“Do You Have a Formula When Considering a Business Purchase”?
Question: I’m looking at six different businesses to purchase. Three of the businesses are online and three of them are offline. Time is an issue for me so I prefer buying an active (profitable) business. Do you have a formula when considering a business acquisition?
D.R. Miami Florida
Thanks for your note and question.
Yes…I have a formula. I think I’ll write about this more in the future because I’m asked it so often. Here’s my take……
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My preference has always been to start a business from the ground up, or working it “on the side” until it becomes profitable. But…when I’ve purchased a business, or when I’ve helped an investor or client buy one, I always recommend buying them when “there’s blood in the streets”.
This is what I mean….
You’ll always get a better deal when a seller is desperate, or theoretically “bleeding” from things like a bankruptcy, divorce, embezzlement issues or plummeting sales and profit.
But some start-up entrepreneurs prefer the perceived safety and reduced risk of an active, profitable business when looking to buy one. That’s okay, if the right conditions are in place.
My objective is always the same: make money – don’t lose it.
Business schools often teach the following business acquisition formula:
Three Times Net Profit
The business school formula works like this….
Let’s say you bought a restaurant with an annual net profit of $500,000, you should be willing to pay $1.5 million or three times net profit.
I’m not a big fan of business school formulas, and especially when it comes to buying a business. I would never pay $1.5 million dollars for a restaurant with an annual net profit of $500,000. There are too many variables for an investment this large. Many things can go wrong (and usually do).
For example, is the $500k net profit certified in writing by an independent CPA firm? How many years has the restaurant generated a net profit of $500k…one? The biggest question on my mind would be whether or not the restaurant will produce the same numbers going forward — in the current environment!
The CURRENT environment is the foundation of my formula.
For example, there’s a hot dog stand on the coast of Maine with annual sales of about $300,000. I’ve written about it often. The owner’s net profit is about $70,000 per year.
If the owner listed his restaurant for sale using the “three times net profit” formula, it would be offered for $210,000. This purchase would make more sense to me because you would only have to shell out $200k (and change) to make $70k annually. What’s more, the probability of an established hot dog stand surviving a depression is much higher than a fancy “boutique” restaurant with an asking price of $1.5 million.
On top of that, this particular hot dog stand is always packed with customers and it only takes two or three people to run it! The fancy “boutique” restaurant probably takes 20-25 people to run properly.
But that’s not all…
I’m confident the Maine hot dog stand has scooped up plenty of business from 6 or 7 restaurants which have bitten the dust in the current economic downturn too. I’m not big fan when it comes to buying someone else’s business, but there are exceptions.
My preference, as I said, is to start (or acquire) a small or failing businesses with no overhead or debt and build it up. I’ve done this dozens of times myself…and I’ve helped more than a hundred entrepreneurs, clients and investors do the same thing.
You can use the “three times net profit” formula as a guide or for reference but nothing more. It’s like judging the current “real” market value for something on eBay.
But you have to take the CURRENT environment into account.
Business Buying Formula #2
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Debt, overhead and inventory are business killers! Ask ANY restaurant owner, retail store owner or farmer (for starters) if this is true. When you launch a business and it’s already saddled with debt, not to mention overhead like inventory, equipment maintenance, vehicles, supplies, buildings, lawsuits, and taxes, etc…it sucks the life out of you and the business. Believe me… I know what I’m talking about.
Granted, some entrepreneurs can handle the debt and overhead better than others. One of my client’s owns a successful restaurant equipment and refrigeration company. He doesn’t have a care in the world.
But his business holds more than a million dollars in debt, his vehicles are falling apart (employees don’t care), his building needs repair, and the market has changed (a depression), which means fewer sales and pickier customers. And so…my client may be handling debt and overhead problems better than most. But I think in the long run, it will affect him in a big way.
This client paid for my advice, but ignored it. I told him to sell everything before sales peak. The best time to sell a business is just before sales peak. The best time to buy a business is when there is “blood in the streets”.
Business Buying Formula #3
Can the business run on auto-pilot or without the owner physically present? Are there people you can trust to run the business as good as or better than you?
This is one of my greatest weaknesses. In most of my businesses I rarely trusted anyone as much as myself. That’s a problem. Nothing of any magnitude has ever been built on one person.
Whenever I look at business acquisition (for myself or clients) auto-pilot is always a concern. I like the idea of businesses running smoothly without the owner or investors physically present.
I hope that helps!
Your humble host,
(Ed Note: Marc Charles is referred to as “The King of Business Opportunities” ….and for good reason. He should be known as “The King of Legitimate Business Opportunities”…because he’s launched, bought, sold reviewed and advised on hundreds of businesses and money making opportunities. He understands legitimate opportunities. Marc has agreed supply League of Power members with crucial updates regarding legitimate business and money making opportunities.)
You can use the conventional “business school formula” of three times net as a general rule of thumb to evaluate listing prices. Then ask yourself if the business you are considering is in a rising trend and whether could produce the same numbers going forward — in the current conditions (recession / depression / raging bull market).
One question I ask myself is could I start this businesses part time, or on the side, and with less capital requirements? What’s more…Most businesses offered for sale are overvalued or overpriced (let’s say 90%) or sometimes both!
In most cases you won’t be unable to produce the same numbers in the current environment. This is the formula I use when considering a business purchase for myself or client. Armed with this insight you’ll be in a better position to buy a business and start the negotiations!
And remember… When you are negotiating always be willing to walk away – literally and figuratively. This is a secret weapon billionaire’s use. They have the time, money and resources to walk away and this usually means much better deals.
You can find a ton of businesses for sale on these sites (using my formula for the best deal):
AppBusinessBrokers.com (I really like what these guys are doing)
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