5 Things a Buyer Should Know and Understand Before Buying Any Business:
- You should look for businesses that will be able to return your down payment (from net profits) within 12 to 24 months. Example: a company claims cash flow of $150,000 per year and is selling for $400,000. You put down $200,000 to buy the company (other financing is in place too). If the cash flow of the business remains the same for the next year or so under your management you will have your $200,000 down payment back in 16 months from the cash flow of the business ($150,000 / 12 = $12,500 per month for the 1st year and then $50,000 / $12,500 = 4 more months). Sometimes you can’t always work the deal out as basic as we mentioned above, but if you use that rule of thumb you’ll be way head of the game.
- You should look for deals that won’t burden you with a heavy debt payment. Your payment (with interest) on a note shouldn’t equate to more than 25% of the yearly cash flow. Example: You purchase a $500,000 company with a booked cash flow of $150,000 per year. Don’t structure your payment to be more than 25% of $150,000 or $37,000 per year divided by 12 = $3,125 per month (always be cognizant of the interest element too). No one can accurately predict exact sales revenue, the economy or the business climate in general, which could make the $3,125 a real problem if you are going to leave yourself something to live on.
- Anticipate what would happen if sales declined by 25% to 30%. If the deal still looks promising and you can swing the monthly payments with that kind of a reduction in sales, then continue on with the purchase if everything else looks good.
- If a seller tells you “I pull $$$$ amount of cash a year out of the business”, don’t base your purchase on this statement. You cannot make a buying decision on what may or may not be pulled out in cash. What if he used the “cash” to pay for various vendors? Those payments wouldn’t show up on the income statement. There are ways to verify what the company is producing in cash flow, but it’s up to you and your broker to determine what the actual numbers reflect. Remember, no matter how you cut it, a deal like that will be risky if not illegal. Double and triple check your numbers with your broker and CPA, before you go forward.
- Expect the worst and hope for the best! Look at the downside of the deal. Run your projections on worst case scenarios and see what happens to your monthly income. There is an old saying, and it's priceless, "take care of the downside and the upside will take care of itself."