Thoughts on business purchase

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Miguelito
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Thoughts on business purchase

Post by Miguelito » Thu May 16, 2019 11:07 am

Assume a simplified scenario where a couple, in their early 40's and projecting to have a comfortable retirement by 60, makes $300k a year combined, each spouse making $150k.

They are considering buying a business for a price of $3M. The business makes $550k a year. They have 25% ($750k) for a down payment made up of (excluding emergency fund) all their non-retirement assets ($250k) and a home equity loan for all they can squeeze out of the home equity ($500k). Financing the business and home loan over 10 years will cost $400k/year combined. One spouse will quit to run the business (the business is in the area of expertise of this spouse), the other can continue working making $150k but would prefer to stop working in 3-5 years if business is as profitable as advertised.

The couple never touched their $1M in retirement accounts and will continue maxing 401k's & backdoor IRA's.

So for the first 10 years, the net household income will remain unchanged, but assuming the business has continued steadily for a decade, it is now paid off, home is now completely paid off, and the entirety of the business profit is income.

Is this is a bad move? Is the business too expensive? Is it worth the risk?

I know a lot depends on the health of the business (TBD), but it has been around for 20+ years and manufactures specialized parts.

financialdude
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Re: Thoughts on business purchase

Post by financialdude » Thu May 16, 2019 11:10 am

I have a ton of business experience and would advise against this - unless it's in the current industry they are in or have substantial small business experience.

The rule with small biz is that anything that will go wrong will. Hiring good people is really difficult so they may not be able to take a vacation.

For every biz that grows from $550K EBITDA to $3M of EBITDA and sells for $20M, there are a ton where people end up making half of what they thought they would with no vacations and a ton of headaches.

mrmass
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Re: Thoughts on business purchase

Post by mrmass » Thu May 16, 2019 11:28 am

My non business experience says for every set of books there are 2 other sets. One for the IRS, one for the current owners, and finally one for the future investors/buyers.

smitcat
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Re: Thoughts on business purchase

Post by smitcat » Thu May 16, 2019 11:33 am

Miguelito wrote:
Thu May 16, 2019 11:07 am
Assume a simplified scenario where a couple, in their early 40's and projecting to have a comfortable retirement by 60, makes $300k a year combined, each spouse making $150k.

They are considering buying a business for a price of $3M. The business makes $550k a year. They have 25% ($750k) for a down payment made up of (excluding emergency fund) all their non-retirement assets ($250k) and a home equity loan for all they can squeeze out of the home equity ($500k). Financing the business and home loan over 10 years will cost $400k/year combined. One spouse will quit to run the business (the business is in the area of expertise of this spouse), the other can continue working making $150k but would prefer to stop working in 3-5 years if business is as profitable as advertised.

The couple never touched their $1M in retirement accounts and will continue maxing 401k's & backdoor IRA's.

So for the first 10 years, the net household income will remain unchanged, but assuming the business has continued steadily for a decade, it is now paid off, home is now completely paid off, and the entirety of the business profit is income.

Is this is a bad move? Is the business too expensive? Is it worth the risk?

I know a lot depends on the health of the business (TBD), but it has been around for 20+ years and manufactures specialized parts.
You do not give sufficient details to make any reasonable recommendations so here are a few thoughts as a substitute:
- a 3 Mill purchase on a $550 cash flow is a very high multiple for most business's of this size (5.5)
- what did due diligence turn up regarding operation and tax numbers for the past 3-5 years?
- why is this business successful? Due to the current owners participation?
- what is the barrier of entry for competition?
- what is the research on the future market for these goods/services?
- do you understand all of the liabilities associated with this business?
- what exactly do the owner(s) do each day and week currently?
- what would the exit plan be for the business?
Really just a random set of thoughts without knowing enough about the business to ask valuable questions.
Hope this helps

SovereignInvestor
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Re: Thoughts on business purchase

Post by SovereignInvestor » Thu May 16, 2019 11:35 am

Miguelito wrote:
Thu May 16, 2019 11:07 am
Assume a simplified scenario where a couple, in their early 40's and projecting to have a comfortable retirement by 60, makes $300k a year combined, each spouse making $150k.

They are considering buying a business for a price of $3M. The business makes $550k a year. They have 25% ($750k) for a down payment made up of (excluding emergency fund) all their non-retirement assets ($250k) and a home equity loan for all they can squeeze out of the home equity ($500k). Financing the business and home loan over 10 years will cost $400k/year combined. One spouse will quit to run the business (the business is in the area of expertise of this spouse), the other can continue working making $150k but would prefer to stop working in 3-5 years if business is as profitable as advertised.

The couple never touched their $1M in retirement accounts and will continue maxing 401k's & backdoor IRA's.

So for the first 10 years, the net household income will remain unchanged, but assuming the business has continued steadily for a decade, it is now paid off, home is now completely paid off, and the entirety of the business profit is income.

Is this is a bad move? Is the business too expensive? Is it worth the risk?

I know a lot depends on the health of the business (TBD), but it has been around for 20+ years and manufactures specialized parts.
Price is 3M and it generates 550K..but requires someone to quit a 150K job to run...so net gain on business is 400K based on price of 3M. That's barely 13% Return pretax (pretax right?)...plus if it can grow more but it can also shrink? After tax that's under 10% likely plus any growth but it's very risky. Youre.implied ROE would be higher since it's bought with leverage but that is super risky then.

Barely 10% income yield unlevered seems pretty risky when you are taking on a risk and it can theoretically decline and stick you with a lot of debt.

If the numbers were divided by 2 or 4 it would be more worth it but you're putting all your free cash and taking on relatively large debt for it.

bloom2708
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Re: Thoughts on business purchase

Post by bloom2708 » Thu May 16, 2019 11:45 am

Is it likely that the current owner owns the business "Free and clear"?

The new owner will owe $2.25 million and have to service that debt.

I see so many business change hands and the new owner is highly in debt and just can't make it go with the heavy debt burden.
"People want confirmation, not advice" Unknown | "We are here to provoke thoughtfulness, not agree with you" Unknown | Four words. Whole food, plant based. Bing it.

smitcat
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Re: Thoughts on business purchase

Post by smitcat » Thu May 16, 2019 11:46 am

SovereignInvestor wrote:
Thu May 16, 2019 11:35 am
Miguelito wrote:
Thu May 16, 2019 11:07 am
Assume a simplified scenario where a couple, in their early 40's and projecting to have a comfortable retirement by 60, makes $300k a year combined, each spouse making $150k.

They are considering buying a business for a price of $3M. The business makes $550k a year. They have 25% ($750k) for a down payment made up of (excluding emergency fund) all their non-retirement assets ($250k) and a home equity loan for all they can squeeze out of the home equity ($500k). Financing the business and home loan over 10 years will cost $400k/year combined. One spouse will quit to run the business (the business is in the area of expertise of this spouse), the other can continue working making $150k but would prefer to stop working in 3-5 years if business is as profitable as advertised.

The couple never touched their $1M in retirement accounts and will continue maxing 401k's & backdoor IRA's.

So for the first 10 years, the net household income will remain unchanged, but assuming the business has continued steadily for a decade, it is now paid off, home is now completely paid off, and the entirety of the business profit is income.

Is this is a bad move? Is the business too expensive? Is it worth the risk?

I know a lot depends on the health of the business (TBD), but it has been around for 20+ years and manufactures specialized parts.
Price is 3M and it generates 550K..but requires someone to quit a 150K job to run...so net gain on business is 400K based on price of 3M. That's barely 13% Return pretax (pretax right?)...plus if it can grow more but it can also shrink? After tax that's under 10% likely plus any growth but it's very risky. Youre.implied ROE would be higher since it's bought with leverage but that is super risky then.

Barely 10% income yield unlevered seems pretty risky when you are taking on a risk and it can theoretically decline and stick you with a lot of debt.

If the numbers were divided by 2 or 4 it would be more worth it but you're putting all your free cash and taking on relatively large debt for it.

"Price is 3M and it generates 550K..but requires someone to quit a 150K job to run...so net gain on business is 400K based on price of 3M. That's barely 13% Return pretax (pretax right?).."

I don't think so - actually the way this is stated the business generates $550K/yr but they will be giving up a $150K job and incur a $400K yearly loan payment.
Truly a loser unless these facts are not being conveyed well.

smitcat
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Re: Thoughts on business purchase

Post by smitcat » Thu May 16, 2019 11:48 am

bloom2708 wrote:
Thu May 16, 2019 11:45 am
Is it likely that the current owner owns the business "Free and clear"?

The new owner will owe $2.25 million and have to service that debt.

I see so many business change hands and the new owner is highly in debt and just can't make it go with the heavy debt burden.

"I see so many business change hands and the new owner is highly in debt and just can't make it go with the heavy debt burden."
Fairly easy to calculate that ahead of time - existing business's have a track record that can be reviewed either good or bad.
New business's started from scratch not really possible.

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3CT_Paddler
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Re: Thoughts on business purchase

Post by 3CT_Paddler » Thu May 16, 2019 11:58 am

Your family has basically won the game by having two well paid earners. If you get serious about saving you could retire closer to 55. That is less than 15 years away.

Investing so much in a manufacturing business when you have limited time to recover if things go poorly is risk piled on risk.

jminv
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Re: Thoughts on business purchase

Post by jminv » Thu May 16, 2019 12:05 pm

You say that one spouse has an area of expertise in this business but has that spouse ever managed a business? There is a difference between working in an industry and running a company in an industry (and also between creating and owning versus just managing)

What prevents you from copying whatever this company is doing? What I’m getting at is what exactly are you buying? Is it a competitive advantage, ip, etc or really just existing customers and the sales coming from them?

The other party is selling for a reason. Put some effort into figuring out why exactly. Maybe it’s a small part of their company and they want to focus on other things. Or maybe they know something about business trends that you don’t.

Also, why start off with a 3 million purchase? Why wouldn’t you try to buy something smaller or build something yourself? It doesn’t have to be all or nothing. I really wouldn’t want a purchase to hinge on using a heloc.

Check the financials very closely as well as your assumptions.

beanfire
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Re: Thoughts on business purchase

Post by beanfire » Thu May 16, 2019 12:49 pm

Hello,
A couple of questions:
1. What is the revenue number?
2. What is the gross profit%?
3. What is the expertise of the spouse who will run the business? If this is a manufacturing business, is your expertise sales, accounting, operations?
4. You explained what you will borrow to purchase the business, but how leveraged is the balance sheet of the business that you’re buying?
5. Does the price include a building? If so, what is the value of the building?
6. What is the value if the physical assets such as equipment?

GuyFromGeorgia
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Re: Thoughts on business purchase

Post by GuyFromGeorgia » Thu May 16, 2019 12:59 pm

I'd recommend doing some research on Net Present Value (NPV) specifically because the way you word your scenario you are talking cash flow. That $150k income could come from the current job or the new business. After considering the loan, your cash flow would be the same. However, you have to pay a huge chunk up front and that $750k could be utilized for something else. Maybe invested in the stock market, maybe buying a boat, maybe buying a different company. Also, the future value of money is less than the present value of money. You have to have a way to discount each subsequent year's cash flow. As this is purely a speculative exercise, I pulled out the spreadsheet and I see you have a 15 year breakeven point. At that point, your cash flows from years 11-15 (discounted of course) offset your initial investment and you have an equivalent Net Present Value as you do today. From this point onward, your cash flow increases rapidly and you likely continue to have the ability to sell anytime you want.

There are a lot of variables that could go for or against you. You should do a lot of research and model a wide range or possibilities. And as another user said, you're already on a great path to retirement. This business could make it even better, or it could make it such that you don't retire until you're 70.

SovereignInvestor
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Re: Thoughts on business purchase

Post by SovereignInvestor » Thu May 16, 2019 1:00 pm

smitcat wrote:
Thu May 16, 2019 11:46 am
SovereignInvestor wrote:
Thu May 16, 2019 11:35 am
Miguelito wrote:
Thu May 16, 2019 11:07 am
Assume a simplified scenario where a couple, in their early 40's and projecting to have a comfortable retirement by 60, makes $300k a year combined, each spouse making $150k.

They are considering buying a business for a price of $3M. The business makes $550k a year. They have 25% ($750k) for a down payment made up of (excluding emergency fund) all their non-retirement assets ($250k) and a home equity loan for all they can squeeze out of the home equity ($500k). Financing the business and home loan over 10 years will cost $400k/year combined. One spouse will quit to run the business (the business is in the area of expertise of this spouse), the other can continue working making $150k but would prefer to stop working in 3-5 years if business is as profitable as advertised.

The couple never touched their $1M in retirement accounts and will continue maxing 401k's & backdoor IRA's.

So for the first 10 years, the net household income will remain unchanged, but assuming the business has continued steadily for a decade, it is now paid off, home is now completely paid off, and the entirety of the business profit is income.

Is this is a bad move? Is the business too expensive? Is it worth the risk?

I know a lot depends on the health of the business (TBD), but it has been around for 20+ years and manufactures specialized parts.
Price is 3M and it generates 550K..but requires someone to quit a 150K job to run...so net gain on business is 400K based on price of 3M. That's barely 13% Return pretax (pretax right?)...plus if it can grow more but it can also shrink? After tax that's under 10% likely plus any growth but it's very risky. Youre.implied ROE would be higher since it's bought with leverage but that is super risky then.

Barely 10% income yield unlevered seems pretty risky when you are taking on a risk and it can theoretically decline and stick you with a lot of debt.

If the numbers were divided by 2 or 4 it would be more worth it but you're putting all your free cash and taking on relatively large debt for it.

"Price is 3M and it generates 550K..but requires someone to quit a 150K job to run...so net gain on business is 400K based on price of 3M. That's barely 13% Return pretax (pretax right?).."

I don't think so - actually the way this is stated the business generates $550K/yr but they will be giving up a $150K job and incur a $400K yearly loan payment.
Truly a loser unless these facts are not being conveyed well.
The loan payment should be excluded bevause it is financing.

Not all of the loan is interest some is gain of equite in business.

My calculation was unlevered...like once they own it free and clear is it an asset worth owning? Since their goal eventually is to own it clear and free of debt.

In the interim..on leveraged basis..they put 750k and net 400K after losing salary and then pay 400K of mortgage. But some of mortgage is gained equity in business (eventually they'll own it free and clear and their equity rises from 750K to 3M). So if say even 150K of the mortgage is equity then they are gaining 150K equity via paying mortgage each year on 750k initial capital or ROE of 20%.

If you're going to focus on leveraged returns and include financing you need to parse interest versus equitt/principal.

I focused on unlevered returns since eventually and for long term they want to own it free and clear.

Your calculation isn't correct because it ignores principal payment. If you're focusing on cash flow...you're right it is $0. But then magically eventually they'll own a businessential worth $3M once the mortgage is paid...so your model isn't including the eventual 3M cash flow when they have a 3M business and can theoretically sell it. That's clunky...that's why I stick with unlevered return calculation .

sergio
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Re: Thoughts on business purchase

Post by sergio » Thu May 16, 2019 1:04 pm

Miguelito wrote:
Thu May 16, 2019 11:07 am
Assume a simplified scenario where a couple, in their early 40's and projecting to have a comfortable retirement by 60, makes $300k a year combined, each spouse making $150k.

They are considering buying a business for a price of $3M. The business makes $550k a year. They have 25% ($750k) for a down payment made up of (excluding emergency fund) all their non-retirement assets ($250k) and a home equity loan for all they can squeeze out of the home equity ($500k). Financing the business and home loan over 10 years will cost $400k/year combined. One spouse will quit to run the business (the business is in the area of expertise of this spouse), the other can continue working making $150k but would prefer to stop working in 3-5 years if business is as profitable as advertised.

The couple never touched their $1M in retirement accounts and will continue maxing 401k's & backdoor IRA's.

So for the first 10 years, the net household income will remain unchanged, but assuming the business has continued steadily for a decade, it is now paid off, home is now completely paid off, and the entirety of the business profit is income.

Is this is a bad move? Is the business too expensive? Is it worth the risk?

I know a lot depends on the health of the business (TBD), but it has been around for 20+ years and manufactures specialized parts.
Does the business have any significant assets (real estate, IP, etc.)?

smitcat
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Re: Thoughts on business purchase

Post by smitcat » Thu May 16, 2019 1:10 pm

SovereignInvestor wrote:
Thu May 16, 2019 1:00 pm
smitcat wrote:
Thu May 16, 2019 11:46 am
SovereignInvestor wrote:
Thu May 16, 2019 11:35 am
Miguelito wrote:
Thu May 16, 2019 11:07 am
Assume a simplified scenario where a couple, in their early 40's and projecting to have a comfortable retirement by 60, makes $300k a year combined, each spouse making $150k.

They are considering buying a business for a price of $3M. The business makes $550k a year. They have 25% ($750k) for a down payment made up of (excluding emergency fund) all their non-retirement assets ($250k) and a home equity loan for all they can squeeze out of the home equity ($500k). Financing the business and home loan over 10 years will cost $400k/year combined. One spouse will quit to run the business (the business is in the area of expertise of this spouse), the other can continue working making $150k but would prefer to stop working in 3-5 years if business is as profitable as advertised.

The couple never touched their $1M in retirement accounts and will continue maxing 401k's & backdoor IRA's.

So for the first 10 years, the net household income will remain unchanged, but assuming the business has continued steadily for a decade, it is now paid off, home is now completely paid off, and the entirety of the business profit is income.

Is this is a bad move? Is the business too expensive? Is it worth the risk?

I know a lot depends on the health of the business (TBD), but it has been around for 20+ years and manufactures specialized parts.
Price is 3M and it generates 550K..but requires someone to quit a 150K job to run...so net gain on business is 400K based on price of 3M. That's barely 13% Return pretax (pretax right?)...plus if it can grow more but it can also shrink? After tax that's under 10% likely plus any growth but it's very risky. Youre.implied ROE would be higher since it's bought with leverage but that is super risky then.

Barely 10% income yield unlevered seems pretty risky when you are taking on a risk and it can theoretically decline and stick you with a lot of debt.

If the numbers were divided by 2 or 4 it would be more worth it but you're putting all your free cash and taking on relatively large debt for it.

"Price is 3M and it generates 550K..but requires someone to quit a 150K job to run...so net gain on business is 400K based on price of 3M. That's barely 13% Return pretax (pretax right?).."

I don't think so - actually the way this is stated the business generates $550K/yr but they will be giving up a $150K job and incur a $400K yearly loan payment.
Truly a loser unless these facts are not being conveyed well.
The loan payment should be excluded bevause it is financing.

Not all of the loan is interest some is gain of equite in business.

My calculation was unlevered...like once they own it free and clear is it an asset worth owning? Since their goal eventually is to own it clear and free of debt.

In the interim..on leveraged basis..they put 750k and net 400K after losing salary and then pay 400K of mortgage. But some of mortgage is gained equity in business (eventually they'll own it free and clear and their equity rises from 750K to 3M). So if say even 150K of the mortgage is equity then they are gaining 150K equity via paying mortgage each year on 750k initial capital or ROE of 20%.

If you're going to focus on leveraged returns and include financing you need to parse interest versus equitt/principal.

I focused on unlevered returns since eventually and for long term they want to own it free and clear.

Your calculation isn't correct because it ignores principal payment. If you're focusing on cash flow...you're right it is $0. But then magically eventually they'll own a businessential worth $3M once the mortgage is paid...so your model isn't including the eventual 3M cash flow when they have a 3M business and can theoretically sell it. That's clunky...that's why I stick with unlevered return calculation .

"Your calculation isn't correct because it ignores principal payment. If you're focusing on cash flow...you're right it is $0. But then magically eventually they'll own a businessential worth $3M once the mortgage is paid...so your model isn't including the eventual 3M cash flow when they have a 3M business and can theoretically sell it. That's clunky...that's why I stick with unlevered return calculation ."

OK fair enough - but if you prefer to look at the prospects this way that 3 Million business sale will need to be reduced by all taxes, fees and adjusted for inflation.

gougou
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Re: Thoughts on business purchase

Post by gougou » Thu May 16, 2019 1:11 pm

How "safe" is this business? If things go wrong what exit strategy do you have? If this is a multi-family/commercial real estate and you are just a landlord then it is a crazy good deal but I doubt you could get that kind of returns from real estate. If this is a restaurant or a store and you don't own the place then it is a lot more risky.

DonIce
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Re: Thoughts on business purchase

Post by DonIce » Thu May 16, 2019 1:16 pm

Miguelito wrote:
Thu May 16, 2019 11:07 am
They are considering buying a business for a price of $3M. The business makes $550k a year.

...

Is this is a bad move? Is the business too expensive? Is it worth the risk?

I know a lot depends on the health of the business (TBD), but it has been around for 20+ years and manufactures specialized parts.
Seems too risky to me. What's wrong with the business that they are willing to sell it at a P/E of only 5.5?

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Wiggums
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Re: Thoughts on business purchase

Post by Wiggums » Thu May 16, 2019 1:18 pm

Normally the current owner will stay for two years to have a smooth change in ownership. How much will the seller get for this service?

smitcat
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Re: Thoughts on business purchase

Post by smitcat » Thu May 16, 2019 1:21 pm

DonIce wrote:
Thu May 16, 2019 1:16 pm
Miguelito wrote:
Thu May 16, 2019 11:07 am
They are considering buying a business for a price of $3M. The business makes $550k a year.

...

Is this is a bad move? Is the business too expensive? Is it worth the risk?

I know a lot depends on the health of the business (TBD), but it has been around for 20+ years and manufactures specialized parts.
Seems too risky to me. What's wrong with the business that they are willing to sell it at a P/E of only 5.5?
Most small business sell between a multiple of 3 and 4 - 5.5 is very high for most.
I would expect a cash flow of about $800K for a business selling at 3 million.
Then the financing also makes more sense.

smitcat
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Re: Thoughts on business purchase

Post by smitcat » Thu May 16, 2019 1:22 pm

Wiggums wrote:
Thu May 16, 2019 1:18 pm
Normally the current owner will stay for two years to have a smooth change in ownership. How much will the seller get for this service?
That is not typical at all of these small business's.

KyleAAA
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Re: Thoughts on business purchase

Post by KyleAAA » Thu May 16, 2019 1:31 pm

Is the business growing? How fast? When you say "makes $550K" do you mean revenue or profit? Is it Seller Discretionary Earnings (SDE) or just net income in the more traditional sense? Unless the business is growing double digits per year the valuation feels a bit high to me. At $3 million you should probably consult a valuation expert on the details.

DonIce
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Re: Thoughts on business purchase

Post by DonIce » Thu May 16, 2019 1:42 pm

smitcat wrote:
Thu May 16, 2019 1:21 pm
Most small business sell between a multiple of 3 and 4 - 5.5 is very high for most.
I would expect a cash flow of about $800K for a business selling at 3 million.
Then the financing also makes more sense.
Depends on the business. If it's a retail store, restaurant, real estate, or other very low entry barrier business, then sure. But according to the OP, this is a business that "manufactures specialized parts". That means if it's been well managed, it probably has valuable business customer relationships, proprietary parts designs, perhaps some patents or other intellectual property, and potentially some growth prospects. Such a business could probably sell itself to its main customer or a competitor in a strategic acquisition at a far higher valuation.

If it's just a "dumb" machine shop then sure a 3-4x valuation might make sense, but it would still be a risky deal because the only contracts might exist because of the current owner's relationships with a few business clients, which will just take their parts designs to a cheap foreign machine shop once the business is sold to someone they don't know.

Or perhaps the business could have just lost its main customer and the owners want to sell it at a profit before the losses show up in the books.

Sorry I just don't see the upside in buying a specialized manufacturing company that's willing to sell itself at at PE of 5.5 unless its perhaps because the current owners are desperate to sell immediately at a low price because of a life event.

Anyway that's all speculation. We need a lot more details on the business to provide better recommendations to the OP.
Last edited by DonIce on Thu May 16, 2019 1:44 pm, edited 1 time in total.

SovereignInvestor
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Re: Thoughts on business purchase

Post by SovereignInvestor » Thu May 16, 2019 1:43 pm

smitcat wrote:
Thu May 16, 2019 1:10 pm
[


"Your calculation isn't correct because it ignores principal payment. If you're focusing on cash flow...you're right it is $0. But then magically eventually they'll own a businessential worth $3M once the mortgage is paid...so your model isn't including the eventual 3M cash flow when they have a 3M business and can theoretically sell it. That's clunky...that's why I stick with unlevered return calculation ."

OK fair enough - but if you prefer to look at the prospects this way that 3 Million business sale will need to be reduced by all taxes, fees and adjusted for inflation.
Yeah true but they probably intend to hold so better off with ROE on unlevered ownership in long run which isn't thst high for the major risk.

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Re: Thoughts on business purchase

Post by KyleAAA » Thu May 16, 2019 2:01 pm

DonIce wrote:
Thu May 16, 2019 1:42 pm
smitcat wrote:
Thu May 16, 2019 1:21 pm
Most small business sell between a multiple of 3 and 4 - 5.5 is very high for most.
I would expect a cash flow of about $800K for a business selling at 3 million.
Then the financing also makes more sense.
Depends on the business. If it's a retail store, restaurant, real estate, or other very low entry barrier business, then sure. But according to the OP, this is a business that "manufactures specialized parts". That means if it's been well managed, it probably has valuable business customer relationships, proprietary parts designs, perhaps some patents or other intellectual property, and potentially some growth prospects. Such a business could probably sell itself to its main customer or a competitor in a strategic acquisition at a far higher valuation.

If it's just a "dumb" machine shop then sure a 3-4x valuation might make sense, but it would still be a risky deal because the only contracts might exist because of the current owner's relationships with a few business clients, which will just take their parts designs to a cheap foreign machine shop once the business is sold to someone they don't know.

Or perhaps the business could have just lost its main customer and the owners want to sell it at a profit before the losses show up in the books.

Sorry I just don't see the upside in buying a specialized manufacturing company that's willing to sell itself at at PE of 5.5 unless its perhaps because the current owners are desperate to sell immediately at a low price because of a life event.

Anyway that's all speculation. We need a lot more details on the business to provide better recommendations to the OP.
If you find a strategic buyer, then sure. For a strategic buyer it could sell for 20x earnings. But smitcat is correct that in the vast, vast majority of cases a business like this (even assuming proprietary parts designs and patents) would sell for 3-4x earnings (or SDE, more likely). If the business was growing rapidly it would change the multiple, of course. You will always have to sell a private business, especially a very small one, at a FAR lower P/E than you could sell a public company doing the same thing. 3-4x is the correct ballpark. For reference, even small tech SaaS companies with predictable revenue and good growth prospects tend to sell below 5x SDE at that size, and that is for an extremely asset-light business model (i.e. very high ROE compared to manufacturing).

smitcat
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Re: Thoughts on business purchase

Post by smitcat » Thu May 16, 2019 3:07 pm

DonIce wrote:
Thu May 16, 2019 1:42 pm
smitcat wrote:
Thu May 16, 2019 1:21 pm
Most small business sell between a multiple of 3 and 4 - 5.5 is very high for most.
I would expect a cash flow of about $800K for a business selling at 3 million.
Then the financing also makes more sense.
Depends on the business. If it's a retail store, restaurant, real estate, or other very low entry barrier business, then sure. But according to the OP, this is a business that "manufactures specialized parts". That means if it's been well managed, it probably has valuable business customer relationships, proprietary parts designs, perhaps some patents or other intellectual property, and potentially some growth prospects. Such a business could probably sell itself to its main customer or a competitor in a strategic acquisition at a far higher valuation.

If it's just a "dumb" machine shop then sure a 3-4x valuation might make sense, but it would still be a risky deal because the only contracts might exist because of the current owner's relationships with a few business clients, which will just take their parts designs to a cheap foreign machine shop once the business is sold to someone they don't know.

Or perhaps the business could have just lost its main customer and the owners want to sell it at a profit before the losses show up in the books.

Sorry I just don't see the upside in buying a specialized manufacturing company that's willing to sell itself at at PE of 5.5 unless its perhaps because the current owners are desperate to sell immediately at a low price because of a life event.

Anyway that's all speculation. We need a lot more details on the business to provide better recommendations to the OP.
5.5 is not a low price its very high.
I am not sure what your sources are but sources like the sold bus data , SBDA, SCORE and business brokers would all concur at a lower multiple.
Its been in business for 20+ years with a current cash flow of $550 - how likely is it a fast grower or a highly margined business with those facts.

Topic Author
Miguelito
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Re: Thoughts on business purchase

Post by Miguelito » Thu May 16, 2019 4:46 pm

Thanks to all for the feedback. At this point very little is known. Asking price is closer to 3.6M. I just found it ridiculous out of hand and assume the most that would be paid would be 3M. They allege the owners have very little involvement, but I also assume that is not true. It seems the owners/founders originally designed and started manufacturing these parts. They want to retire, they say. The 550K is listed as "cash flow." They allege their parts go into OEM equipment. It could be that products are stagnant, equipment is outdated, etc. It could also be that there is opportunity to improve products and revitalize business. Included in price is 800k in FF&E. No real estate. Revenue is 2M.

That's all the info I have so far. I have the technical experience and good business acumen. My father bought and owned small businesses and I was with him as he did due diligence on dozens of them and found most lied about the numbers and claims.

I just wanted to know if it should be dismissed out of hand. This is the first business ever that sparks interest due to location, field, and magnitude of income. But I have the same concerns you guys bring up. I just wanted to know if I was alone. We have good careers and a good life. We are not about to risk that on a whim.

jminv
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Joined: Tue Jan 02, 2018 10:58 pm

Re: Thoughts on business purchase

Post by jminv » Thu May 16, 2019 7:32 pm

Miguelito wrote:
Thu May 16, 2019 4:46 pm
Thanks to all for the feedback. At this point very little is known. Asking price is closer to 3.6M. I just found it ridiculous out of hand and assume the most that would be paid would be 3M. They allege the owners have very little involvement, but I also assume that is not true. It seems the owners/founders originally designed and started manufacturing these parts. They want to retire, they say. The 550K is listed as "cash flow." They allege their parts go into OEM equipment. It could be that products are stagnant, equipment is outdated, etc. It could also be that there is opportunity to improve products and revitalize business. Included in price is 800k in FF&E. No real estate. Revenue is 2M.

That's all the info I have so far. I have the technical experience and good business acumen. My father bought and owned small businesses and I was with him as he did due diligence on dozens of them and found most lied about the numbers and claims.

I just wanted to know if it should be dismissed out of hand. This is the first business ever that sparks interest due to location, field, and magnitude of income. But I have the same concerns you guys bring up. I just wanted to know if I was alone. We have good careers and a good life. We are not about to risk that on a whim.
I commented before but anyway, with these details, no way would I pay 7x (thought it had been 5.5) cash flow for a manufacturing business and definitely not secure the make the purchase with a loan secured by your home.

If it's a manufacturing business, it's very unlikely they have any sort of competitive advantage. It's also unlikely they're actually making 550k on 2 mil revenue. Extremely unlikely, actually. I would guess the cash flow does not include the managers salaries and a lot of other things. The idea that the owners are not involved is also not credible. There's something wrong with the business. Check how many customers they have. They probably have or know they will have a major customer defecting.

smitcat
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Re: Thoughts on business purchase

Post by smitcat » Fri May 17, 2019 5:12 am

Miguelito wrote:
Thu May 16, 2019 4:46 pm
Thanks to all for the feedback. At this point very little is known. Asking price is closer to 3.6M. I just found it ridiculous out of hand and assume the most that would be paid would be 3M. They allege the owners have very little involvement, but I also assume that is not true. It seems the owners/founders originally designed and started manufacturing these parts. They want to retire, they say. The 550K is listed as "cash flow." They allege their parts go into OEM equipment. It could be that products are stagnant, equipment is outdated, etc. It could also be that there is opportunity to improve products and revitalize business. Included in price is 800k in FF&E. No real estate. Revenue is 2M.

That's all the info I have so far. I have the technical experience and good business acumen. My father bought and owned small businesses and I was with him as he did due diligence on dozens of them and found most lied about the numbers and claims.

I just wanted to know if it should be dismissed out of hand. This is the first business ever that sparks interest due to location, field, and magnitude of income. But I have the same concerns you guys bring up. I just wanted to know if I was alone. We have good careers and a good life. We are not about to risk that on a whim.
"This is the first business ever that sparks interest due to location, field, and magnitude of income."
If you are actively looking for a small business I would be surprised if you had not come across many that had much better ratios and opportunities.
Online, SBDA, brokers, SCORE - any of these should yield many candidates.

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