*** This article is intended to give you a high overview of the buying process for new buyers. Of course, hire professionals to help you. The money you spend on them isn't wasted. You've worked hard to earn what you have, don't try to do it alone.***
So you have the idea of buying a business and this is your first time venture into buying one. You've made it this far in your search and found a few websites advertising businesses for sale. You look at the ads and you're a bit confused at what it all means and how one goes about buying one of those businesses and insuring that what you see is what you get.
I too was a business buyer back in 2002 through 2003. It was a frustrating and frankly confusing process. It didn't have to be, I wasn't prepared or had knowledge of what I was doing or looking at and the business brokerage industry in general wasn't very helpful. So I started SellingRestaurants.com...I knew nothing about restaurants, but the business model I had in mind fit well with restaurants - make it easy for the buyer to gather knowledge and information about the business over the internet as well as to go visit the business on their own time without relying on a broker's and seller's personal schedule. Often it would take me months to get to see the business I had an interest in. Not good!
So let me impart some of my wisdom upon you.
1. GET BUSINESS BROKER: My first suggestion is to get a reputable business broker (not real estate or commercial broker they're not qualified to broker businesses.) to help you with your search and to help guide you through the buying process. You're not buying a house or commercial piece of real estate here, you're buying complex and risky business with lots of moving parts needing professional guidance.
2. KNOW THE NUMBERS: Understand the financial numbers of the business and what they mean. If the broker is doing their job, they are advertising Seller's Discretionary Income (SDI) also called Cash Flow or Seller's Cash Flow. This represents how much cash a working owner - one working owner 40-50 hours a week - puts in his pocket after all business expenses are paid without paying anything to him or her, not even perks such as medical costs, auto expenses, salary, etc. The SDI calculation should be derived from tax returns and not profit and loss statements, although profit and loss statements are used to dig into the numbers. The tax return and profit and loss statements usually won't tie to each other usually due to accounting adjustments for depreciation and amortization...and sometimes for cash...if you get what I mean.
3. QUALIFY YOURSELF TO BUY A BUSINESS: Being qualified to buy a business gets bit personal, but remember, you're asking folks to trust you that you can pay the rent or even the loan on the business. So not getting personal is not an option. The landlord holds the key to you getting the business. No landlord approval, no business. And also keep in mind the Seller usually remains on the lease and liable should you fail to pay the rent.
So here are the four things to consider when qualifying to buy a business.
First, you need to have plenty of cash on hand to buy the business and have plenty left over as working capital. Exactly how much depends on the size of the purchase. If you're buying a business for $100,000 and paying all cash, you should have no less than $135,000 in the bank. There will be closing costs as well as rent deposits to make. So your out of pocket costs to close a deal will be about $105,000 to $110,000.
Second, you need experience in the business area that you're thinking of going into. Most landlords want you to have either ownership or extensive management experience. 5 years in management usually does the trick, but each landlord is different.
Third, you need good credit. Your credit score should be in the 700+ range. Any lower you'll need to outline in detail the reasons why.
Finally, your net worth needs to be meaningful compared to the purchase. This shows the landlord that you're responsible for building wealth and not just a big spender without any restraints on spending money.
If your solid in each of these areas, then great. Let's move on.
4. KNOW THE BUYING PROCESS: This is the part where I need to say...hire a good attorney and CPA. Be careful not to select a deal killer attorney who see trouble with every thing little detail. You'll never get a business deal done with those types of attorneys.
Now you've visited a number of businesses. You've reviewed the numbers. You're qualified. You want to make an offer. Now what? There are two different approaches to making an offer. First, there is the letter of intent approach or LOI. Some brokers use this to cut to the chase and not get into micro details that are needed at the moment until the due diligence is over. The letter of intent outlines under what conditions you'd buy the business. It focuses on major items such as price, due diligence items and conditions. It is literally a letter to the Seller. The LOI is the preferred method for deals in excess of one million dollars, at least in my opinion.
Next is a purchase agreement. This document is far more detailed and is preferred for smaller transactions of less than a million. The broker usually has one that he or she completes for the buyer.
The Broker presents the offer to the seller. the seller either accepts, rejects or counters the offer. Once the back and forth ends and the parties agree or we have a meeting of the minds, then there is a contract!
Once in contract, then the due diligence process begins. This is where you need to do your homework to make sure you're buying what you think you're buying. This is where so many buyers fail in their purchase of a business. I hate to be negative, but always challenge the information you receive, ALWAYS. Cross check it. Give it the smell test. If it smell then cure it or get out of the deal.
The due diligence process is where you check the books and records, review the lease, inspect the building, request a lease assignment from the landlord and file applications with any state of local agency that needs to approve the transfer.
Your broker should be guiding and advising you through the due diligence process.
Best of luck to you.
We at SellingRestaurants feel obligated to educate the public, our customers and our clients with information that can help them make more intelligent buying and selling decisions.
Mel Jones is one of the premier restaurant brokers in the nation having published hundreds of articles on buying and selling a restaurant and bar business, selling thousands of restaurants in CA., WA and AZ and building one of the most copied business models in the brokerage industry. Mel started SellingRestaurants in 2004 with the one simple concept, give the buyers the information they need to make intelligent buying decisions without being pestered by a broker or hiding information, prepare the business for market by researching key details that make or break deals and educate the buyer on the buying process to create an intelligent buyer. Prior to SellingRestaurants, Mel was a Chief Financial Officer for Universal Music Group, the largest music company in the world. There he participated in more than $11.5 billion of merger and acquisition transactions. He also work for top companies such as Nestle Foods, USA. He hold a Bachelors in Business Administration Finance as well as attened Law School at Gonzaga University. Give Mel a call at 480.274.7000 or e-mail him at [email protected] if you have any questions.