I promise to keep this rant to two paragraphs, not counting this one. Then I'll get on topic. If I don't, you can bitch slap me up side my ugly, arrogant head.
I'm tired of caring about crazies. Notice I didn't write "mentally ill", "clinically depressed", or any of the other PC euphemisms for crazies, nuts, and whack jobs. Instead, we need to aim our concern towards protecting potential victims. Psychiatrists worry about stigmatizing nuts. Their victims are already stigmatized. Many times they're called corpses.
Ron White says you can't cure stupid. Well, you can't cure crazy either. Many of the craziest people in society are psychiatrists, like Sigmund Fruit (Archie Bunker's term). Show me one brand of crazy that has a cure. The crazy thing about crazies is that they won't take medication, because they're too crazy to believe they need it. What's my point? (I'm running out of space.) We need to put nuts in nuthouses. Their rights are less important than the rights of their victims.
In part I of making an offer, I covered the basics of deal structure. Yes, it was a couple months ago. Give me a break, I've been driven crazy worrying about crazies. In this installment, I'll cover determining your offering price.
Let's set some ground rules about the size of potential business purchases I am addressing. In this installment, I will cover buying businesses from roughly zero to five million dollars in annual revenue. For businesses larger than that, the principles are the same, but the details, calculations, and deal structure tend to be different.
First, let's define what you are buying. When you buy a business, you are really buying a cash flow stream or a stream of profits. You aren't buying the seller's cash flow; you are buying the cash flow of the business in your hands. That's an important point. The cash flow available to you from the business and the cash flow to the seller are usually different. Sometimes your cash flow is higher, but sometimes it will be lower.
Determining the cash flow available to you is an art as much as a science. You start out with profit from either financial statements or income tax returns. Then, you add back non-cash expenses, such as depreciation, and financial costs like interest expense. You will also add back any discretionary expenses, such as the rent on the owner's girlfriend's apartment. You also add back any other owner perks, like family on the payroll and extravagant auto expenses or benefits.
You can expect the owner and his broker to volunteer most of the above additions to cash flow. They won't volunteer anything that should be subtracted. If the owner worked actively in the business, but you don't plan to, subtract the cost of a manager to replace the owner. In some admittedly rare cases, family members are paid below market value. You'll have to pay more to replace them. Determining the cash flow of the business in your hands is the objective. I doubt you'll pay for the girlfriend's apartment unless she is really cute and digs you. That last part you verify with some due diligence in a seedy motel.
After you determine the cash flow available to you, determine the appropriate multiple of that cash flow to get your offering price. My business broker friends tell me small businesses are selling from two to three times cash flow. To get multiples for your type of business, you can find databases of small business sales such as Bizcomps and the database from the Institute of Business Appraisers. These cost money. Your CPA, if a valuation professional, probably subscribes to these already. Don't rely in any way shape or form on multiples from franchisors. Their job is to get the highest prices for their franchisees. To do so, they'll lie to their mothers.
You will find that multiples of cash flow sometimes vary wildly even within an industry. Company size has a big effect. Larger companies typically sell for larger multiples. Even accounting for size, you may see some pretty wide variations in multiples. Don't expect a "correct" answer in your search for a multiple. If you get outside two to three times as a multiple, you are outside the norm, and you need to perform some detailed research into the reasons for higher or lower multiples.
If you find that businesses of similar type and size sell for three times cash flow, don't immediately offer three times. Multiples are subject to negotiation. Don't go to your top acceptable multiple immediately. The seller will likely counter your offer. You need some wiggle room.
Expect to accept terms somewhere between your original offer and your top acceptable price. If you can't get a price in that range, walk away. The number one frustration expressed by buyers about deals is buyer's remorse about paying too much. Remember that the friendly business broker represents the seller, not you. He'll tell you his price is fair all day long. He gets a percentage of that price.
The final price for a business will probably be a multiple times cash flow plus any inventory. You will likely not get receivables, and you should probably not accept any liabilities. For businesses with significant equipment, you will probably have to buy the equipment in addition to the price as calculated above.
Once you have determined your offering price, don't immediately rush to the seller and definitely don't fill out the offer form from the broker. Run to your attorney. You will be making an offer with a plethora of caveats. For instance, your offer will be subject to verifying the financial numbers provided by the seller. If the numbers are garbage, you won't consummate the sale. The offer will also explicitly detail what assets you are purchasing and what assets and liabilities you do not want. There will also be state law niceties to consider. Since, I'm only a shit house lawyer, get some real advice from a real lawyer.
Thanks for reading! As always, please visit the main S&K web site for real tax and accounting advice, www.skcpas.com. Also please like the "How to Screw Up Your Small Business" Facebook page. I post tidbits of incredible value there daily. Yes, that's sarcasm. Sometimes, I just spew forth. You get what you pay for.
Until next time, let's do it to them before they do it to us!
