Small Business Financing

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Small Business Financing

Post by KennelOwner » Wed Jun 10, 2015 6:54 pm

My husband and I are looking at purchasing a small business upon his separation from the Navy this Fall. We hope this will be our single income stream (so need net profit to be NLT $125K). Everything we've seen with SBA loans says we need 15-20% cash downpayment. The current kennel we are looking to purchase is listed at $825K. Where do "normal" small business owners come up with $125K cash?

I see the following options:
1. I own a home in San Diego that I purchased for $305,000. It is valued at $380K (per Zillow), and I owe $280K. I currently have renters who cover the mortgage payment and property management fee. Ideally, I'd hold onto this indefinitely as asset diversification. However, I've considered taking out a second mortgage on the equity (although it's not our primary residence, so the rate may be less attractive...) or selling it.
2. I have ~$120K in my ROTH IRA. I hate to take it out & incur the fees (not to mention not have it for retirement).
3. I have ~$150K in various mutual funds & brokerages. However, I really hate to put my entire life's savings in one proverbial basket.
4. Find SOME way to come up with approx $100K (and I'd be comfortable putting $25K in from my mutual funds).

Does anyone have any insight into the best way to do this? Not sure if this helps at all, but we'll both be veterans, and I'm a disabled veteran.

Thank you!

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Re: Small Business Financing

Post by Liberty1100 » Wed Jun 10, 2015 8:33 pm

I am not sure but depending on the current owners, you can certainly get creative in financing this deal. Some possible options to think about:

[*]Seller financing: you negotiate with the seller/current owner a loan through them. You essentially cut down the purchase price by making monthly installments to the seller. This would decrease the amount of money you would need from SBA. If you default, they could take the kennel back from you.
[*]Find investors: friends, family, and maybe people here could provide you with some cash to help you start out. Depending on the arrangement, it could be more of a loan or equity in the business.
[*]Find VA loans: Thank you and your husband for your service. There might be some type of small business loans and grants available for veterans. Googling or even talking to someone at SBA might help you to find such programs.

Good luck and thank you again for your service.

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Re: Small Business Financing

Post by moshe » Wed Jun 10, 2015 9:13 pm

Hi Liberty1100,

First off thank you both for your service.

FYI you can withdraw the contributed principal from your ROTH without penalty for any reason and without penalty.

You can borrow the money. Companies do it all the time. You borrow at x% and produce a ROE of x+%. It's called leverage and is a wonderful "gift" assuming the numbers make sense. (borrow at 5% produce a return on the borrowed funds of 15% for example)

That being said, unless you have a background in finance, hire someone that does to review the deal with you. Not all(or most!) CPA's qualify BTW. You need to look at the net present value of your cash flows. IOW does the money flowing out today to buy the business justify the money that will flow in tomorrow and into the future? Money is worth less over time. Don't know? No idea what i am on about? Many small companies go under because they did an accounting return calculation and not a NPV calculation. They difference can be fatal to your finances.

FIND OUT before you sign anything. Just my 2 cents.

My money has no emotions. ~Moshe | | I'm the world's greatest expert on my own opinion. ~Bruce Williams

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Taylor Larimore
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Re: Small Business Financing

Post by Taylor Larimore » Wed Jun 10, 2015 10:05 pm


I thank you and your husband for your service to our country.

As chief of the SBA Finance Division in South Florida, I approved (and declined) thousands of Small Business Administration loans to new and existing businesses. I retired many years ago.

Things to think about:

* Buying a business is fraught with risk. About half new businesses fail within 4 years. This statistic does not apply to purchased businesses.

* Time and again, we saw retirees go into debt (especially in Florida); use their life savings to buy a business; the business fails; they end up in poverty.

* Most small businesses are for sale because their owners are losing money. Slick accountants can make unaudited businesses statements look great. Have your own accountant analyze all statements. Sales and profit trends should be up.

* Insist on copies of at least three years of income tax returns which will probably show the worst financial picture. Sellers will often say actual results are better than shown on their tax return (if a seller lies to the IRS, you can be sure they will lie to you).

* Beware of business brokers. Their primary goal is to close the deal. However, a good broker can be invaluable.

* The sellers have all the facts and present the positives. Buyers must use diligence to learn the negatives.

* The primary reason for business failure is lack of experienced management. High debt payment is also a cause.

* Contact Service Corps of Retired Executives (SCORE) to help and advise you. Their service is usually free.

* Banks and SBA want to make good business loans. If they will not make the loan because they feel it is too risky -- it probably is.

Best wishes.
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Small Business Financing

Post by fredjohnson » Wed Jun 10, 2015 10:38 pm

When I purchased a small business 13 yrs ago I used my savings for the down payment. The down was $200k and the business cost $1.2 million. That $200k was almost all my savings other than my retirement account from when I was employed elsewhere. In general you cannot borrow the down-payment as the bank will not allow it. It has to come from your personal savings, etc. I wouldn't use your retirement accounts. I just never liked doing that. I saved up for years to get the $200k, so it didn't come easy. Ok, now for the more fun part. Wife and I grew that business from around $1.5 mill in sales to about $5 mill in sales today. We've taken salaries of around $8 million out of that business the past 13 years. The business is probably worth around $4-$6 million today. Our net worth climbed from well under $1 mill when we bought it to around $10 million today. So, sure it was worth it despite the risks associated with owning a small business. We are probably the exceptions however and not the rule. Most small businesses fail from poor management, lack of capital, bad marketing, etc, so beware.

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Re: Small Business Financing

Post by KennelOwner » Thu Jun 11, 2015 5:37 am

Thank you for your insights! I'll have to look into your recommendations and see what works for us.

Fortunately, the business we are looking at purchasing has been in business for 25 years, so thus far, they are doing something right! I have my MBA from Darden School of Business, and together my husband and I have 20 years of management experience, so hopefully we wouldn't do WORSE than the current owners!

No one mentioned double mortgaging the San Diego home. Does that not seem wise?

Thank you!!

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Re: Small Business Financing

Post by Liberty1100 » Thu Jun 11, 2015 9:16 am

Well, are you cash flowing anything from that San Diego property after all taxes, payments, and expenses? If you are only making money on appreciation and payment of your mortgage, I would sell it. Those things are not in your control and you should never count on it. It could become a liability if something happens to it as well, like a new roof, problem tenant where you need to bring to court, etc. Plus, if you take out the equity, you would then have an increased payment ruining the cash flow you might had.

Basically, unless you like the cash flow from the property, I would sell it and use the proceeds to fund this down payment.

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Re: Small Business Financing

Post by futureman » Fri Jun 12, 2015 12:18 am

Before trying to figure out how to come up with the money, I would determine what it is worth to you. Usually this sized business is seller financed.

First separate the fixed assets from the business - is there a building and land? If so this can be appraised and financed and this value can be extracted from the overall value the seller is seeking. This asset can be financed at a regular bank with a mortgage.

Second, for the business (clients, brand, operations, etc), I would not pay more than 3x EBITDA for a kennel. For the purposes of a small closely held business, I would consider EBITDA to be the combination of owners W2 salary plus S Corp income (about the same as the adjusted gross income on a personal tax return). What is the average adjusted gross income of the owners on their tax returns for each of the last three years? I would take this number and multiply by three to give you a baseline value of the business. Other factors to consider are competition in the area, is the business trending up or down, are there any key employees who you can depend on to help run the business,... These can raise or lower the value.

If you buy the building, the owner may sell you the business and give you 6 years of seller financing where you pay them 1/2 of your EBITDA (your w2 income plus S Corp income) each year plus interest. The sellers collateral is the business, so if you cannot pay the loan, the seller gets the business back (not the building, unless you want to sell it back to them).

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Re: Small Business Financing

Post by skjoldur » Fri Jun 12, 2015 8:47 am

futureman wrote:I would consider EBITDA to be the combination of owners W2 salary plus S Corp income
Hello futureman,

I'm curious as to why you would count owner wages as part of earnings? It seems like that would misleadingly inflate the value of the business. I think I would want to make sure owner wages are high enough to be market value for the jobs that the owners are doing and that the business has earnings above and beyond those expenses. So my instinct would be to figure out the appropriate market rate for the owners' jobs and recast the books assuming you hired people to do those jobs, then look at the earnings.

I'm not an accountant or expert in this so I'm very possibly mistaken, but In my own business I did not think of my salary as return on capital, I thought of it as a business expense associated with doing my job.

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Re: Small Business Financing

Post by TerryDMillerMBA » Fri Jun 12, 2015 9:26 am

skjoldur wrote:
futureman wrote:I would consider EBITDA to be the combination of owners W2 salary plus S Corp income
I'm not an accountant or expert in this so I'm very possibly mistaken, but In my own business I did not think of my salary as return on capital, I thought of it as a business expense associated with doing my job.
But the point is that it is the business entity that is generating that salary for you. futureman is just offering a method of getting a reasonable valuation for the entity.

EDIT: Plus one on the possible VA small business resources. Please contact your local office to find out details.

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Re: Small Business Financing

Post by futureman » Fri Jun 12, 2015 9:56 am

I prefaced my comments on the valuation method with "For the purposes of a small closely held business,", because my experience is that small businesses under a $1M or $2M are not traditionally valued. What I mean by traditionally valued is using a method like multiple of revenue, discounted cash flows, multiple of EBITDA, or some valuation method you might see for a very liquid company trading on a public exchange. Liquid businesses trading on the NYSE trade for 7 to 100+ times earnings (some variation on EBITDA). My understanding from accountants and brokers are that closely held private business without big growth prospects usually trade for 3 to 5 time earnings. If the business is very sticky and long term that multiple may be a little higher. If the company is totally dependent on very unique skills/relationships of the outgoing owner, the multiple may be lower.

Usually business brokers tell business owners to add back the owner's salary to inflate EBITDA to target a higher listing price. Often, the business has zero EBITDA (I have seen this in franchise food service companies listed in general business brokerage websites), but pays the owner salary of $100k or something. In these cases, the buyer is basically buying a job with the hopes of expanding profits in some way down the road. If the business has an owners salary and decent profits (maybe 10%), then owner financing is a great way to have everyone have a little skin in the game to ensure a smooth and successful transition.

Unless I knew a business up and down, I would never borrow money from a third party to buy a business because the odds are heavily stacked against you and you will be stuck with that debt for long time. I would be OK with a small down payment (maybe 10%) to show my commitment and then a multi year owner financed deal.

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Re: Small Business Financing

Post by skjoldur » Fri Jun 12, 2015 10:22 am

Futureman: That all make sense to me. I had the same thought that if you consider the owner compensation as part of earnings (and there are not much other earnings) then the business is basically operating as a job for the owner. I would be leery of 'buying a job.'

OP, my main concern in this case is that you might overpay for the business and end up with a kind of high risk job (uncertain wages, unpredictable large expenses, legal liability for all kinds of situations etc. and a lot of net worth tied up in a business that is hard to value and not easy to sell).
Last edited by skjoldur on Fri Jun 12, 2015 2:02 pm, edited 1 time in total.

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Re: Small Business Financing

Post by futureman » Fri Jun 12, 2015 10:44 am

Can the OP post general financials of the firm
- revenues, gross profit, profit, owners salary
-assets and liabilities (buildings, land, cars, loans)

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Re: Small Business Financing

Post by KennelOwner » Fri Jun 12, 2015 1:35 pm

Thank you again for sharing your wisdom! It's extremely helpful to us.

We currently don't have very detailed financial information about the kennel, but just submitted our finances yesterday, and should receive more detailed disclosure once they've been reviewed.

This is what we know: (sorry- couldn't figure out how to get it to paste well from excel
Asking price: $825K (also includes 22 acres & 4 bedroom house)

2014 2013 2012
Gross Sales $279,442.00 $268,249.00 $253,399.00
Net Income from Tax Return $29,117.00 $56,579.00 $76,195.00

Positive Adjustments:
Add: Depreciation @ 75% $7,747.00 $7,982.00 $10,823.00
Add: Travel, Meals $28.00 $55.00 $327.00
Add: Interest $11,322.00 $12,576.00 -
Add: Officer Compensation $24,000.00 $2,500.00 -
Add: Auto (personal) $1,766.00 $2,433.00 $1,765.00
Add: Veterinary (personal dogs) $1,978.00 $2,337.00 -
Add: Officer Health Insurance $24,854.00 $25,070.00 -
Add: Business Use of Home - - -
Total Positive Adjustments $71,695.00 $52,953.00 $12,915.00
Negative Adjustments: $- $- $-

SDE $100,812.00 $109,532.00 $115,886.00

Notes Regarding Positive Adjustments:
Deprecation is a non-cash expense and will not continue for buyer (will be repalced by buyer's depreciation schedule)
Travel, Meals are for the current owners and will not continue for buyer
Interest will not continue for buyer but will be replaced by buyer's intrest on acquisition debt
Officer Compensation is payroll paid directly to the owners (sellers)
Veterinary is for owners personal dogs
Owner Car & Truck Expenses are expenses for the owner's personal auto usage
Officer Health Insurance for current owners and will be replaced by buyers health insurance plan

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Re: Small Business Financing

Post by futureman » Fri Jun 12, 2015 10:45 pm

Do you have an estimated value for the property and house. Zillow might give you a rough number.

Is there a kennel building and assets associated with that? What is the price estimate for these assets?

Any loans they are trying to sell you as well? Often, you see a property with a loan worth more than the property is worth.

The business looks like you are buying a job which earns you about $75,000 per year (w2 income and S corp distribution) before taxes. Unless it has some growth prospects, I don't see much value in the business. Maybe $5k down and $5k or $10k per year for 2 or 3 years (total of about $30k). This is 1 x's EBITDA (net earnings from the company before taxes, but excluding owner compensation). You could go to 2 or 3 times EBITDA (spread over more time), if the business is super stable, strong position and brand in the community, has key employees who do all the work, the books are super clean, etc.

Also, you should be able to save 10k on the health insurance if the$24k charge is for the owner and his/hear family. $15k can buy you a decent policy if you are middle aged and generally healthy.

So if they are asking $825k, then I would expect the house, property and kennel building to be worth around $700k to $800k with no debt against any of the assets.

I would recommend before you buy something like this, that you shop for a while. Look at 20 different deals and learn what looks good and what looks bad. This may be a good deal If the assets support the price. It may be a very bad deal too if the assets are only worth a few hundred thousand. Take your time and be patient. You have one swing of the bat to get this right.
Last edited by futureman on Sat Jun 13, 2015 8:43 am, edited 1 time in total.

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Re: Small Business Financing

Post by Beekman » Sat Jun 13, 2015 12:57 am

As a small business owner who has bought and sold multiple businesses and helped many others do the same, I would strongly advise that you make conservative assumptions in terms of your capital needs! Make sure you have planned for sufficient working capital in addition to the purchase price, including budgeting for potential drops in the business profitability during the transition. Having sufficient working capital will greatly reduce your stress and increase your chances of success.

So to specifically answer your question... if it was me, I'd sell the San Diego house. I wouldn't touch retirement, and I'd want the mutual funds as backup capital just in case. In addition, I would expect the seller to be carrying back at least 10% of the purchase price for a business of this size (at least of the non real estate portion)... the SBA lender may allow this carry back (all or a portion) to count toward the down payment requirement if the carry back is subordinate to the SBA loan.

So taking the two above comments together... you need to budget additional cash beyond purchase price. I'd need more financials to give a more informed answer, but I'd guess that number would be something like $50K as a minimum if it were me. Remember you are going to have closing costs, deposits for utilities, time lag for receivables, expense timing, surprises you are not thinking addition to the very real chance that you may see some short term decline in the business when you transition. On the flip side, you may not need as much down as you think for SBA if the seller carry back is accepted, so this some of this working capital may come from the carryback.

It terms of the deal...probably not something I would do as a first business with this structure and your resources/situation. You are spending a large percentage the deal size for real estate, meaning in general your cashflow is not going to be as high as if you were spending $825k for a business that is renting it's facilities and you are just paying for earnings. In other words, for the money you are putting in, you have a lot less cashflow as a safety net, and it sounds like the numbers are tight for your situation. If it was me and this was a business and facility you really liked, I'd try to structure the deal where you RENT the real estate. Your cash down will drop considerably. SBA will probably require you to have a commercial lease for the life of the loan (10 years), but you can structure it as something like 3 years plus two 4 year options. I'd then try to negotiate a real estate purchase option somewhere in there. If after a few years you still like the business and you are comfortable with the numbers, buy the real estate. This structure has some tax benefits to the seller as well, and likely would be happy to sell when you are ready. But you very well may find that you are happy to continue renting, or you want a different location, etc.

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