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?
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.
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