But That’s Not My Job, Part III: How to Buy a Business

Owning a business is a part of the American Dream. It’s not for everyone, but it might be for you.

In 2009, there were 27.5 million businesses in the United States, the Office of Advocacy estimates, up from 2004 when there were approximately 24.7 million businesses.

Wikipedia says today that the United States is home to 29.6 million small businesses, 30% of the world’s millionaires, 40% of the world’s billionaires, as well as 139 of the world’s 500 largest companies.

About.com reports this: 99 percent of all independent enterprises in the country employ fewer than 500 people. These small enterprises account for 52 percent of all U.S. workers, according to the U.S. Small Business Administration (SBA). Some 19.6 million Americans work for companies employing fewer than 20 workers, 18.4 million work for firms employing between 20 and 99 workers, and 14.6 million work for firms with 100 to 499 workers. By contrast, 47.7 million Americans work for firms with 500 or more employees.

Nobody’s saying owning your own business is going to make you a millionaire (it might!) but there’s one thing for sure: owning your own business is one of the paths to true independence for most people.

Over 50% of small businesses fail in the first five years. You can avoid being in this batch by understanding some of the reasons small businesses fail.

You can lessen those odds if you purchase an existing business. Owners oftentimes ask five times what they earn in a particular business as a sales price. The logic here, if you think about it, is that it takes three to five years for most new businesses to reach profitability.

If you have the resources, this is the route I encourage you to take. When I say resources I’m talking cash. Business sellers don’t want to hear your hare-brained ideas about how you’re going to pay them sometime in the future if you don’t have some cash upfront.

If you want to buy an existing business and have cash for the down payment, many small business owners will finance you themselves.

In fact, I’ll go out on a limb here and say that in today’s financial market they have no choice, really, if they want to sell. This gives you an advantage as a buyer.

Banks don’t want to know you. It’s a sad, sorry fact that most lending institutions in America don’t lend to small business. They say they do — they claim they do in expensive advertising — but when it gets right down to it, go ahead — try to get a bank loan to buy a business.

It ain’t gonna happen in most scenarios so let’s disabuse ourselves of that fantasy and move on.

A seller typically wants to see you bring one third to one half of the purchase price to the table. He’ll want terms on the balance and expects you to pay a higher than average interest rate.

Typically an owner wants to be cashed out (paid off) in a maximum of 10 years, with a preference more toward a five-year average. There are exceptions and your repayment schedule is one that must make sense for both you and the Seller. This is one critical reason both seller and buyer need to bring an accountant to the table.

When I said many owners ask five times what they earn in a typical year I’m definitely not saying buyers are willing to pay that.

Most buyers are willing to pay two to three times what an owner earns in a typical year as a purchase price.

There are exceptions to that rule.

If a business has a lot of capital equipment, real estate — you know, hard stuff you can smell and feel — most times the asking price is going to be on the high end of that one to five times algorithm.

I’ve seen it higher but I’m mostly speaking averages here.

There’s a financing caveat that goes into play here — the more “hard stuff” a business possesses, the more your sorry chances of getting a bank to look at the thing rise, but don’t expect much. The bank is likely to demand even more of a down payment than a typical seller –many times 50-60% of the purchase price!

If a business does not possess much hard stuff and is basically a service business reliant on an owner’s own efforts as the jet fuel that launches earnings each and everyday, a multiple closer to one is more the norm.

I further caution you to hire professionals if you’re going to buy an existing business. Seek out an attorney you trust skilled in business, an accountant you have faith in, and a person that can be the middle person between you and the seller.

Many times this is someone who calls themselves a business broker. A good business broker is worth her weight in gold. She knows the skittle on the street as to who’s selling and who might want to sell.

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Those “might want to sells” are the ones you especially want to know about.

Don’t get me wrong. There’s a fallacy in thinking that because a business is for sale it’s failing in some way. Trust me: this is rarely the case.

The hungry mouth of competition chews up and spits out businesses that fail faster than you can blink.

A business that is for sale (you’ll rarely see a physical “for sale” sign on a business, and if you do I’d advise steering clear of those, particularly if you want to avoid failure) is usually a healthy, creative and moving force.

Reasons for sale can be varied, but many times it’s an owner ready for a change of scenery.

Other reasons could be retirement, illness, or a lack of someone in the family to take a business over.

Those are all good reasons to sell a business and all good reasons to buy one.

In our recruiting community, I suppose you could call a “might want to sell” a truly passive candidate and those businesses on the market jobseekers. In doing so all the divisive bally-hoo that goes around the subject of passive vs. active could be applied. Just as I do in recruiting, I think you’d be making a mistake in ruling either one out.

As you can probably tell, much has been left out because I’m striving to contain myself to a low roar of 1,000 words on this subject. We’re almost here but let me say one last thing about where you can find the down payment to buy a business.

Ideally it could come from your savings. If you don’t have any (and many people don’t), it could come from the equity in your home. This is less and less an option these days with declining real estate values. You could borrow it from friends or family but I see this as the hardest (and most seldom used) row to hoe of all the options.

Savings include a lot of things: stock, bonds, and that small severance package you’re being offered after (how many years has it been of?) work service.

You could sell something of value (I once saw a guy sell a pen collection to bring a down payment to a closing. I had no idea pens could be worth so much money!) and use that money as a down payment.

Trust me, after you own your own business, in the first few years you’re not going to be able to enjoy any toys you value anyway.

Oh. One more thing. You’d better find out what your spouse thinks about this idea before you waste your own or anyone else’s time. He or she may have some very definite plans of their own.

Next time I’m going to offer you several reasons to own your own business and yes, we’re going to talk about how you can start a business from scratch with very little money. In the meantime I see several stories beginning to emerge in the comments sections of this series on just that very subject. Be sure to read them! If you have a story to tell, tell us.

Maureen Sharib has been a “Socratic sourcer” her entire sourcing career; from the moment she first picked up the faxed list of Silicon Valley high-tech companies that was her target list to “phone source” in 1996 to today she has instinctively followed this method of investigative sourcing using (mostly) the telephone.  She is a proponent of sourcing as a synonym for success and envisions the craft moving away from a dangerously drudgery-paced life-form existence to an exciting investigative/competitive place within organizations where practitioners co-exist within a framework of market research, human resources, and C-level future planning. She owns the phone sourcing and competitive intelligence firm TechTrak.com, Inc. You can contact her at Maureen at techtrak.com or call her at (513) 646-7306.  If she’s not on the phone she’ll pick up!

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4 Comments on “But That’s Not My Job, Part III: How to Buy a Business

  1. Thanks, Maureen.
    Organizations like the San Francisco Renaissance Entrepreneur Center (http://www.rencenter.org/) are very helpful in teaching potential entrepreneurs how to define, create, and successfully run their businesses. Check and see what your areas have to offer with similar programs.

    Keith

  2. Hi Keith,

    Thanks for the info.

    It’s not easy to get professionals to step forward and talk about price ratios like I have in this article. I found a few resources but hardly any do the bare knuckles analysis I did.

    This NYTimes 2010 article was one of the best I’ve seen on the subject in a long time:
    http://tinyurl.com/23knqpv Determining Your Company’s Value: Multiples and Rules of Thumb
    (By the way, Ebitda means Earnings before Interest, Taxes, Depreciation and Amortization)

    I applied twenty-two years of industry experience to the formulas I used. It was a while ago but things don’t change that much.

    Business Valuation Multiple Tables are available to purchase but be warned – they’re expensive!

    I do want to say each business is different and each industry is different but the 80/20 rule applies here as well – 80% of every business (think processes) is the same and 20% is about what makes it unique.

    Therefore, what works specifically for one industry may need to be adjusted somewhat for another – but not by that much for similar businesses within a same industry!

    Traditionally service businesses (where the owner is primarily working the business as a job) bring the lowest multiples in a sale – about one times (yearly) earnings (if they can be sold at all – it’s one of the toughest sells!)

    Below are a few resources I found on the web that might help you in determining a proper price to pay for or to sell a business/they don’t give any really hard numbers like I did or the piece above did but they contain interesting information:

    http://tinyurl.com/mdewvj

    http://tinyurl.com/26mv284

    http://tinyurl.com/2bkm785

    http://tinyurl.com/27gn5d9

    If you have a recruiting business and you’re thinking of buying or selling, I wrote another article on Fordyce a spell back that you might find interesting:
    http://tinyurl.com/ygp73g4

    And here’s another one I wrote as a follow-up:
    http://tinyurl.com/yzbasp7

    I hope you enjoy them!

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