Buying A California Small Business - 6 Important Items To Consider
Anyone who wants to know how to buy a California business for sale should understand how the market for small and mid-sized California businesses has been rapidly changing.
There are at least six "to do" practices that apply to the current market. The smart California business buyer should become familiar with them. These are a partial list of what is covered in the successful BizBen ProBuy Program for business buyers.
1. Require seller financing. When money was more readily available for small business borrowing, and business buyers had sufficient collateral in their home equity, many if not most sellers could expect to be "cashed out." That picture has changed dramatically. The entrepreneur wanting to sell today will probably be required to carry back part of the purchase price.
2. Consider an earnout. A pricing gap occurs when a business with a profitable history is now experiencing a slump in sales and earnings. The seller wants to be paid on the basis of the glorious past; the buyer thinks the price should reflect present performance. The solution might be an agreement by which the buyer's payments to the seller, hence the final price paid, will be adjusted up or down depending on the performance of the business for an agreed-on period after close of escrow.
3. Figure in the cost of the business "makeover". Part of the challenge in knowing how to buy a business is to evaluate the changes needed so a company can be adapted for the current business and social climate. When placing a value on a business, it's important to consider the makeover cost and perhaps adjust the offering price accordingly.
Among the company features to be considered are its website - providing information, promotion, ordering, customer relations and related functions, social media campaign, customer relations protocol, system of green practices, and employee/contract-labor composition of the work force.
4. Determine what is renegotiable. If the premises lease is near its end, if the pricing and terms of supplier arrangements are no longer advantageous for the business being considered, it may be time for significant changes in key relationships.
The supply/demand balance for rented retail and commercial space in many markets has changed to favor tenants. Similarly, suppliers of products and services to the business still may be operating on price schedules from 2008. Entrepreneurs who know how to buy a business are aware of the cost savings that might be implemented by renegotiating with vendors.
5. Insist on real inventory value. Paying a seller full cost-basis prices for inventory of merchandise and supplies was common practice in business transfers. No longer.
Now that business owners have to operate with a "clean and mean" mentality, the buyer needs to question the inventory values claimed by the seller.
Buyers should purchase only items that have use and value for the business. If the seller wants money for old stock discovered under an inch of dust, it should be purchased at a fraction of original cost, or taken on consignment; paid for only if and when sold.
6. Buy into industries with a future. As part of the how to buy a business tool-kit, the smart buyer becomes educated about the kinds of businesses that are expected to thrive for the next generation or so.
It's obvious that buyers should be interested in enterprises involved in the green economy and avoid offerings on businesses that have outlived their usefulness. But it usually requires some education to learn what the business landscape will look like in the next ten years and beyond. Because styles and market patterns change quickly, that education is more important now than in the past.
An old saying maintains that as times change, the people who come out on top are the ones who know how to change to fit the times. That's a good lesson for those who want to be successful when buying a business today and in the future.
Peter Siegel, MBA - Founder Of BizBen.com (over 25 years), I am the Lead Advisor for the ProSell, ProBuy, & ProIntermediary Programs. I advise/coach buyers, sellers, and brokers daily about buying & selling small to mid-sized businesses throughout the Nation. I can be reached direct at 925-785-3118.
Great points, Peter. I live in Southern California, which is notorious for having traffic on the freeways, even in non-rush hour times, and so I advise my clients to give it some serious thought before purchasing a business, which is going to be very tough to get during busy times. Many times as the owner, either an alarm will go off in the middle of the night or an employee will not show up to open the store, etc. and so it helps that the owner can get there in a reasonable manner. In Southern California, it's tempting to live in Riverside, but work in Orange County or visa versa, but as anyone who lives here knows, it can be a real head ache, so my advice is to just give it serious thought, before making a commitment.
Earlier comments on this topic raise a critically important issue, the extent to which so many buyers are woefully uneducated about the process of buying and operating a small business. As someone who spent a number of years as a business school professor and more years as a business owner, I can attest to the extensive foundational knowledge that is required to be a successful business buyer and business owner.
And, even more distressing, is the number of buyers who don't know what they don't know, and refuse to accept the advice, counsel, and mentoring of those who have more expertise and experience.
That leads to three misconceptions touched on in an earlier comment:
1. The buyer thinks the seller HAS to sell:
This is usually NOT the case. I advise sellers that "the best time to sell is when business is doing well." It's also the best situation for most buyers in most situations--buying a healthy thriving business. While getting a "bargain" on a struggling business may seem attractive, turn-around management is NOT for the inexperienced, uninitiated would-be entrepreneur - it's risky.
Usually a business owner will sell for the right price and the right terms; but, he has several alternatives and doesn't NEED to be rescued by the buyer. The seller can just keep operating, can contract with a current manager to operate the business as a "quasi-owner", can turn the business over to employees and/or family, or can double-down and build the business to the next plateau. Buyers who assume that the owner of a healthy business must sell are just dead wrong.
2. The buyer thinks he can buy the business on the promise of future success--an "earn out":
Buyers may have heard of such transactions; but, they are very few and very seldom. Earn-outs can work for a small percentage of the consideration when an experienced buyer who the seller knows and trusts takes over the business, or there are definite specific contracts or "deliverables" that are "done deals" except for the passage of time, e.g., a consulting contract that is half completed and won't be paid for until the end of the engagement, product that has been produced for a customer but won't be delivered for another month or two.
I have had buyers propose offers containing terms such as: "10% of the profit in the next fiscal year," "half the sales increase over the previous year," "5% of sales over the next three years if sales exceed the previous year." The seller has absolutely no control over whether the buyer will succeed or not succeed, increase sales or decrease sales, make a profit or a loss, or, if there would be a profit, expenses it out to himself and/or others to show no profit. The presumption by so many buyers that business owners would consider an offer with earn-out terms is preposterous. I tell my sellers that except for very rare and exceptional circumstances they should only take a deal that has a finite, absolute, definite price; and, even if that price might be paid over time, it must not be dependent on the buyer's performance.
3. Buyers presume that a seller will provide financing without any reasonable security:
Sellers can usually sell their businesses for 10% to 15% more if they are willing to "take back" some seller financing. Often third-party lenders (e.g., SBA) require or prefer that the seller "have some skin in the game" and provide 10% to 15% seller financing subordinated to the third-party note. If they are indeed getting more than they would for a cash deal, there really is very little risk; and the seller knows that another lender with far more at stake has vetted the buyer's financial situation and found them a viable candidate for a loan. In my experience the very most a seller should take back is usually 20%, unless it is secured by tangible, marketable hard assets, like real estate. But, again, buyers often show their ignorance of the business environment, expecting sellers to finance 40%, 50%, or more of the purchase price, with no security other than the business itself (and often little or no tangible assets). If the buyer eventually can't pay the loan it's probably because they've run the business into the ground so there's nothing left for the seller-lender to recover. Seller's are not banks and they ought not to be the buyer's lender-of-last-resort when the buyer doesn't have the requisite credit history to obtain funds from a bank or other institutional lender.
As in any successful negotiation you need a motivated seller and a motivated buyer. However, both sides must remember to not become emotional regarding the structure as this is a business deal and both sides are just trying to get the terms they can.
First, earn outs are rare in smaller business transactions. We see these in larger deals when the business has a healthy multiple. The terms of earn outs are custom to the deal, participants and their attorney's but they are a least favorite with sellers due to their contingency.
Seller carry backs are not contingent upon the success for the business after the sale but rather just a straight promissory note. Sellers offering to carry a small portion of the sale help make the buyer feel comfortable that all that has been said is true and the seller is willing to put his money where his mouth is. There are many reasons pro and against for a note. When I meet with a seller I examine the whole business and then make my recommendation on whether its necessary to offer that up front. It is incorrect to say that the main reason a buyer gets turned down for an SBA loan is his credit. The main reason is that the book and records of the business will not support the strict regulations of the SBA.
As Ron said, the term of the transaction must be fair for everyone. Both buyer and seller are free to reject the offer if their is no meeting of the minds.
Posted By: Business Broker, Northern California
An interesting post and have a little different take on some of the items.
It's critical to remember that the sale of a business closes only when you have a motivated seller and a motivated buyer. At the moment I see too many buyers making offers with the belief that the seller has to sell and so will agree to their terms and conditions.
I've repeatedly seen sellers back out of a deal because the buyer wants an earn out. The sellers without exception say they don't like an earnout because the buyer gets to pay the seller based on the efforts of the seller and their previous years of work, plus the buyer wants to use the sellers money to learn the business.
The same argument goes with seller finance. A lot of buyers are unable to get an SBA loan approved as they have poor credit. The seller doesn't want to extend credit to a buyer if they are unable to bring a good credit report and good credit history as their preference is to wait for a more qualified buyer to come along rather than take so much risk to accept the offer from the buyer in front of them.
The bottom line is that a buyer should always present themselves as strongly as possible if they are motivated to buy the business opportunity in front of them.
In addition to everything Peter Siegel mentioned, which all makes great sense, be sure to buy a business that you enjoy, that you are passionate about. If you enjoy your business, you will be far more successful than if it's just another job--one that you can't quit. Make sure it's a business that you will own; not a business that will own you.
Place A Posting To Sell Or Buy A Business, Search All Postings
Recently a business owner asked me on the phone, "Why do you keep the sale of a business confidential? How do you keep the sale confidential - any good tips?" Multiple Advisors weigh in on this subject. What would be your answer to this business owner? ProIntermediaries on BizBen discuss this topic.
Even without meaning to be dishonest, sellers or brokers talking to someone who wants to buy a small business often make statements that are not true. And sometimes what is said is known to be a lie. The buyer is smart to carefully evaluate what they hear - six untrue statements sometimes told.
The use of add backs & sellers discretionary cash is common among sellers of businesses when showing their financial information & explaining that the buyer will actually enjoy more profit than is shown. But buyers are cautioned to review documents closely. Peter Siegel, MBA with BizBen explains.
In this month's Business Buyer survey for BizBen.com, we asked participants in our ProBuy Program and 250 other random business buyers what they look for and avoid when looking at a business for sale postings online. Of the 20 potential posting characteristics we asked about, 8 stood out with most.
Peter Siegel, MBA - BizBen Founder discusses the difference between a hands on owner and an absentee owner. It covers why someone would want to be an absentee owner and then goes on to discuss the pros and cons of buying an absentee run small business in the California marketplace.
Buyers interested in buying a janitorial cleaning business will find companies in this industry for sale that are quite profitable. Careful due diligence, including the six factors covered in this blog post, is advised before completing a deal. Peter Siegel, MBA with BizBen explores this industry.
Lee Petsas (Southern California Business Broker) shares his concerns regarding some questionable business practices by some California Business Brokers lately. Other Business Brokers and Advisors weigh in as well on this BizBen Blog post with other "dirty tricks" they have observed and heard about.
The latest BizBen.com survey of California Business Brokers and Agents outlined what it takes to be a top ten percent performer in the business brokerage industry. From good communication to utilizing your resources, these traits are something to take note of and put into practice to be successful.
We are finding that many laundry buyers and investors are not being given true light to selected elements of value or there are inconsistencies in the interpretation of these elements of value. This common error needs to be addressed. In this BizBen Discussion we address many of those factors.
This post is essential reading for any prospective business seller. Curb appeal is critically important, not just to the amount of the final sale price, but also to whether there will be a sale at all. Top ProIntermediaries and ProAdvisors discuss this valuable topic on this BizBen.com Discussion.