There is this small business in my area that is for sale for ~$1.2 Million. I know that the business is a bit struggling (and I know the reasons). As a customer in the sector, I know that there is demand and I have some ideas to increase the gross revenue and the profit margins. This is an absentee-run business with ~12 employees and a manager.
I have a full time job (in a different sector) and I want to keep it. I have never run a business but I have successfully managed big long-running projects. I have a CS degree but read some books on finance and business. I am married with a kid and we have a net worth of $500k. It is a bit scary to buy a million dollar business.
Question: I am curious if anyone has any suggestion on how to tell if it is okay to buy a business twice someone’s net worth. Is it too big of a step for a first business? Any suggestion on risk analysis or minimizing the risk here?
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Hi SnooOranges (“love your oranges, State of Florida, thank you.”). I was in a similar situation as you 15 years ago. I had a good corporate job and was looking to buy a playground business. My first point is you need to be asking different questions. 1st question is you need to understand if the business can afford itself if you were to buy it. In other words can business provide enough cash flow to fun the monthly payments? Yes or no? If no, the business can not afford you buying it. It does not matter if you have “good ideas “ to increase cash flows. If the business isn’t generating the cash flow’s needed to fun the purchase you can afford it. Question 2. Why is the owner selling now and is it still a “good business? 3rd point. Your risk increases hugely when you buy a business you are not actively managing and running. (“When the cat is out the mouse (ie employees) will play). I know first hand as a former semi absentee business owner. 4th point. If the thought of losing everything you have is a deal breaker for you (ie. Personal bank guarantee) than don’t do it. Your not ready, respectfully. 5. Go ahead and sign the NDA and get all the information. It’s not a big deal at all from your side. It’s simply providing protection to the seller. Good luck!
It’s impossible to tell. 1.2m should get you 500k in your pocket every year. If the number is around that and you know the business, buy it and quit your other job.
The number is not around that. The net profit is around 100k/yr and I think I can take it to 200k or maybe 300k range in a year or so. I don’t yet see a 500k opportunity :)
Stop it right there and forget about this. 12x is asinine for a business like you have been describing.
OP this business is extremely overpriced. Something is off. Proceed with caution. Most non-tech local industries are trading 2-3x net profits. Unless there is real estate or some other tangible assets the business is worth less than half that.
Can you share what is the net profit for this business and how long it will take you to recoup the cost? Also how are you going to buy the business up? Loans or??
Its really missing many details for me to even comment.
The listing only tells me that the gross revenue is 1.5m. I have not yet reached out for more information (because I know that they will ask me to sign an NDA and I was not yet ready for that step). This is an indoor playground business. By looking at some similar businesses, I guessed their profit margin as 6-7%. That is how I arrived at 100k/yr profit.
I am still investing how to buy. I don’t yet know if there will be a seller financing, that would be my first option. If not, maybe that’s already a red flag and I should reconsider this whole thing. I can afford putting down 100k. I can probably raise some more 100k from my network for down payment and get a loan for the rest.
You see the problem here is you don’t have any details on the business and you don’t even know how you want to afford this business.
Yes I know that I don’t know all the details yet. I will learn all of them if I convince myself that buying a million dollar business is not a terrible idea. I was trying to get some insight here on how big of a business one should try to buy as their first business.
Do you think it is at least worth to keep investigating or should I focus on a business more in the range of 500k?
It’s impossible to convince anyone because you don’t have the details. Please share the details.
Paying a 12x on net revenue probably isn’t feasible for an established stable business. If one paid this for the business, you would theoretically operate it for 12 years without making anything or having any extra to “build” the business up. Don’t pay for what you think you can grow the business to, pay what it’s truly worth today. Sign the NDA, time for dd.
It sounds very over priced. If its apparent to you that its struggling, its quite possibly actually doing worse than you believe. If this is a first round venture for you, I suggest starting much smaller. There are plenty of businesses for sale that could generate more profit at a lower cost to you. Taking on a struggling business as an absentee owner (even semi absentee) will likely be more work than you predict.
Make sure to get at least 3 years worth of both Financials and tax returns.
Watch out for tricks that can be done to boost profits (like foregoing an owner salary) or expenses they don’t have that you will (like if they own real estate outright they won’t have a mortgage, but you will).
If you get a loan to buy this business, it will be personally guaranteed.
Do you mean that getting a loan would definitely cause losing life savings? That is something I am afraid of. It feels too much is at steak. Would it make sense to ask for a seller financing somehow tied to future earnings to avoid the risks of a sinking ship?
If the business is for sale for $1.2 million, it should have free cash flows or an SDE (seller’s discretionary earnings) of around $300-400k per year, or it should come with real estate or other real property to make up the difference. The multiples for small businesses are typically around 3-4x annual SDE or free cash flow.
If the business is “struggling” and not making much of a profit, it is NOT worth $1.2 million, regardless of the “opportunity.” That’s just not how it works. Don’t get scammed into buying a failing business. Businesses with declining revenues or profits go for lower multiples… of actual TTM (trailing twelve months) SDE. So if the business has a TTM SDE of $200k, and it’s declined the past two years running, then I might be willing to offer somewhere in the neighborhood of 2.5x for it, or $500k.
If you don’t have experience as an entrepreneur AND don’t have experience in the particular industry, and the business is struggling, then I would caution you to be really cautious before jumping into a sinking ship. I know several people who lost their life savings and set themselves back decades by buying businesses like that. If you get a loan to buy this business, it will be personally guaranteed.
As for whether you could buy it, your net worth is honestly meaningless. What matters is your short term assets - do you have enough cash or cash equivalents for 10-20% of the purchase price + short term operating capital? At a purchase price of $1.2 million lets say you might need $300k operating capital to get started, or $1.5 million total. You would need liquid assets of $150k to $300k to be approved for a loan to purchase the business. If all your net worth is tied up in your home or other long-term investments, it probably wouldn’t be possible to be approved for a loan.
But as I said above, there’s a really good chance you wouldn’t want to pay that anyway. If you’re at all interested, sign a LOI and nondisclosure and get the past 3 years financials, bank statements and tax returns. Use them to corroborate the financials and see what the trend lines show. If the business isn’t clearing over $300k a year, beware.
Check out the book Buy Then Build if you’re interested in buying a business. It’s a great resource.
If you get a loan to buy this business, it will be personally guaranteed.
Do you mean that getting a loan would definitely cause losing life savings? That is something I am afraid of. It feels too much is at steak. Would it make sense to ask for a seller financing somehow tied to future earnings to avoid the risks of a sinking ship?
If you get a loan and default on it, yes, you would expose your life savings to being taken for repayment.
This is fairly typical in small business when it comes to debt and a lot of people get ruined financially as a result.
Extremely unlikely you’ll get the seller to carry the whole note, especially if the business is making money. A lot of buyers will do 80% bank note, 10% seller note, 10% equity
I am in a similar boat. But after recently going down the YouTube rabbit hole of buying a small business starting with Codie Sanchez, then looking at other content providers like Acquiring Minds, and David Barnett, and then branching into looking at Tax Strategy and business structure and other related business topics I have become completely convinced that this is what I have to do. I’ve never really calculated my net worth, but I have a 6 figure W2 Salary that is closer to 200k then it is 100k and have a fair amount of equity in a home that is decent size, although not one that most would consider luxury, and I don’t have a lot of liquid. My wife earnings are fairly minimal compared to mine. I am looking at a business right now that would likely cost me between 3-4m which includes two real estate properties associated with the business. I’ve already met with the owner and more due diligence is occurring.
I’m not sure any biz w/ gross revenues of 1.5m is worth paying 1.2m for. If I pieced that together correctly.
I paid much less, much, on a 1.4m revenue biz. And would not expect 1m now on my 4.5 m in revenue.
I thought the valuations are usually based on profit or cashflow. In this case I think net profits are around 100k so 1.2m does sound expensive. If it was around 300k, wouldn’t it make more sense?
Here the Risk Analysis you requested: This analysis is based on; If a lender is dumb enough to lend you $1 Million:
- Failure
- Personal Bankruptcy
- Your home repossed
- Your children’s future is fukt
OP, why would you even consider wasting $1.2 million, to run a failing business with an absentee owner as
- An absentee owner ?
- No prior ownership experience?
This is called “rinse and repeat.”
You will have the same outcome; FAILURE.
The good news:
- It appears unlikely you have $200k for a downpayment
- IMO no lender will gamble on a $1million loan for a failing business to someone with no experience
- You won’t F-up your childrens’ future.
Don’t do it!
“This is an indoor playground business.”
Based on ask of $1.2 million, I assume business does not include real estate.
This means you would be buying goodwill and perhaps some equipment, furniture, and fixtures, and inventory.
Here, the true investment value of the business will be a function of the free cash flow available to you as new owner.
Consequently, key to understanding market value is to determine stabilize earnings (weighted three-year average) and apply appropriate multiple or capitalization rate.
The latter of which can be determine with industry benchmarks, broker guidance, commercial software, appraiser, or industry consultant.
As for finance, a rational approach might suggest a cash injection of between 20 and 30 percent for someone new-to-industry.
Another consideration is best fit.
What happens if key personnel such as manager and lead staff decide to split after you take over?
Are you capable of taking over day-to-day operations and providing a customer-centric operation?
You can probably make more. Quite your job and go fulltime and focus on growth… get rid of few employees. I bet there are few just not worth keep them around.
absentee-run business are run poorly and always room to improve.
You could always consider seller financing. Give a nice down payment, give a cut of revenue for x years.
Cody Sanchez does a lot of instagram marketing about business buying with “creative financing”.
I thought seller financing was more like pay $X/year to the seller sort of thing. Is it possible to tie the payments to the future revenue? Like paying the seller half the revenue until the full amount plus interests are paid?