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Tyler
06-08-2013, 08:58 PM
Hi all -

My wife and I are considering purchasing an existing, healthy business. We've just started looking and, while there is a wealth of information out there, it's been difficult to find answers to some rather important questions.

Specifically, we are trying to get an idea of how much we might qualify for with traditional (bank) financing so we know what price range of businesses we should narrow our scope to. We would be able to come up with a down payment of approximately $175k - $200k. We currently have a net worth of approximately $600k including real estate and retirement accounts, both with excellent credit (if that matters).

The intent would be for the two of us to work full time in the business, so we would be able to pull in a salary of at least $100k+ (for the both of us). What I am very unclear on is how much the cash flow history of the business we would want to buy impacts what we might qualify for. My thought is that if a company with a $700k asking price can show a clear history of $300k in cash flow, the loan approval should be a no-brainer. (I realize this is a very simplistic view.)

While we are not certain exactly what kind of business we want, it will not be in food service, retail or online (relying on SEO, etc.). I have a solid operations and management background, my wife sales/marketing and financials (executive level) but neither of us has owned our own business before.

We're trying to do our homework now and will not be quick to rush into anything. But before I sit down with bank, I want to get a rough idea of what to expect so I don't go in looking the fool. I understand that this might very well be one of those questions whose only answer is "it depends" and that's fine. It's just that I have seen people insisting we would need at least 50% down whereas others say something along the lines of 15 - 20%.

Any insight would be appreciated.

Thanks,

Tyler

ArcSine
06-09-2013, 07:47 AM
The amount of the buyout price you'd need to put down ("equity" in the deal) (or equivalently, the amount of loan you'd qualify for, given a particular amount of equity) is typically a function of multiple factors, the heavyweights being...
• The nature, quality, value, and liquidity of the company's assets
• The extent to which such assets are already encumbered by pre-existing debt, or free to collateralize new debt
• The biz's cash flow history (as you mentioned)
• Risk: The stability vs. variability of the cash flow (larger swings argue for more equity, less debt, as debt service payments are fixed and constant obligations)
• Your personal balance sheet
• The lender's particular appetite and diversification objectives (e.g., some banks have a specialization in deals involving a heavy real estate component, as where the biz you're buying includes land / building as a large %-age of the total assets; another bank might shy away from increasing their exposure to residential construction if they're already holding a lot of paper from that sector; etc.)

So yeah, as you suspected I'm afraid the words "it depends" can't be kept out of the answer. But having a handle on these actual factors which drive the wide range of down payment requirements beforehand, means more effective planning on your part as you explore buyout possibilities.

That said, keep in mind also a couple of issues that might make a diff...
• If you're personally a little short on the equity requirement of a particular deal (which otherwise sniffs out to be an excellent investment, in terms of price, growth potential, etc.), you might consider plugging the gap with some "outside" equity. That is, maybe some friends / family kick in a little equity investment in exchange for a small piece of the pie.
• Seller paper is a component of many-to-most small business deals. It's a rare situation wherein a seller can expect to get his entire asking price in the form of cash at closing (alternatively, he gets an all-cash deal only after agreeing to a reasonable discounting of the price). Hence your loan requirement isn't the difference between the buyout price and your down pmt / equity, but rather it's the excess of the buyout price over the sum of your equity + the portion of the price being financed by the seller.

Hope those might be of a little help at some point in the journey. Best of luck with it, Tyler, and stay tuned: the gang 'round this forum are generous with helpful ideas.

Tyler
06-09-2013, 09:54 AM
Thanks very much for the informative post, ArcSine. Regarding your last point, personally I would prefer that the seller had some skin in the game.... whether that's through financing or an earn out. The latter is an interesting concept that I am just starting to explore. My wife and I are very nervous about this undertaking and anything that would encourage/incentivize the seller to make sure the business stayed healthy/grew would give us some sense of security (as opposed to the seller who grabs their bag of cash and heads for the door).

davidb3069
06-09-2013, 11:43 AM
Unless you are experts in the business you are buying, you would probably want/need to make sure the business owner stays in the business long enough to train you and get you up to speed.

Why not start with a smaller business? If this is your first business, that seems like a sizeable investment and I would be nervous too. You seem to be picking the size of the investment based on the revenue you want to earn but you have to consider what the business overhead vs. net earnings are as well. There are businesses such as my software business that are purely profit after development is done (give or take some minor overhead such as an office or telephones).

Tyler
06-09-2013, 12:38 PM
All valid points, David. Thanks. The income I listed is based on what we would need if I were to quit my job. We are not ruling out anything at this point, so finding something that she could work with me supporting on the side is certainly a possibility. If it were the right fit, however, we would consider going "all in". There seems to be no shortage of businesses listed that claim the owner works just a few hours a week and makes a tidy profit. I am suspect, though, of why someone would be selling if they are pulling in $50k - $60k/yr with very little work on their part.

Regarding a business like the one you reference, if we could find one with a proprietary product(s) that we could run out of our home and make a decent return, we would be interested (regardless of price/income). What we don't want is a commodity product or online-only service that lives and dies by SEO. My father has something like that and the stress Google inflicts on him on a weekly basis is something I'd prefer to avoid.

davidb3069
06-09-2013, 12:54 PM
Exactly. Why would someone with a good business sell it? There are valid reasons obviously such as them simply wanting to retire, being burned out, or looking to get into something new. Businesses with little or no time investment should be very suspect. If money was easy to make in business, everyone would be chiefs instead of Indians. The fact is, any business old or new is a lot of work.

Putting all your eggs in one basket though is a big risk ("going all in"). I think if I were going to buy a business, I would probably want to talk with some of the existing clients or customers. At least you might get some red flags to pop up.

The business model I never noticed before but seems very prominent now is the "work as a salesman for free, sell my product and I will pay you handsomely on a performance basis". Great for the business that gets cheap/free labor. Not so good for the person that is desperate for work and money to pay their bills and has to accept almost anything in order to put food on the table. I wonder how long it will take government to outlaw the practice. Or will they ever?

Business Attorney
06-10-2013, 03:14 PM
ArcSine gave you an excellent summary of the financing issues involved in buying a small business. I would just add that in today's environment it is very difficult (but not impossible) to find a bank that will make a small business acquisition loan that is not fully secured either by the value of your own assets or the hard assets of the business. If you are buying a successful business, chances are that a substantial portion of purchase price is for intangible assets such as goodwill, customer lists, etc. You will need a lot of time and a lot of luck finding a bank willing to take any risk that is not fully collateralized.

Which leads directly to ArcSine's last point. Apart from buying a distressed business or a business already in bankruptcy court, very few of the purchases of privately held companies that I have been involved with over the last 35 years were done without some form of seller financing. Since you are looking for a successful business, it's almost certain that you will need seller financing to bridge the gap.

Of course that does not answer your question about bank financing. In almost all transactions there is still some element of bank financing, whether it is financing current receivables and inventory or providing a term loan for equipment or a part of the acquisition cost. However, without knowing the specifics of the business, even a banker is not going to be able to tell you anything more than how much they are willing to lend based on your own balance sheet and credit history. It would also normally look at your income, but if you and your wife plan to work full-time in the new business, the bank will probably discount any past earnings history as having very little relevance to the future.

Tyler
06-10-2013, 03:39 PM
Thanks very much, David. So if I could oversimplify this for a second: if we have a net worth of $600k and the target business has hard assets of $100k, a bank would likely only be willing to finance up to $700k, whether that's in the form of an acquisition loan, receivables financing, a combination of the two, etc. Do I have this correct? (Oversimplified in the extreme, I know; I just want to make sure I've got the gist of what you're saying).

If the above is the case, any additional financing needs we might have would likely need to come from the seller.

Business Attorney
06-11-2013, 12:50 AM
Thanks very much, David. So if I could oversimplify this for a second: if we have a net worth of $600k and the target business has hard assets of $100k, a bank would likely only be willing to finance up to $700k, whether that's in the form of an acquisition loan, receivables financing, a combination of the two, etc. Do I have this correct? (Oversimplified in the extreme, I know; I just want to make sure I've got the gist of what you're saying).

If the above is the case, any additional financing needs we might have would likely need to come from the seller.

Generally speaking, that is correct, although banks would also look at the cash flow of the business and might adjust the amount they are wiling to loan up or down. In addition, banks loaning on assets will typically only loan on a percentage of the assets. For example, depending on the nature of the business and the assets, they might only loan up to 70% on the receivables and inventory. If the inventory is fresh flowers or some other rapidly spoiling products, they might not want to loan on the inventory at all.

But generally speaking, I would assume that the maximum loan in your example would be $700k or less and that any other financing would need to come from the seller.

In larger deals, there are various types of mezzanine lenders who provide another tier of financing between the senior debt provided by a bank or other institutional lender, and the seller debt. Because it is more at risk than the senior debt, a loan from a mezzanine lender carries a higher rate and often requires some form of participation in the equity. The size of transaction that you are talking about, however, isn't suited to a typical mezzanine lender.

Tyler
06-11-2013, 11:42 AM
Got it. Thanks again David. And thanks to everyone else for their input. Some good stuff here and it is very much appreciated. I need to spend some more time going through this site as I know there are some gems waiting.

I have a stack of books on small business to get through - currently reading "The E-Myth Revisited", then "Built to Sell", "The Personal MBA" & "The $100 Startup". Trying to learn as much as we can.

phanio
06-23-2013, 08:26 AM
Why is your most important requirement to take $100K+ out of the business? Are you looking for a business to buy - one that you can grow and grow and grow or are you looking for something that you think will just provide you a better lifestyle. If it is the latter, save your money and find something else to do.

Want to see what you can qualify for in a bank loan - ask a bank. All bank's have different policies and underwriting guidelines - thus, each would give you a different answer. The bottom line is that banks or any business lender just want to get repaid. This means that you have to put at least 20% down and that your past cash flow - the past cash flow of the business should at least cover the loan payments. However, once a lender hears that your major requirement is that you and your wife take out $100K+ - they will think that you are more interested in paying yourself then paying them.

As already stated, let the seller carry the note. Put 10% to 20% down, amortize the balance over 20 years and set a five year balloon payment. If you make it those five years (especially paying yourself $100K+ from day one) then maybe a bank or the SBA will look at your deal.

Tyler
06-24-2013, 12:31 PM
Phanio, thanks for your post. Based on your tone it sounds as if you think all I care about is making $100k/yr. Far from it. Of course the goal is to find a business with room to grow and do just that with it. And, of course, the ultimate goal in all of this is to provide myself and my family with a better lifestyle. I won't apologize for that. But we are prepared for the work ahead of us to make the business as successful as possible.

With that said, we also need to be able to live. If I quit my current job, the company has to bring in enough cash flow to pay us. In assessing a target business we will run the numbers such that there would need to be enough cash to service the debt and pay ourselves even if both revenue declined and expenses increase. If the numbers don't work out, we'll keep looking. Perhaps we won't find anything or we'll just need to start much smaller.

As for having the seller carry a note, we are very much open to that and would prefer they have a vested interest in the company succeeding. We won't rule out any combination of financing possibilities; but the numbers have to work out for everyone or we won't do it.

Fulcrum
06-24-2013, 07:26 PM
As already stated, let the seller carry the note. Put 10% to 20% down, amortize the balance over 20 years and set a five year balloon payment. If you make it those five years (especially paying yourself $100K+ from day one) then maybe a bank or the SBA will look at your deal.

Note - I am not an lawyer nor am I an accountant so please take that into account when reading this.

I wouldn't recommend setting up a seller financed loan this way. There is too much risk for both the buyer and seller of the business. Assuming you buy a business for $675K and use $150K of your funds as a down payment (leaving the remaining $25K for operating funds/unforeseen expenses) you will be financing $525K over 240 months at 10% interest with a monthly payment of approximately $4,825 for 59 months and in month 60 a lump sum payment of almost $470K. I can't speak for everyone but that $470K alligator (or maybe brick wall) would keep me up all night, every night until it was paid off. Not to mention the $242K paid in interest over those 6 months.

In my opinion you would be better off setting up the total term for 10 years with no balloon. Your monthly payment will increase to about $6,600 but you loose that big, fat $470K elephant and pay around $293K in interest over the total term. As long as the business has the cash flow to cover this, you can save yourself money over the long term and give the seller a relatively secure note that he can sell down the road if needed (if selling a business not is still legal that is).

I hope I didn't confuse you with my chicken scratch math.

ejkeels27
06-25-2013, 03:18 PM
Tyler, it sounds like you are doing the right thing by educating yourself before you make a life-changing decision. There are many possibilities and ways to fund a business acquisition. Traditional funding today can be tough to acquire, because they have very tough requirements to meet. Even if the bank does approve your loan request, they will require a considerable down payment. And if you do find a business that you like, how are you going to know if the asking price is a good deal or not. Who valued the business at that asking price? The owner? Someone who has a vested interest in the sale of the business and has sweat equity and is sentimental about selling his baby that he built from the ground up. He/she may have set the price at a figure they can be happy walking away with, which may or may not be indicative of what the business is actually worth. It is not like real estate, where you have comps to help value property. And unlike Real estate transactions that are recorded at the courthouse, business purchase transactions are not recorded anywhere. Furthermore, without having access to the financials of the business and then not knowing how to do some sort of forensic accounting, you can't know with any certainty whether the books have been cooked to show a profit that may or may not be real.

rshughes
06-25-2013, 08:40 PM
IMO it would be much more likely that you can obtain SBA financing rather than a conventional loan, primarily because of the government guarantee. In a 7a program, the down payment can be as low as 10% which means you might be able to look at larger businesses. The downside is that there's an involved process in applying for such a loan, plus you and the business need to qualify. I'm not a financing expert, so you should discuss your plans with a commercial loan broker knowledgeable about SBA loans (preferably someone not tied to a specific lender). Some lenders are very receptive to SBA loans, and some are not. A financing specialist will know which lenders to approach, and he/she can also guide you regarding the size of business you might qualify for, and what financial info or other documentation you will need.

Some "gotcha's":
- The SBA loan has to be senior to other debt, such as seller financing
- You cannot use the SBA loan to buy only part of the business, has to be 100% (seller can't retain part ownership)
- You may need to pledge your personal real estate or residence as collateral

Let us know what you find out.

LindaKing
07-15-2013, 03:41 PM
Tyler - I just came across your post and wanted to see where you are now in your decision???

You had some great information from several other members but I was curious to see if you had also looked at non-traditional financing options?
Had you looked into Franchise vs. brick-and-mortar style businesses?

Let us know where you are as this is a subject many of my clients are also struggling with - We have Boomers seeking alternate ways of investing their money instead of it sitting in an account!!! Many have realized that starting a solid business, or at least investing in one, can make bigger profits for their wallets...

Thanks - LK