successful existing businesses have a proven track record of profits that generally continue long after a business has been sold. As the new owner, you can take the business to even higher profitability by incorporating new ideas, expertise and energy. A business with a well-known name, location, product mix, knowledgeable employees, etc. will enable a new owner to focus on long range strategic planning rather than day-to-day minutiae. There will be no suffering through an extensive start-up period as you struggle to attract customers to your business. You can use the business’ established customers for immediate cash flow and as your base for future business growth.

Another reason existing businesses can be very attractive is that typically buyers are able to use the seller’s financing to leverage their buying potential. This ensures that the buyer gets maximum bang for their investment dollar.

Also, a new owner can negotiate a time frame where the previous owner will stick around to ensure a smooth transition. Additionally, with seller financing, sellers will want to do everything they can to ensure the success of the new owner.

A professional business broker can help them. They can show the buyer a variety of businesses that are legitimately interested in selling and help them through the purchasing process. They should be able to explain the owners’ motivations for selling and be able to provide pertinent information regarding their financial performance, staffing, facilities, equipment, inventory, product lines, customer base, etc.

A professional broker will be able to draft a purchase agreement that covers all pertinent issues (i.e. non-compete agreements, trade name rights, leases, due diligence, etc.) plus any unique contingencies that are relevant to the transaction. When making a decision to buy your own business, using a professional business broker will allow you to concentrate on important matters associated with operating the business.

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.

Inventory is not included in business value

Pity the Accountant (or Business Broker) that has to explain to a business owner the following concept: The amount of inventory and equipment they carry typically has no direct impact on the value of their business.

Inventory is a tangible asset required to generate sales and earnings.  What is important is the amount of cash flow generated from these and other operating assets, not the value of their assets.

In purchasing businesses, buyers don’t determine the value without its equipment or without its people and then through some mysterious process add the value of these items later.  Many business owners believe their business has a value without the inventory and equipment and buyers will pay extra for whatever inventory and equipment is on hand.

The correct way to look at it is to consider the following examples of two businesses.  One business was a trucking company that had $500,000 in trucks and dispatch equipment that was required to operate the business.  The other was a roofing company with a small amount of employees and only $45,000 in inventory and equipment.  The trucking company generated $200,000 in cash flow and the roofing business earned $800,000.  Even though the trucking company had more hard assets, most buyers would find the roofing business a much more attractive company because of its significantly stronger cash flow. 

Proponents of the “add-on” inventory philosophy would lead us to believed that if the above two businesses each had a cash flow of $300,000; the trucking company would justify a higher price.   This does not make good business sense.  Why would someone pay more for the same level of earnings?  Knowledgeable buyers are interested in a business’ cash flow and insist the assets needed to generate it are included in the sale price.

Use of the “add-on” inventory method is rationalized by business owners based on the concept that inventory will fluctuate throughout the year.  Unfortunately, this method increases the risk for any given business as the inventory at closing may not be enough to support the cash flow, thus requiring the buyer to invest within to support the business.  At best, adding inventory to the price of a business increases the risk that the buyer will not get their expected rate of return on their investment.  At worst, this method could lead to business failure because of being undercapitalized and unable to acquire additional funds to get the necessary inventory.

The fact is that many businesses do not have significant variations in the amount of inventory that they carry throughout the year.  For those businesses that do, they tend to do so only during a few months of the year, such as holiday seasons.  It is not that difficult to determine the inventory that should be included in the price to support the annual gross sales and cash flow.  By doing so, the buyer can prepare for the needed investment by arranging for the required working capital in their equity or debt capital structure.

Assets and inventory are considered when a business is being sold under less-than-ideal conditions, such as when the company has not profits or cash flow.  In those cases assets such as inventory and equipment would be used to determine the value of the business.  Problems then arise in establishing the worth of those items.  Typically, buyers usually aren’t interested in these businesses because the seller already has proven that the company hasn’t made a profit.

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.

Protecting your interests after selling your business

Besides asking “How much is my business worth,” the second question all owners want answered when selling their business is, “How can I protect myself so I don’t get the business back later?

In many ways, the latter question is more sensitive issue than the first.  An improperly structured transaction can create problems for the seller years after he has sold the business.  For example one Windsor owner, who had been in the home improvement business for 25 years, decided to sell.  He found a willing buyer whose enthusiasm to have his own business unfortunately exceeded his abilities to run it. 

After 18 months, the new owner decided that the rewards of owning the business weren’t worth the time or the effort and decided to walk away from his responsibilities, both of running a successful business and paying the previous owner. 

What sellers need to realize is that just like there are risks with owning their own business, there are risks with selling it.  Similarly, just like they can minimize their risks when starting a business, they can also minimize their risks when selling it.

Although there are no guarantees, a combination of the following recommendations will significantly reduce the likelihood that the seller will be stepping back into the business after stepping out.  Many of these suggestions, such as having an adequate training period for the new owner, having a good client base, having strong relationships with suppliers, etc. are obvious.  However, many are not. 

One of the most common mistakes sellers make is not getting enough of a down payment.  One of the best ways to ensure the successful transition of their business is to have the buyer invest a significant amount of their own capital in the transaction.  Few incentives inspire the new owner to achieve success greater than the risk of the loss of a significant amount of their own money.  In simple terms, it is a lot harder to walk away from a $150,000 down payment than $15,000.

Another way to minimize a seller’s risk is to know their buyer.  This goes beyond having some of the same interests, common friends and an affinity for the same brand of Cabernet.  It means a thorough review of the buyer’s credit, analysis of their personal finances and a complete resume illustrating, not only their accomplishments but their life experiences.  For example, if the buyer has a poor history of paying off his credit card, he likely might have problems making his monthly principal and interests payments to the seller on a timely basis.  If the buyer doesn’t have a strong financial statement, he may not be able to weather any unexpected slow periods. 

As far as life experiences go, the passion and skill sets that are required to run a day care will be significantly different than what would be needed to operate a light manufacturing business.  This is what happened with that Windsor home improvement business owner.  Although they shared many interests, the buyer didn’t share the seller’s passion for customer relations which was so important to the success of the company.

Another common error sellers make is having a due on sale clause in the promissory note.  In some cases, buyers find that being a business owner just isn’t what they thought it was going to be or that they can’t successfully operate the business and they just don’t want it anymore.   A smart seller will give them the opportunity to resell it to someone else who will operate it effectively.  As long as the original seller reviews and authorizes the second buyer, he can ensure that his payments will continue to be made.  Additionally, instead of having one buyer listed on the promissory note, he now has two!

Finally, securing the services of a good business broker to help the seller navigate through these issues can be good preventative medicine.  A qualified facilitator will structure the transaction to ensure that potential potholes are covered. 

By incorporating these obvious and not-so obvious suggestions, business sellers will be able to significantly increase the likelihood that they won’t have to come back into their business once they have left.

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.

Hope is not a Strategy

I first heard the term from Andrew Tepperman, President of Tepperman’s Furniture Stores a few years ago.  Since, the likes of Obama and other have used the term to describe strategies in politics and business.

I want to tell you about a GREAT day I had yesterday with 2 different business owners who have created successful businesses, based on the above premise. 

We all know of the tough economic times the world has faced, and more specifically Southwestern Ontario.  Image the struggles business owners face, seeing top-line sales shrink, and watching bottom-line profit almost vanish. They are responsible for the well-being of the families that work for them.  Some failed and pack things in, and some prevailed because they didn't rely on hope to get them through the tough times.

Both business owners, with completely different businesses and backgrounds had a few underlying strategies in common that not only got them through, but positioned their businesses to be stronger than ever.

1.    They found new revenue streams.  They didn’t change their strengths, they opened their eyes to new customers and clients, they put themselves in position to speak with those clients, and they grew they’re customer base. 

2.    They focused their advertising.  We’ve all heard the expression, throw enough ‘bleep’ against the wall something will stick.  Well I hate to say this but if you’re not focusing on who and where your customers/client are, and why you can satisfy there need for service or product you’re wasting a valuable resource… your money.

3.    They diversified their product/service offering.  Having all your eggs in one basket of products, services or worse, customers is dangerous to say the least. Both business started offering auxiliary services and products, they broadened their reach of prospective clients and customers and mitigated the impact of ‘slow-times’ by supplementing with their new offerings.

4.    They made tough decisions about staff.  Ugly conversation I know, but sometimes your employees are not in position to be successful and in turn make you successful.  Sometimes your employees don’t have the values and core competencies to make good on the cheque you provide them by-weekly.  These owners juggle responsibilities amongst their people and unfortunately parted ways with others. Those savings went directly into their back pockets.

5.    They took a hard look at operating and fixed expenses.  Both these business realized that while revenues continued to be hard to come by, many of their costs continued as if nothing had changed.  When was the last time you reviewed your insurance costs, medical insurance, lease rates for equipment and property, membership dues, utilities, telephones and internet, sub-contractors, repair and maintenance services, etc.  Business owners should be reviewing these regular, especially in tough times, and consistently once a year. Many of these costs are negotiable, these owners leveraged what was happening around them and had difficult conversations with their service partners, but it paid off.

Hope was not a strategy for both these businesses, they are actively building value in their enterprise and while tough times are always a possibility, they will continue find new ways to survive. 

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.