Buying a struggling business

[FLC]

I am new to the forum - so I apologize that I am asking for help before I have provided any value. My initial look-around tells me this is a valuable forum, and I will provide as much help going forward as I am able!

I have been looking to buy a business in my local area for over a year. After five offers and two deals (both of which fell apart during due diligence), I have recently given in and taken a position with a local employer. Just as I did that, however, I was presented with the opportunity to buy a struggling business in the area. Since I committed to working for my new employer, I am not in a position to take on the day-to-day operations of this struggling business. I have a potential partner (call him Bill) who I trust and who has significant experience in running businesses, and he has proposed a deal.

This manufacturing business is struggling primarily due to a lack of capital (caused by gross under-pricing of the product). The current owner (call him Sam) has personally-guaranteed debts of about $250k, but is very good at design and production (when he can fund it) and would like to remain involved in some capacity for about five more years.

The rough outline of the deal would be that Bill and I partner to buy the business in the following manner. I fund the initial capital needs (about $150k), Bill provides no funds, but agrees to run the business (he will be working half days, as he is a business broker and has lots of other work going on), Sam stays on as the production manager and designer. Sam takes a nominal salary, but Bill and I take none. Bill's equity vests over three years, at which point he owns 50% of the business. We would decide together on issues such as salaries, distributions, etc. The business would pay down Sam's debts as it generates earnings (this is what Sam gets out of the deal). After the debts are paid, Sam simply gets his nominal salary.

The goal would be to sell the business in 3-5 years.

Does anyone have thoughts on this deal - is it equitable to everyone? Should there be some return on my capital built into the deal, or is the "sweat-equity" provided by Bill equivalent to the invested capital (all of which is at risk if the business can't generate the earnings we project)?

I appreciate any feedback!

[GoldenGateTradingPost]

Hi FLC,

You haven't said what you've done to convince yourself that if you do buy this business why it will become successful. You should know very specifically what you will change, and have direct validation from customers that you're right, before getting involved.

I've never liked the idea of part-time management. If the management isn't fully committed to the business' success that's not a good situation.

If you're a passive investor in this deal, is it the best investment you can make with your capital? E.g., could you buy investment property, or commercial property, instead?

Good luck to you

[Freelancier]

I'm unclear why you need a part-time Bill instead of a full-time you. Just because you took a job doesn't mean you can't just leave with 2 weeks notice, it's not servitude, is it?

[turboguy]

It sounds like a fun project even though most would be more motivated by the potential gain to me the challenge looks like fun. That was one of the things I would have enjoyed doing but had to settle for turning my own business around a few times when times were bad.

If your partner is making 100 grand a year on his other enterprises then that deal sounds appropriate. I am not as overly concerned about him only working a half a day as some of the others. What does concern me a bit is if he will really put that half day in. Busy people sometimes have the best of intentions but end up with so many other things they need to do that that half day doesn't always happen. People tend to put out fires and sometimes that can drag them away from things they committed to do.

My other concern is that being able to run a business is far different from being able to turn one around. You mention that the product is grossly under priced. Keep in mind it is easy to sell something that is underpriced and if you raise prices sales may fall.

I think you need to address more than just being under priced should you proceed with this. I will talk a little about the financial side first. People running a business that have 250K in debts tend to pay late. They miss discounts and pay late fees. This can add up to tens of thousands of dollars a year. Make sure you have the financial controls in place to buy at the very lowest cost and that means taking every discount and never paying a late fee. People who are running a troubled business don't pay a lot of attention to expenses and many businesses over time acquire a lot of expenses they don't need. Really look for ways to cut expenses. Work on your processes. That is both in production and the office side of things. Pay particular attention to whoever is handling your money. Track everything. Pay close attention to the numbers. Make sure you know your costs. People running a troubled business often do the numbers on the fly and really don't understand their costs.

If I had more time I would share the story of the efforts we went through to turn my business around after the housing crash (we are loosely tied to the housing market and two of the 6 companies who do what we do went out of business after the crash). In brief, I had a gal who paid our bills and was lazy. When she came to work for me we had no debt, a few hundred thousand in the bank and a nice business. She seemed like she did ok but I did notice some things like her not taking a 5% discount on a $ 30,000 order even though we had a few hundred thousand in the bank. Well 11 years later although we seemed to be doing ok with her there we now had our line of credit maxed out, no money, hundreds of thousands in payable s, far less in receivables half of which was noncollectable and I was seriously thinking about shutting the place down while an auction would still give me a way to pay off everything and walk away with a small amount of cash. We we got rid of the lady handling my money and my wife came in and took that over and between her and my daughter we went through and slashed expenses, watched the cost of everything, saved every penny we could, I can even remember my wife having me call the credit card company over a 50 cent charge she didn't think we owed. Even now she asks if I remembered to turn of the heat when I left in the winter and the AC in the summer. With the help of a few zero percent credit card loans we started taking every discount. In 60 days the phone had stopped ringing off the hook with people looking for money. We cut every unnecessary expense. We spent a lot of time calling those who owed us money. 6 months later we had no past due bills and a comfortable amount in the bank. Now about 4 years later we have paid off all debt, have more money in the bank than we have payable by a good margin and our income is enough to put me into one of the top tax brackets. Actually we are thinking about spending a quarter million or more next year on a major expansion and expect to pay for it without a loan. Just as a side note and I have no way of knowing but my best guess now that we can really see the difference was that the lazy lady we had paying our bills wasted somewhere between $ 60,000 and $ 75,000 a year on unnecessary late fees and unused discounts. Now add that up over 11 years. Watch every penny.

If you go ahead, I wish you the best of luck.

[Fulcrum]

I'm with Turboguy that this could be a fun project. Turning a business around is harder than just running one. You will have to breakdown barriers with both former and potential customers. I'm not a gambler, but I would be wiling to wager a bet that there are more than a few dissatisfied former customers.

If you go ahead with this, you may be better suited to working in the new business rather than the day job you just took. You will get the opportunity to see first hand where the inefficiencies are and how to eliminate them.

@Turboguy, if you find yourself with the time, I would love to read that story. Something tells me that there are some lessons that can be learned there in addition to what you have already said.

[turboguy]

I may have some time tonight. If I do I will share a bit more.

[FLC]

Thanks everyone for providing your thoughts... I'm still evaluating this deal, and have a long way to go to convince myself that it's a good investment. I appreciate everyone's time!

[Business Attorney]

The posts by turboguy and Fulcrum made a similar statement with a nuanced but essential difference. Turboguy said "being able to run a business is far different from being able to turn one around" while Fulcrum said "Turning a business around is harder than just running one." I don't think it is always harder, but it is always different.

Your proposal sounds equitable, but whether it is the best arrangement is something only you and your partner can decide. The ownership vesting is something that is often overlooked by people who are joining forces in a business. I have seen way too many people come to me seeking a legal solution to a problem caused by sharing ownership up front based on expectations that were never met. Be sure to spell out those expectations and don't hesitate to pull the trigger if the person supposedly doing the work is not fulfilling his part of the bargain.

[CardSSmile]

Wow investing in bussineses that not doing good daaamn.. Im new in bussines thing.. but I would be so scare to do that hahaha

[turboguy]

We all have our things we find scary and things we don't. I don't like heights much and get nervous if I am on a roof or up on a tall ladder (which I have to do next week). Others think climbing mountains is fun. You wouldn't catch me climbing a mountain for anything. I think for the mountain climbers it is a bit of a macho thing. They can stand up on the top of Mt Everest, beat their chest and give a Tarzan yell and feel good about themselves because they did something not too many people can do.

When it comes to running a business, there are lots of people who can not run a business. There are a few who can but really shouldn't. There are some that can run a business just fine. There are far fewer who can turn a business around. I have been in business forever and have turned mine around a few times during crashes and the like. It may be something like the mountain climber. If I were to take a business that was in the toilet and turn it around to a successful and prosperous business, then I can beat my chest and do a Tarzan yell and feel good about myself since I did something not everyone can do. It is basically a challenge and the satisfaction is in overcoming the obstacles with the odds against you.