Buying A Business
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The Broker just gave you the first few items that you should have requested - last 3 years of the Businesses Tax Returns, a trial balance from the Seller's accountant, sales tax returns, check register, last years bank statements and current year to date P or L along with same period last year.

Don't be too concerned that you didn't get all these items - especially for a smaller business - Why? Because the owner - whether you like it or not - can believe it or not - may not have some of these items. All this means is that you'll have to do it yourself from the checkbook and receipts. As you will recall from my previous articles - I prefer starting with a blank piece of paper anyway - to do a current P or L of the business.

If you followed my suggestions and have begun doing a Business Plan from the questions you've asked the Owner in previous meetings and the research you've done on your own - you should have a good idea of sales revenues - the expenses are easy - check the latest garbage bills - utilities - insurance etc. But when the above materials are available - use them.

OK - now that's out of the way - lets continue... First if you have them - compare the accountants P or L to the Tax Return. The P or L will be more detailed - e.g. the utilities line on the Tax return may have only one figure - the financials will show each expense like gas - electric. Try to match up each item on the P or L to the Tax Return. (If you received the accountant's trial balance - this step will be done for you. Once completed any item noted that doesn't make sense - must be researched.

Now put the P or L's away and work from the Tax Returns - they're easier and less complicated. Next you have to adjust the Tax Returns - that is remove any non-recurring items - any Owner's personal stuff that has nothing to do with the business and some accounting entries that have nothing to do with cash flows etc. etc. etc.

On a blank paper show item name in the first column - sales, cost of goods, gross profit, expenses etc. In the second column write the corresponding figures from the Tax Return. In the next 2 columns show + adjustments and - adjustments. Here you will add and subtract items that do not have anything to do with the business and the way you plan to run it yourself - which may be different than the way it is presently being operated. For example - you probably won't be making payments for the Owner's car, health insurance for himself and family, his interest payments, the depreciation and/or amortization charges, his gas and repairs - especially in a business where a auto isn't necessary, owner's salary etc.

All of these would be minus items. Plus items would be current rent expense if higher than the Tax Return year, labor not shown on the Tax Return (don't forget to increase sales revenues too for this item). Speaking of labor - show plus or minus on how you plan to run the business - the previous Owner may have his wife and kids working - are they getting paid?...more next time...

 Due Diligence Part 3
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Last time we were discussing labor. Remember - we are adjusting the tax returns of the business you are thinking of purchasing for personal items, one time items, extraordinary non recurring levels and some non cash accounting entries. Ask the Owner the name, function, how paid (on or off the books) and amount paid. Add everything up and annualize. The total should be reasonably close to what is shown on the tax return. Make any addition or subtraction entries. Note - you will adjust these figures for unnecessary family labor or for family labor that's not getting paid. When done - the final labor cost will be the total you can expect should you buy the business. One last point - don't put a labor cost for youself. The reason being you may over value or under value your services. This is not the place to decide what you are worth. Save it for the end - What's left after paying all your expenses. Did you get a fair salary? A return of your investment? A return on your investment?

Moving up the tax return we come to the Cost Of Goods section and Gross Profit. In my opinion - this is the most important part of your number crunching. (Determining sales volume is more important overall but...) You don't need to be an accountant to see if the Owner screwed up this section - whether by accident or on purpose or maybe just lazy or sloppy in doing an accurate ending inventory. You just want the facts - the actual gross profit percent of the business your thinking of buying. Once this percent is obtained - you can apply it to the sales volume directly to obtain your gross profit dollars. This step must be done at the store. Look for representative items of what the business sells - note the retail price - go to the invoice - see what the item costs - subtract & divide - get the gross profit percent. Keep doing this till your comfortable with what the overall gross profit percent of the business is. Compare to the tax return and standards from reference books in the library or internet. If your result is different - do more samples - ask questions - but for better or worse the percent you obtained is probably the percent you will get when you buy the business.

Now we can go to the top of the return - revenues. Don't get mushy on me at this point. We aren't determining the value of the business so any philosophical ideas you have on unreported income needs to be thrown out the window - here and now! Your only concern is to determine: (1) what volume the business did in the year you're examining and (2) what volume you expect to make in your first year of operation. Why? The Owner of this business may have inflated sales - either thru outright falsifying the results or perhaps selling at a lower price to increase sales (you'll probably notice this in your gross profit check). If you've been following these articles...more next time..

 Due Diligence Part 4
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Now you are ready to look at sales revenues. You should have started you Business Plan by now - so you should have some idea of the demand for the products/services of the business you thinking about buying. In any event there are a slew of methods you can employ to check the sales of the business.

Let's start with the easiest - the tax return. Add to this what the Owner told you - when you asked - he doesn't report. Don't believe whatever he tells you - but note it anyway - see if it agrees with what you find. Perhaps he has kept the original receipts of what he didn't report (why a Owner would keep them or show you if he did - is a mystery to me - but if he did and he shows you - its better than just him telling you. In any event still be skeptical - very skeptical.

Now let's verify some of these numbers. Get the bank statements - add up last years deposits - do they agree with the number on the tax return? If they don't - ask the Owner why? Another way to get an idea of total sales (especially when you think or know there is some unreported income) is to add up his total purchases of merchandise bought and used last year (don't forget to include the adjustment to beginning and ending inventory). Since you know the GP% (from previous article) - you can figure sales (assuming of course he didn't pay cash & throw out the receipts for some of the purchases that year).

You should be getting comfortable with actual sales volume by now - but if still in doubt - you can make arrangements to personally observe the operations - add up sales in the store at the end of the day - do this for a week or two - or longer if necessary. If the business your buying isn't seasonal or cyclical - you might get the picture of what's going on. If your still not sure you must now become a detective or pretend you're an IRS Revenue Agent.

There are almost fool proof methods for checking every business. For instance - sit in your car - count customers coming in - you should know the average customer sale - so do the arithmetic. Buying a Pizza restaurant - find out from vendors how many boxes - pounds of cheese - cans of sauce etc was used last year. For a laundromat - go to the town - find out total water consumption - for a car wash determine traffic count - for a gas station & "C" store get gas purchases from the supplier - with this readily obtainable info - you can determine sales activity fairly accurately - when compared to the other methods described above - you should be able to verify or determine sales volume. If you can't or still not sure - then use the tax return figure and forget anything else the Owner tells you. But keep this in mind - you may be paying the Owner for the sales volume he's achieved - but you are buying the business for the sales volume you will achieve - based upon your ideas for marketing - promotion - better service and hours etc.

The above will help you determine actual sales - what you do with this info - is up to you. Next time we discuss...

 News Article - Do I Need To Finance A Buyer?
 Let's talk about financing a business you're thinking of buying/selling. How many people are walking around with all the cash needed to buy the business they found? Even if they have it - how many of them would put that much cash into a deal and leave them that much short in case of personal emergencies or at the least - having money available for the future needs of the business e.g. a "rainy day fund", working capital or additional investment. Even when you think you have enough cash – more is often needed. When the Broker tells a Buyer the business is selling for $75,000 plus inventory he/she is usually asked “...how much inventory is there..." Seldom is he/she asked “ …how much working capital do I need when I take over? Remember most of the time you are buying the assets of the business - and they don't include the Owner's checkbook. The Buyer's banker, his accountant or advisor will sooner or later tell him about this and all of sudden another +/- $10,000 is needed to put together the deal. (helpful hint: the amount many advisors tell their clients to have available at the time of purchase is least 2 - 3 times the average monthly expenses of the business - some businesses even more!).

What does all this mean - most people won't use all their available cash to buy a business. There are also financial reasons why a Buyer won't use a lot of cash for their initial investment - ROI, leverage or just plain risk (in case something goes wrong they want a cushion or in case of Owner Financing they think they can stick it to the Seller).

Hopefully I've shown that when buying a business - financing it is not an option - it’s a necessity. I didn't even mention that more prospects will be available to buy any particular business. For example why should a Buyer take $100,000 and pay all cash for a business when he could take that same $100,000 and buy a business worth +/- $400,000 that could be financed!

Now with all this being said - how many businesses out there can be financed? How many have tax returns that can justify to a banker, investor, mom & dad or even the Buyer that the business can afford debt service (payback) along with a salary for the Buyer? I'll answer for you - few. In fact most businesses can't justify even being bought from what is found on the tax returns. If what I said is correct - and it is - why talk about trying to get financing from any of these sources? (Actually in a future article I will) So the only thing left is financing from the Owner. As a matter of fact, if someone is selling a business and won't finance it - that Owner will probably wait a long time before finding someone willing to buy - and when/if he does – he will probably have to discount the fair selling price (not the asking price) more than 25% - 35%.

There are other reasons why a Seller should (and must) finance his business. Some are financial - additional money (interest), possible lower taxes on the sale and of course proof to a Buyer that you think your business is strong enough that you will even finance it. This is called by a lot of bankers - "putting your own fat in the deal" - and this goes a long way in their decision to finance the bulk of the sale. More next time...