Author Topic: Evaluating Business Purchase  (Read 2227 times)

zulumaster

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Evaluating Business Purchase
« on: November 07, 2017, 08:41:18 PM »
Hey everyone, first time posting, but have been lurking and reading for some time now. Recently have been given the opportunity to purchase a local business, custom apparel industry. The majority of the purchase would have to be financed, with a purchase price of $300,000 if purchasing the LLC and $400,000 if purchasing just the assets.  I've attached a basic summary sheet I received today for review to see if I am interested in digging deeper into this. Hoping to get some insight from others with more experience than myself on whether or not this makes any sense.

OkieM

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Re: Evaluating Business Purchase
« Reply #1 on: November 07, 2017, 08:51:57 PM »
Usually it seems the biggest risk in these deals is that the numbers are fudged or misrepresented. So you canít verify them with just an income statement. And looking at it Iím not sure if itís even correct. Iím no accountant but how can they add back officer compensation for adjusted income when it is zero on the deductions line for year 1 and year 2?

The other gotcha is that something has changed in the market or business that hasnít shown up in the numbers yet and they know about it but you donít.

zulumaster

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Re: Evaluating Business Purchase
« Reply #2 on: November 07, 2017, 08:58:16 PM »
Yeah, I have some questions as to the accuracy of how they got these calculations...supposedly done by a CPA. The officer compensation jumped out immediately.
« Last Edit: November 08, 2017, 06:13:52 AM by zulumaster »

OkieM

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Re: Evaluating Business Purchase
« Reply #3 on: November 07, 2017, 09:15:39 PM »
So are you ready to drop 400 large on a business that doesnít even have clean books on its consolidated income statement? Ha ha. Iím guessing that is really why you posted is some of the heartburn on that.

zulumaster

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Re: Evaluating Business Purchase
« Reply #4 on: November 08, 2017, 06:13:12 AM »
So are you ready to drop 400 large on a business that doesnít even have clean books on its consolidated income statement? Ha ha. Iím guessing that is really why you posted is some of the heartburn on that.

Yeah, my gut is saying that it doesn't make sense, but wanted to see others opinions on this since it is my first time reviewing a purchase like this. Even if the income was correct, it seemed to me that given the income and asking price, it would take quite a while before you could pay off the loan and make a profit unless you were to get a loan with a lengthy payback period.

KBecks

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Re: Evaluating Business Purchase
« Reply #5 on: November 08, 2017, 06:30:27 AM »
OK, interesting stuff.  How did this opportunity come to you? 

Here are some quick thoughts -- if you're planning to buy a business, you will need your own team of advisors, your own accountant, your own banker, your own lawyer, etc.  Ideally, get referrals from successful small business owners that you like and trust.

Second, what makes this business special that you should buy it, in lieu of establishing your own similar business from scratch?  Where's the value?  Where's the opportunity?  Are there ways you can add value to the business to make it more successful than it is now?

Third, how does buying this business compare to other types of investing?  Would you have increased return and/or reduced risk if you chose a different investing path?

What is your level of business experience?  Are you ready to take this on?  Have you managed businesses before?  Do you have capital reserves and will you qualify for a loan?

I have never bought a small business, so I think you should find more experienced people to talk with, and that would mean some paid advisors, particularly your own accountant.  (If you are not ready to pay some accounting fees for expert help assessing a major life decision, then you are definitely in over your head here.)  Also, connecting with a banker and accountant -- they may come across other opportunities for you to consider.

Owning a small business can be great -- but it's a giant commitment.  You have to do your homework and be extremely cautious, especially if you are taking on debt and all the risks that go with it.

Best wishes.

« Last Edit: November 08, 2017, 06:54:48 AM by KBecks »

bwall

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Re: Evaluating Business Purchase
« Reply #6 on: November 08, 2017, 06:51:12 AM »
Why is the owner selling?

CareCPA

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Re: Evaluating Business Purchase
« Reply #7 on: November 08, 2017, 07:36:38 AM »
Yeah, I have some questions as to the accuracy of how they got these calculations...supposedly done by a CPA. The officer compensation jumped out immediately.
Judging by the summary, they pulled these numbers from the tax return. It looks like Officers' wages were lumped into the general Salaries and Wages line.
Officer's comp would be added back because you could theoretically make that amount whatever you want.

SC93

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Re: Evaluating Business Purchase
« Reply #8 on: November 08, 2017, 07:57:48 AM »
Not all the time but most of the time when a person borrows money for a business, they soon regret they ever made that move. Yes, there are many successful businesses that have borrowed money and made it work but for every successful one there are 10,000 unsuccessful ones. No matter what business you borrow money for it will probably be the worst day of your life.... you just won't find out for 2 years.

I've made MILLIONS and have never spent over a few thousand dollars on any of my businesses. My most successful business was my cleaning business where I had to borrow a bottle of window cleaner, a bottle of shower cleaner and cut up some old rags to start it. My current business was started on less than $1500 and that included a $1300 minivan so without the van, it cost me $150 to start my current business. Next year it will profit in the $100,000 range and that is because I'm choosing to not have over 3 workers. It could be twice that.

Custom apparel, a business that can change before I finish typing this......

craiglepaige

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Re: Evaluating Business Purchase
« Reply #9 on: November 09, 2017, 11:49:15 AM »
Unless this business has some contracts that are in place long term, I wouldn't even consider it. The custom apparel business, which I'm somewhat involved in since I own a vinyl cutter and heat press and make about $1000 a year without even promoting it, is insanely difficult to profit from after you have counted all the time it takes.

For example, I'm currently in the process of making 10 shirts for a co-workers' mom's business. She owns a hair salon and wants new "uniforms" done. I've already spoken with her 4 times regarding what she wants and after mocking up a quick logo for her (she didn't even have one) it seems all is good to go.  For all of that I'm getting $100, so $10 per shirt and she provided the blanks.

I've spent about 2.5hrs of my time between talks and logo design plus the other hour or so it's going to take me to actually do the shirts. So let's round it off to 4hrs of my time, so yeah on paper 4 hours for $100 isn't bad, but its not something you do for an actual career.

I bought the equipment long ago and it has paid for itself but to go into $300k in debt for this type of work, nah, I'll pass. As a hobby? Sure, make some side money. As a biz? Nope.

Liberty Stache

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Re: Evaluating Business Purchase
« Reply #10 on: November 09, 2017, 02:56:12 PM »
Lots of good advice above. This would be a quick, hard NO.

zulumaster

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Re: Evaluating Business Purchase
« Reply #11 on: November 09, 2017, 09:06:10 PM »
Thanks everyone for your replies and advice. Re-affirms my gut feeling to pass on this. To answer some of the questions posed, Found out that the owner was looking to sell from a mutual friend that used to work there part time in college. Contacted the owner about it and he is wanting to move out of state to be closer to family. The initial thought about the benefit of buying vs starting was that there were employees in place, and a well known name around town making it easier to get sales going. More investigation into the business details has only made it look less appealing. Appreciate everyone's input.

Rufus.T.Firefly

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Re: Evaluating Business Purchase
« Reply #12 on: November 17, 2017, 08:06:10 PM »
Just to add one more thing: I saw you were adding 110K for asset value to the income multiple figure at the bottom.

This probably is not correct. When using an income multiple approach, one typically does not take the multiple and then add the asset value to it. The assets are used to generate the income and thus are part of the multiple. Let's say comparable sales history shows that the apparel industry businesses typically sell at a 2x multiple - those are completed transaction prices with the assets already baked into the cake.

There are exceptions to this, of course, but just wanted you to be aware in case you look at another opportunity.

zulumaster

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Re: Evaluating Business Purchase
« Reply #13 on: November 17, 2017, 08:21:20 PM »
Just to add one more thing: I saw you were adding 110K for asset value to the income multiple figure at the bottom.

This probably is not correct. When using an income multiple approach, one typically does not take the multiple and then add the asset value to it. The assets are used to generate the income and thus are part of the multiple. Let's say comparable sales history shows that the apparel industry businesses typically sell at a 2x multiple - those are completed transaction prices with the assets already baked into the cake.

There are exceptions to this, of course, but just wanted you to be aware in case you look at another opportunity.

Agreed. Those numbers were written in by the owner, as to why, I'm not sure. It looked almost like they were trying to use both an asset valuation and income multiple approach and then add them together.

Everyone on here has been great with honest and helpful feedback.

Rufus.T.Firefly

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Re: Evaluating Business Purchase
« Reply #14 on: November 17, 2017, 08:26:59 PM »
Just to add one more thing: I saw you were adding 110K for asset value to the income multiple figure at the bottom.

This probably is not correct. When using an income multiple approach, one typically does not take the multiple and then add the asset value to it. The assets are used to generate the income and thus are part of the multiple. Let's say comparable sales history shows that the apparel industry businesses typically sell at a 2x multiple - those are completed transaction prices with the assets already baked into the cake.

There are exceptions to this, of course, but just wanted you to be aware in case you look at another opportunity.

Agreed. Those numbers were written in by the owner, as to why, I'm not sure. It looked almost like they were trying to use both an asset valuation and income multiple approach and then add them together.

Everyone on here has been great with honest and helpful feedback.

Haha, oh that explains it. Just wishful thinking...

SC93

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Re: Evaluating Business Purchase
« Reply #15 on: November 17, 2017, 10:32:27 PM »
.... and always remember, with an already established name comes good and bad. What you thought would happen is that you could spend a few dollars and piggyback off of someone else's hard work to start a business. Go out and start your own thing with your own name and get your own good reputation going.


wbranch

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Re: Evaluating Business Purchase
« Reply #16 on: December 09, 2017, 09:19:25 AM »
It sounds like  a decision was already made and it was the right one. I thought I could throw in my two cents that is hopefully helpful for others reading.

It looks like the numbers probably came from the Form 1065 (partnership tax return). The net income is probably from line 22, the reconciling amounts to "net income per books" are Schedule K/M1 items that are reported separately.

A good CPA probably has an engagement letter that the numbers from the tax return cannot be used for something like the valuation shown. And if it is they don't take responsibility for it. If someone tells you the numbers were prepared by a CPA there should be a report (compilation, review, audit) attached.   

A buyer would probably want to hire a CPA that would do some sort of work related to this. A CPA could do a compilation, review, or audit engagement depending on the size of the business. I know that small banks in the midwest will still use compilation/review reports when doing financing even though they provide no/limited assurance on the numbers. Other parts of the country may require financial statement audits. There are also CPA (or other professional service) firms that provide valuation services. I would not buy a small business without getting copies of full supporting tax returns, financial statements, quickbooks files, bank statements, etc. I would also want some sort of proof/evidence that the numbers from the business returns match what was reported on the owners 1040.

On some business valuations I have seen or worked on "excess" officers(owners) compensation is added back. i.e. owners get paid 120k, 70k gets added back because a reasonable manager wage would be 50k, and the 70k is a return on ownership.

Generally when buying a small business it should always be a asset purchase. You do not want to end up owning interests in a LLC or shares in a closely held Corporation that has been around for years. You would end up owning all of the problems that may have came up over the years and they do not disclose (I am not lawyer, this is just what I have heard from multiple people over the years).