I entered the due diligence period, and I have until December 31st to back out. This is my first business purchase, and I want to make sure I am making a good decision. Here is some information over the business. Established in 2013. Over 300 Google reviews (4.5 stars). In 2023, approx $6m in revenue, $1.5m in A/R. currently showing negative $100K loss ( $1.4m net if all A/R is collected). The business has 14 employees.
The purchase price is $1m + $75K from A/R.
The owner says he is selling because he wants to focus on real estate and will sign 3 year non-compete.
A way I can see improving the business is by trimming the unnecessary expenses (currently $270K per month) and focusing on keeping A/R account low.
Does anyone have any experience or advice in purchasing a business for the first time, or in roofing/ construction? What are the most important questions I need to ask the current owner? Are there any red flags I should be aware of?
This is a huge decision and I am looking for any advice or guidance!
So I’d say a few things, and some one who is an expert in roofing can call me out but…
First based on the fact that the business is operating at 90 days behind and at a 100k loss… you are overpaying by a lot… unless you have some genius plan, or have created a very detailed set of terms that mean the seller only gets his money if the business succeeds this seems like a very bad deal to me…
Collectors buy outstanding debt for pennies on the dollar… so 1.4M in AR is worth between 140k and 300k in value given the company’s track record for not recieving payment within 30-60 days
Then there is your business plan… finding 270k/month in fat in a business with 14 employees and 6m gross revenue means very drastic changes to the core of the business. Unless you are an expert in the field this is a very high risk proposition… you are paying 1 million for a business that might be on the ropes, but longterm successful business, only to make drastic changes… cutting 270k/month means cutting half the costs in the business, which means you think half the costs in the current business don’t provide any significant value… which begs the question… Why are you paying such a premium for this business based on EBITDA? since it is currently showing a loss?
The valuation of the business has definitely brought to questioning since it’s marking a cash loss this year. I actually like the idea of the seller having some skin in the game as well. I think he is open to doing that. Maybe 100-200K in seller financing.
From the AR account, 900K is in the 1-30 days old. The rest is 30+. I agree, I cant value the entire AR dollar for dollar.
Right, I don’t know how much (if any) op expenses I can trim while it still running. I don’t know if they are wasting money on anything yet. I plan on getting a detailed picture of each expense. I know the bulk of it is wages (135k), and marketing (50K).
Thats also a good question, if it’s showing negative EBITDA, how can value be determined? They are still generating $6m in 2023.
Cash flow and EBITDA are two different items.
Are you saying they spent $6.1 million to do $6 million in revenue?
Approximate numbers.
6m revenue 3m cogs 1.6m Op expenses 1.5m in AR
AR is irrelevant for this discussion.
That’s a net profit of $1.4 million. No one sells a business that makes $1.4 million for $1 million.
That’s why I said the A/R was a bit of a red flag… because without it they are operating at a -100k loss… I’m betting that big chunks of those A/R are uncollectable without a lot of effort… the numbers as presented just don’t really add up to a million dollar valuation… either the business is worth Millions of dollars or not very much money really at all… but at a Million dollars it feels wrong…
This is why I suggested experts speak up, there are lots of different ways to value a business… cashflow is just one of them… there are some industries like tech that rely heavily on speculation that you will eventually create a new market… There are other industries like certain types of commercial real-estate where on paper a business might be operating at a loss, but using things like depreciation and creative accounting to actually be running in the green… Cash flow is just the most obvious and obvious way to look at a business… its pretty easy to understand that if you are buying a business with negative cash flow you are buying one that is losing money today… and if you are buying one that has positive cash flow then they are gaining money today, and even if all things stay the same its easy to get figure out how quickly you will see a return on investment…
So the great thing about Business purchases is they are very flexible… you can write up a simple contract that amounts to “in return for 1MM I get ABC Roofing Company”… but you can also say “I will take posession of ABC roofing company on date X, in return I will transfer 300k up front, the other 700k will be transferred pending on the following A/R milestones over the next 90 days”… there are dozens of ways to write something similar into an agreement, and just negotiating it into your contract will often let you know if the accounts receivable is something you need to worry about and a red flag meant to prop the books up… or if it isn’t a problem and just how the industry works as some one else suggested…
Negative cash flow is not even close to the same thing as a loss. Construction businesses are frequently cash flow negative.
It would also be extremely normal to not get paid for 60-90 days if they’re doing commercial projects or getting paid through insurance companies.
You’re making a lot of big claims based off very little info.
And that’s why I started with "some one who’s a subject matter expert can come in and tell me I’m wrong.
I’ve spent the last year and a half selling my business and buying 3 different businesses and I make “at a glance” valuations on businesses based primarily on net revenue/cashflow…
Generally speaking the definition of operating at a loss is that you have a negative cash flow… on the books this means the business is losing money… you might be able to fix things but that’s not how things are right now, it might be a slow bleed and you might have a big bank account… but those are the numbers…
There are certain types of business that can do some accounting tricks where on paper they operate at a loss but in reality they maintain a profit… but if you aren’t already well versed in those worlds (Commercial real-estate for instance… it is very easy for taxes, commissions, and brokers fees to eat up most or all of your profit especially if this is your first venture or if you are an outsider without a mentor showing you the ropes and helping you watch for pitfalls…
There are also other ways to value a business… but a lot of them get complex and very speculative very quickly so its not the type of thing you give advice about over the internet…
Absolutely there are lots of businesses that operate at net 60 or net 90 or even net 100+… but its still a big risk to have a quarter of your A/R sitting in unreceived A/R even assuming you were net 90 that means the business isn’t exactly growing… Having your purchase agreement acknowledge it is just acknowledging the risk… Having a line that says “X% of the agreed upon 1MM will only be released if 75% of the outstanding A/R is cleared within 60/90/100 days of purchasing the business” is a very reasonable milestone and should throw a whole bunch of red flags if the seller isn’t open to it, because it means they don’t expect to collect that money in full in a reasonable amount of time for various reasons…