Specific Business Questions
- Buying a business with customer concentration issues
- Buying an eCommerce website with one key employee
- Buying an insurance business
- Buying a small manufacturer with one large customer
- Buying a gas station
- Buying a convenience store
- Buying a retail camera business
- Buying a dry cleaner/laundry business
- Buying a vending Route
- Buying a florist business
- Buying a wholesale/distribution business
- Buying a transmission franchise
- Buying a car wash business
- Buying a cell phone store
- Is business brokerage a good field?
- Buying a restaurant – what to consider
- Valuation of small independent motel
Buying a business with customer concentration issues
Question:
I am thinking about buying a local moving/storage company. They have been around for about eight years and specialize in B2B accounts. Only about 25% of the business is residential relocation. The business has grown every year and nets about $175,000 to the owner (including everything). They lease all of the vehicles. We have negotiated the price down to $525,000 (from $595,000) and the seller will finance about 50%. The problem is that three of their accounts represent 65% of the business. Of this, almost all of this revenue is related to long-term storage and moving of their stored merchandise. How can I possibly protect myself and what should I be aware of in this situation?
Answer:
This is a GREAT question. In many businesses, one does come across customer concentration issues. However, one must consider the specific nature of the business itself to determine:
- Is customer concentration the norm in this particular industry?
- What is the impact on the business should the customer(s) stop buying?
- How "easy" is it for the customer to go to a competitor? Why would they?
- Is there a special relationship between the current owner and the customer that keeps the business safe?
- What can be done in the future to lessen this percentage of concentration?
Let's examine all of these points:
- In the commercial storage business, it is quite acceptable to have a higher than average degree of customer concentration. If you were selling a highly competitive product rather than a service, I might be inclined to be concerned, but not necessarily in this case.
- Clearly, you'll want to determine the impact should one of these key customers stop buying from you. To this end, you should do a Pro Forma budget isolating each one of these accounts, both from a revenue and net income perspective, to understand your exposure.
- In the commercial storage business, you will be providing the pain relief to your customers. The service you provide eliminates a headache for them. If the business is like most commercial storage businesses, where you charge every time you handle the goods for them, it is not really easy per se for them to go to a competitor, nor do they usually want to. All these clients want is for you to do what needs to be done, when they need it done. This means picking up on time, and delivering on time. This is very much a business that is yours to lose. So, do your job well and you won't give them a reason to even consider switching!
- You will certainly want to review any contracts in place to understand what is involved in the event of a change in ownership. They may simply be able to roll these over to you. Or, they may require written permission. Some can even have far stricter language that doesn't allow these to be assigned. In any event, you need to know the details and also what is the relationship between the sellers and the clients that keeps the business secure.
- I would absolutely recommend that you look to increase the client base. This may be time-consuming because, just like these customers won't be quick to place their goods elsewhere if you do your job, neither will other prospects be quick to give you their business. It takes time to secure new business in the industry. So the lesson here is to take very good care of what you've got because it won't come back easily if you lose it.
As far as protecting yourself, the most effective strategy for any business with customer concentration issues is to establish part of the purchase price as an earn-out or performance- based purchase. You should also keep in mind that the seller cannot guarantee the revenue to you for perpetuity. If the new owner messes up the business, it is not the seller's fault. However, they should be able and willing to effectively guarantee the business for at least 6 - 12 months. You will need to determine the percentage of revenue/profit each major client represents and then factor this by the multiple being paid for the total business, and then this amount should be evaluated and paid at a future date.
As an example, if you are paying $525,000 for the business on $175,000 owner benefits then this is a three-times multiple. If the key accounts represent around $113,000 of the $175,000 this would equate to $400,000 of the purchase price. In 6-12 months you revisit the numbers and if the revenue/profits are still in place, then the seller earns this $400,000 and, ideally, you should build it into the note. If business declines, the $400,000 is adjusted accordingly. In this business, I would suggest a 12-month period since the customer turnover rate is quite low and the clients may take a little longer to evaluate you as well.
Buying an eCommerce Website with one key employee
Question:
I have read your course and found it very helpful. I am currently in the process of buying a business, but I have one question. The business I'm looking at is a small eCommerce Website. There is only 1 employee, but he handles all the technical aspects of operating the Website. The owner just does marketing and non-technical stuff. I am similar in that I have some technical background, but not enough to be able to take over the whole operations of this site. The employee doesn't know the business is for sale. If I buy the business, I would like him to work for me. But I don't know if he will. Is there any way I can find out beforehand, or make the deal contingent on that? Without that employee I wouldn't want to buy the business. Any suggestions?
Answer:
Thank you for your kind words about our program. As you know the online world is very dear to me as we repositioned our entire operation to be online and it has been great.
It is common to have an owner/operator, a "Mr. Do Everything" type operation in the online world. The key questions here are:
- How automated is the business?
- Can you or anyone else step in and, within a short period of time, understand the workings of the business?
- From a technical standpoint can a "techie" figure out the internal programming that operates the business or is it a "big pile of spaghetti" like my friend Bill says, that will be foreign to anyone else?
Now, having said all of this, here are my points related to this deal:
The technical employee will likely stay if he/she is happy and well compensated, BUT you'll definitely want to have their employment or at least a reasonable training period as a contingency to the deal. Since the seller cannot bind the employee, you will need to speak with them directly at the appropriate time. You may want to bring in an outside person after this meeting who you trust and who is technically sound to evaluate what is in place just in case the employee gets hit by a cement truck.
How critical is the technical aspect of the business and can it be duplicated or rebuilt? Personally, if the techie is the one who holds all of the strings in the business and is the only person on the planet who can manage the technical side of the business, then you should consider another venture because you'll always be looking over your shoulder in fear or he/she could eventually hold you hostage.
One other thing to consider when buying an online venture: you need a bullet proof non-compete clause because, unlike a traditional "bricks and mortar" business, the seller can open up anywhere, and you'll never know.
Here's a great article for you to read about buying an online/internet business
Buying an insurance business
Question:
I am looking into buying a medium-sized insurance brokerage that specializes in auto insurance. The current owner is very much involved in the business. He knows all of the clients personally, and even has many of them as friends and social acquaintances. Also, his name is the name of the company. Needless to say I would like to keep him on for a very lengthy transition period. What thoughts do you have on structuring an earnout in a situation like this? I want to keep him motivated, but don't want to give away all of my future upside.
Answer:
This is a common predicament in personal service businesses. Clearly, if the seller is "the business" you'll want to consider all of the ramifications that will come once he walks out the door. An earnout may be an option for you; however, I am not 100% certain what it is that you expect to have the seller "earn" when in fact you're looking more to having a deal whereby the business will continue at current levels at least. For example, an earnout makes sense in some of these situations:
- There is a high degree of customer concentration
- The business has been trending downward or upward very aggressively in recent periods
- The seller has just obtained or is anticipating new revenue that will dramatically increase the business and he/she wants to get paid for it, but there's no current financial proof to substantiate their belief of how much new business will be generated.
- A single contract or component to the business may be up for renewal in the near future (i.e. expiring lease).
Here are things to consider:
- You absolutely must have a substantial seller note in place.
- The multiple paid for these type of businesses will tend to be at the lower end of the spectrum
- The non-compete needs to be at least three years, and if possible, should prevent him from being in any related business whose prospects are current insurance clients although this may be a little harder to enforce.
- While I understand that you'll want his involvement for the longest period possible, it may be more of a window-dressing scenario so that during the transaction clients understand he is still involved. However, if he has a lot of personal relationships as you point out, then surely these clients will be aware of the sale. My concern here is that I sense you are not fully confident in the business being able to carry on once the owner leaves.
- Lastly, in the insurance business the different types of specialties will have various degrees of the importance of the personal relationship between the seller and their clients. As an example, in agencies that specialize in life or health insurance, the relationship between the agent and the clients is crucial. In the auto insurance business, while the relationship is important it is less so.
Buying a Small Manufacturer with one Large Customer
Question:
We are currently performing due diligence on a small manufacturing company. Everything seems to be in good order, and the business is very profitable. Our biggest concern is that nearly 60% of the sales are to just one retailer. There are no indications that there are any problems with this account, but obviously the business would suffer dramatically if it were to lose this customer. What protections can we include in the deal? How should we factor this risk into the purchase price?
Answer:
Oh boy! Customer concentration issues, especially in the manufacturing sector, make me very nervous.
You'll want to attack this deal from two perspectives:
- What is the possibility that the client can shift to an offshore manufacturer or competitor?
- What relationship, contractual or otherwise, is currently in place between the client and the business? My guess is that any contract can easily be terminated but it's worth knowing.
Assuming that you do your research, and are confident that the business with this one client will continue, your best earnout scenario will be to establish the price and have a holdback of at least 50% dependent upon the business' ability to maintain the client for at least one year post-closing. You must also understand that the seller will have some legitimate concerns about this. For example, if you take over and mess up the business, you certainly cannot expect the seller to forfeit the money…right?
Have you determined what keeps this client buying the products? Is there anything proprietary about the product?
On a final note, you'll want to evaluate what opportunities exist for you to expand the business. While the current customer concentration issue may not pose a problem, ultimately it will because nothing lasts forever, especially in manufacturing, and the trend is to move production offshore.
Buying a gas station
Question:
What are some of the key things to look for in evaluating gas stations for sale?
Answer:
Gas stations have always been a popular resale business; however, you should not be misled, as many people are thinking that this is an ideal "absentee" business. It takes a lot of work to be successful and either requires a substantial amount of time, or top-notch management personnel to operate/manage it on your behalf. Here are a couple of points to consider:
- Today, you'll want a gas station that offers additional services such as a mini mart, car wash, etc, and you should be evaluating these to be certain that revenues and profit margins are in line with industry standards.
- Having a brand-name affiliation with a major oil company is important. You want to review the contract in place to be certain that it is transferable. You should also arrange to meet the local representative of the oil company to get their feedback and to be sure that they're on board with the transaction. To this end, ensuring a successful rollover of the contract must be a condition of the sale.
- Consider the competition. In many areas, there is a gas station on every corner, or the possibility that new ones can be built.
- Road traffic: Gas stations/C-stores thrive because of location. If traffic patterns change, it will impact the business. Therefore, you'll want to investigate with the city planning department to learn what new permits have been granted for building in the area (for competition) or other businesses that could impact the traffic and, most importantly, when the last major roadwork was done. Typically, major routes will undergo some work at least every ten years. During this time there can be a major disruption to the business.
Buying a convenience store
Question:
My business partner and I are planning to buy a major-brand convenience store in the next 3 to 6 months. We've already identified three stores for sale in our target area. Can you offer any advice on how we should be comparing/contrasting these stores?
Answer:
I'm thrilled to learn that you have set a very specific time limit to complete a transaction. Not working with a timeline or having a sense of urgency is one of the biggest reasons why many prospective buyers (90% in fact) fail to complete a transaction.
There are numerous considerations you should be making when comparing different opportunities. Although it is oftentimes difficult to compare different businesses, you’ll want to evaluate the following:
- Whether or not the location is a franchise or generic operation. If it's a franchise, what are the ongoing fees to you, what training/ongoing support can you expect, and what are the agreement conditions? Plus, will the franchisor readily transfer the existing contract or require a new one? Either way, you'll want some clarity on this issue.
- Are you and your partner planning on working in the business? If so, you'll want to evaluate any businesses and consider adding back the manager's salary if they are currently being run absentee by the present owner.
- Similar to a recent question I received about gas stations, you want to know about the location. For example, C-stores typically flourish because of location. If traffic patterns change, it will impact the business. Therefore, you'll want to investigate with the city planning department to learn what new permits have been granted for building in the area (for competition) or other businesses that could impact the traffic and most importantly, when was the last major roadwork done. Typically, major routes will undergo some work at least every ten years. During this time there can be a major disruption to the business.
- Regarding the competition, are there any nearby locations currently operating or possibly being planned to be built that could severely impact your business?
- What ancillary services will you have at the store? When comparing businesses, you must attempt to have an apples-to-apples comparison. For example, if one sells gas, while another has a Subway-type in-house satellite franchise, then certainly you must take this into account.
On a separate note, I want to discuss the partnership issue. You and your partner need to be certain that you both have a very clear understanding of what each person is responsible for, that you be upfront with one another in your expectations, that you share the same vision for the business, and that you have a mechanism in place to deal with a decline in the partnership. As long as you get that done now, partnerships can be a tremendous way to build a business.
Buying a retail camera business
Question:
I am considering making an offer on a retail camera business. It has been in biz for over 30 yr. Owner wants to retire. Has posted 4.5% avg. growth over the last 12 yrs. The last two yrs, 15% growth. Gross receipts for 2004 are $400,000. How do I best determine its worth and what is fair value for trade name and goodwill? No real estate is involved. Lastly, is retail a good biz to get into in the current economic outlook?
Answer:
You raise some excellent points in your email. It certainly seems that this business has many interesting and solid characteristics to it, including the years it has been operating and the continued upward trend in revenues. Insofar as a valuation is concerned, there are a number of things to consider: first, while the revenues are important, as you know you will take profits to the bank. As such, it is critical that you breakout the actual Owner Benefits figure. In this business, it will typically be:
Pre-tax profit + Owner Salary/Perks + Interest + Depreciation - Allocation for Capital Expenditures (i.e. store improvements, investments in new equipment, etc.)
Once you obtain that figure (for the last three years at least), you will want to attach a multiple to them to arrive at a reasonable purchase price. Retail businesses such as these typically sell for around 2 - 2.5 times this figure. However, there is a lot of consideration to be paid to the very nature of this business and the inventory and equipment that may be involved. As such, this is one type of retail business where a percentage of revenue is often used to establish the price plus the assets. Under this scenario, valuations are generally around 10 - 20% of the total revenue plus the cost of the fixtures/equipment and inventory (at cost).
Regarding your last question about getting into this type of business given the current market, the question is best answered by your desire to operate a retail location plus key factors such as nearby competition, any changing technology that could severely impact the industry and, of course, to determine with absolute certainty what drives the business. Is it location? Know-how of the owner? If so, is the lease solid? Do you have the same level of expertise?
Buying a Dry Cleaner/Laundry Business
Question:
Hi. I am looking to a buy a running Dry Cleaners/Laundry. What should I be asking about/looking for? Never been in the dry cleaning business before.
Answer:
Coin laundries and dry cleaners are very attractive opportunities to many people. While some can be run absentee, the majority truly need a hands-on, capable owner-operator to really succeed.
With a dry cleaner, you'll want to check out all potential environmental issues to be certain the current owner has been in full compliance with all waste disposal issues. This is crucial because some leases actually hold the current tenant liable regardless of who may have caused the problem.
From a business operations standpoint, you should consider locations that offer a variety of services such as: dry clean, alterations, leather/suede, wash and fold services, etc.
You need to know very clearly what drives the business. Most often, it is location. As such, if the business is located in a plaza, investigate the anchor tenants to be certain they're planning on staying in their premises for many years. Also, investigate any possible road work that may be planned for the area. Typically, major streets undergo some work at least every ten years. The city hall can provide you with additional information. Lastly, you want to be sure that you have a long-tem lease in place.
A great resource for you is the Coin Laundry Association. You can visit their website at: http://www.coinlaundry.org and the Textile and Fabric Care Association at: http://www.ifi.org/industry/index.html.
Buying a Vending Route
Question:
I am thinking of buying an existing vending route (snacks and drinks). What are the things I need to check before buying the vending route? The machines are included in the price.
Answer:
Typically, the most important factor to verify is the relationship that the company has with its clients, and the relationship the business has with its vendor. Are these well established and will they rollover to you without incident? Also, what is the condition of the equipment? Are there any agreements in place with either the clients or the vendors that will require you to purchase and place new machines in the near term. Plus, you want to track the sales trends by month for at least the last two years to see if the business has been losing clients to any particular competitor.
Of course, you certainly need to verify the financials, which are notorious for being undocumented in these businesses. Finally, you should really determine whether you’re going to like this business. In my experience, very often people who buy vending routes tire of the business very quickly. You may want to spend a day or so with the seller and see what it is that they do precisely so that you’re certain you will enjoy it as well.
Buying a Florist Business
Question:
There's a small florist shop that I am looking to buy. It's located in a mall, been around for ten years and seems to be doing well. They get a lot of passer by traffic (it's a busy center because of the KMart)...any suggestions what I should look for?
Answer:
Yes! KMart was in Chapter 11 a few years ago and while their store closing rampage has subsided, you will want to know how long they have remaining on their lease if they do not own the real estate (check local city records). I believe they emerged from bankruptcy protection in April 2003. That does not mean things are wonderful at their stores. They've closed many locations and more may follow. You had better be POSITIVE that the KMart will remain open or you'll soon find your traffic reduced to a trickle!
Personally, I would avoid any location where KMart drives the business until there’s proof that their business is viable. You should do some research which is readily available as Kmart is publicly traded. Their real estate is performing well, but I am not certain about their actual core retail business.
One thing you can do is call the Property Management company from the mall, tell them you're looking to open a major retail location (tell them you cannot divulge specifics) but you'd like to know if there's any chance that you can get the KMart spot. They may very well tell you that either KMart will be leaving or that they have another 10 years on their lease, or they've renewed or several other possibilities, but clearly it will give you tremendous insight into the situation. Or, you may learn that KMart ownes the property (they own lots of their locations) and so they will likely continue to operate the store.
Buying a Wholesale/Distribution Business
Question:
What are some of the pros and cons of buying a wholesale distribution company (an example would be a wholesaler of beer and/or packaged food items to supermarkets)?
Answer:
Wholesale/distribution businesses can be excellent long-term ventures. In addressing your question, I will make the assumption that you will be looking at profitable businesses and not ones that are in a turnaround situation. Here are some of the good and bad points:
The Good:
- These businesses usually have a broad client base and do not suffer from high customer concentration, meaning that you're not dependent on just a few large clients.
- In the examples you cite, there's generally an element of exclusivity in either the product or the territory. While this does not eliminate the competition, at least it allows you to operate without competing with other wholesalers carrying the same brands.
- They're good businesses to grow because you have a built-in customer base and distribution pipeline. The strategy is to continually seek out new products that can be sold to the same clients.
- They're sought-after businesses because they're not overwhelmingly difficult to operate as long as you inherit or implement the right systems. As such, when the time comes to sell it down the road (even though you haven't bought it yet), you'll have a large buyer pool available.
The Bad:
- Accounts Receivables are always a challenge unless you carry high demand products. Therefore, cash flow can get tight at times. You need to be certain that you have a dedicated and highly competent individual chasing down payment.
- Your future is in the hands of your suppliers. They are your most important resource. You'll want to be certain that the current owner does not have any special relationships that have allowed him to handle particular product lines.
- Contracts with the suppliers are usually meaningless and can be terminated with very short notice.
- Quite often these businesses compete solely on price, which is not an ideal business model. Try to find one that thrives because of the service levels it provides rather than selling based upon its aggressive pricing.
Buying a Transmission Franchise
Question:
I'm looking at buying an established Aamco transmision franchise. How do I figure out what to pay for it and if it's better to start it up as a new center from scratch? Most owners that own existing centers tell me that buying an existing center is the way to go, but I get mixed feelings because I ask them if they're willing to sell and some of them are.
Answer:
In my opinion you are far better off to buy an existing location than to start one from scratch. While Aamco has a good track record, a new franchise is nothing more than a glorified start-up. There is absolutely no guarantee that you will be successful. The purchase price depends entirely upon the Seller's Discretionary Cash Flow, although some within the transmission franchise industry feel that the purchase price should be a percentage of annual gross sales (approximately (25%- 30%).
However, it's profit, not sales, that you seek. And so, using a multiple of Seller's Discretionary Cash Flow which includes Pre-tax Profit + Owner Salary + Owner Perks + Interest + Depreciation, less any foreseeable allocation of profit for capital expenditures, is the formula to use. The question then becomes what multiple to use? Generally, these businesses fit right into the one- to three-times times range.
But there is a big difference, and so you must consider such criteria as: how long the shop has been in business, are sales increasing, what does the seller contribute work-wise (actively working on vehicles or managing), any threat of competition, franchise agreement details, etc. Use $150,000 SDCF as your median. Assuming all things being equal, those with SDCF of less than $150,000 should be in the one- to two-times times range and those above in the two- to three-times category.
Buying a Car Wash Business
Question:
I am considering buying a full-service car wash. What do you think of the industry? How would I go about determining the value for this type of operation? Typically these cash businesses say they earn more revenue than they have documented. What is the best way to do due diligence on this type of business?
Answer:
I like the car wash business. I believe that successful ones provide an excellent platform to generate good profits, they can be operated quasi-absentee with a good manager, and there's always a strong resale market.
Insofar as determining a value, it is one of those businesses where sometimes annual revenues are utilized with a multiple of around two times annual sales. The big question of course is what are the true sales? If you are able to reconstruct the revenues, a good barometer of profit is 30% to 35% of gross revenues. As well, most full-service facilities are sold with the real estate. In these cases, the general rules are around 2 – 2.5 times the Owner Benefit figure plus the cost of the real estate and equipment less an allowance for capital expenditures. Without real estate, the multiple ranges from around three- to four-times the Owner Benefit less an allowance for capital expenditures.
You are correct that many times the sellers claim to generate more sales/profits than is documented. While this may be true, my personal rule in any "cash" business is: if they can't prove it, you can't pay for it. And so, the onus is on the seller to validate what has been represented. You can also use the utility bills as a general barometer of X gallons per wash. However, there are additional services like waxing, full detailing, etc, that may be impossible to prove out.
An observation period during due diligence is quite common where you literally monitor the business over a few days and count the cars, hoping to annualize the figure. The problem of course is that a few days really do not give you a true picture. What if it rains for a week? The conclusion here is that you need proof of the figures in order to make any type of realistic assessment and valuation of the business.
During the due diligence, in addition to the financials, you should check out:
- The lease if the property is not owned. This business survives based on its location. A long-term lease must be assignable or a new one granted by the landlord.
- Are all employees legal?
- Any workman's comp or other insurance issues?
- Condition of equipment, maintenance records, amount of useful life remaining.
- What additional services can be added, if any?
- Are there any potential competitors looming? Verify any permits being pulled at city hall.
- When was the last major road construction done? You can figure on work being done at least every ten years or so. Major traffic disruptions could dramatically impact the business.
Naturally, there is far more to be done in due diligence, but these are a few things to consider. I was recently assisting a client with a review of a car wash and found a very good resource in The International Car Wash Association at: www.carwash.org .
Buying a Cell Phone Store
Question:
I have noticed an extraordinary amount of cell phone stores for sale lately here in Southern California at very low prices considering the money that they supposedly make. Do you think that perhaps cell phone stores are oversaturated and the owners are trying to bail out now while they can still show good revenues on the books? It just seems curious that the owners would sell so low.
Answer:
Interestingly enough, over the past year, I have received a lot of client inquiries regarding mobile phone stores. While they can be profitable, you hit the issues dead-on: the competition is fierce. In fact, it’s not unusual to see up to three stores in one large strip plaza.
I was in a large South Florida mall a few weeks back and counted six separate kiosks – incredible. Now, one could easily say that there’s ample business to support it, and they’d be right. The bigger issue I believe is that with such enormous competitive pressure, what opportunities exist to grow the business? The landlords use the “out” that they are different businesses in that one may be AT & T, another Verizon, and a third T-Mobile or a generic seller.
The multiples are simply not high because there are so many on the market, and there’s a lot of competition. The ones that seem to be especially profitable are those that offer a service component, and you don’t see too many of them. I’m not certain why, but I do know there is one in my town that sells one of the major programs but offers service on all brands and the store is always packed with customers. I saw the owner pulling out the other day in a big new Mercedes sedan, so he must be doing pretty well.
Is Business Brokerage a Good Field?
Question:
I learn a lot from your question and answer section. My questions are: 1) Is business brokering a good business to be in, and can you really make good money selling businesses? 2) How do you deal with buyers who want to buy a business but are reluctant to pay the broker an upfront fee?
Answer:
Thank you for your kind comments. We receive wonderful feedback from buyers and sellers from these regular columns. Business brokerage can be a tremendous business to make money. Like all other commission-based fields there are usually a few top earners, then tons of people earning a living, then a few starving ones. I personally believe business brokerage is a wonderful way to earn a living. The opportunity exists to make really big money, and you can have a significant positive impact on people’s lives. The key is to get properly trained, and latch on to a successful broker mentor. It is easy to develop bad habits in any field, and so by aligning yourself with someone who is already successful you can shorten the learning curve to success and always have a sounding board to help you with new situations.
Insofar as dealing with buyers, most business brokers work with, represent, and are paid a commission by the sellers. If you want to have a niche and approach this business as a buyer’s broker then you will need to really qualify the buyer prospects since so many never end up buying. Charging an upfront fee is a good way to separate the serious ones from the tire-kickers. If they don’t want to pay a reasonable upfront fee, then let them find someone else who is willing to put in a ton of work for free.
Buying a Restaurant – What to Consider
Question:
I want to buy a restaurant but have never owned one before. What are the main things I should look out for or consider?
Answer:
Perhaps the first thing you should consider is why you want to buy a restaurant altogether? As long as you are doing so because this type of business fits your strengths and experience, it's fine, but if it's a matter of "it's always been a dream" then think seriously because the failure rate is terribly high in these situations.
Now that we have that out of the way, here are the main considerations:
The Lease and Location:
Unless you're looking at buying a restaurant that is considered a longtime "classic", chances are that the location will drive the business. Naturally, good food/service/value are critical aspects to any good restaurant you would consider buying, but having access to customers is always key. As such, you must investigate the lease to determine whether it is assignable, the number of years remaining (you want at least 10 years between the current lease and available options).
Something very interesting has occurred in this business regarding leases and landlords. They (the landlords) have become very weary of assigning leases to new owners who do not possess any restaurant experience. Often times, they will simply refuse the assignment regardless of lease language, or will require personal guarantees, collateral, numerous months of prepayments, or keeping the prior owner on the lease as well. Usually, you can negotiate with any reasonable landlord, and don't take a hard-nosed approach initially; however, investigating the lease and transferability thereof should be one of your first tasks in your due diligence phase.
The Valuation - Always a Challenge:
Restaurants are notorious for having lots of unreported income. I'll leave the pros and cons aside for another column but the fact remains you'll likely see several restaurants where the books and records state one thing but the owner tells you a whole different story. It's one of those: "don't worry, there's plenty of cash sales."
The onus is on the seller to prove the figures that he represents as the "real" profit. I receive a tremendous number of inquiries from clients and subscribers about this issue of unreported income and this is a very dangerous situation for any buyer. Personally, I have always felt if the seller cannot prove it, he cannot expect to be paid for it. Unfortunately, this is easier said than done and so you need their assistance in reconstructing the figures. As such, it is important that you engage a CPA who is familiar with these situations as well. Usually, the financials can be reconstructed by reviewing supplier invoices, payroll, seller records, meal receipts, etc. Think about it as a three-pronged chair (as an associate of mine once told me). If you have two legs, you can usually figure out the third one. When it comes to unreported income, there are three questions that you must present to the seller:
- Can he prove it?
- How?
- Is he willing to?
Of utmost importance is for you to convey your sincerity to the seller in finding the real figures but it is expected that he complies with the necessary data. If not, you must understand that you are taking a major risk by taking his word for it. Be diligent and be prepared to walk if the numbers simply do not prove out.
The Equipment:
You'll want to be certain that the equipment you will be receiving with the business is in working order. If not, what are the costs to repair and/or replace it? In most cities you can find a local company/individual who will examine the equipment and provide you with a report. This can be very helpful. Naturally, they will want to cover themselves and also find a few problems. Nothing is perfect and a restaurant business will need to replace equipment on a regular basis. So, as long as there is nothing major you will be fine.
Experience and Transition:
If you're someone who has always had a dream to own a restaurant then I won't be the one to squash your goals, but you may want to consider the type of restaurant that you buy to be certain that it fits well with your strength. A good start is to understand what the current owner does on a daily basis since it is he that you will be replacing. If you do not have the same skill set in general terms, then someone has to be hired who does. How will this affect the profits?
Conversely, there are many restaurants where the seller oversees the operation and works the cash, there may be a manager in place, and some where the owner is more host than operator. These all bode well if you do not have direct experience. That's not to discount the importance of prior experience. The key with a restaurant, just as any other business, is to determine without question what drives the revenue and profits. That factor must be what you do best.
Other Issues:
Interestingly enough, the average restaurant purchase involves over 125 points that need to be investigated during the due diligence phase, including the financials, equipment, health issues, the suppliers, employees, lease, and numerous other important issues. You may want to consider checking out the program we have for buying a restaurant at: www.diomorestaurant.com .
Valuation of Small Independent Motel
Question:
What is the best way to determine the asking price of an independent motel business? The motel I am looking at has an asking price of $435,000 and annual revenue of $145,000. This motel is in a very small city with a population of only 12,000 people, but the location is right off the major highway exit.
Answer:
When it comes to valuing motels, there are a wide range of options available to you that are somewhat standard within the industry. These include multiples of the annual revenues, per-room valuations, net income "cap rates" and multiples of what may be referred to as "Owner's Benefit" or "Seller's Discretionary Cash Flow" or "Adjusted Net".
Personally, I prefer a multiple of the Owner's Benefit figure because what you ultimately can put in your pocket, and have available to service debt and build the business, is really what any business owner should be concerned with when valuing any business. After all, if the business is producing solid revenues but weak profits, who cares what the revenues are?
Having said this, the various barometers are:
- 2.5 - 3 times the annual revenues for motel/small hotels
- $18,000 - $22,000 per room
- 6 - 8 times Owner's Benefit
The Owner Benefit Calculation is a combination of:
Pre-tax Profit + Owner Salary + Owner perks + Interest + Depreciation.
Although I prefer to use this technique, be certain that you properly adjust the Owner's Benefit Figure to allow for any anticipated capital expenditures that are required now, or within the next few years.
On a separate note, be certain that you visit with city hall to determine if there is any major roadwork planned for the highway or road which the motel borders. Usually, you can expect to have construction at least every 10 years so you'll want to check this out.
By: Richard Parker: President of The Business Buyer Resource Center and author of How To Buy A Good Business At A Great Price©
