Buying a business: Selection process contains many variables

by Paul Schreiber

SBJ Reporter

pschreiber@sbj.net

Successfully acquiring and operating an existing business involves more than writing a check to the owner and stepping behind the cash register.

Part of the rationale behind acquiring an existing business is that it allows the new owner to step in and continue operations, rather than starting a business from scratch. It has established and predictable cash flow, already-trained employees, vendors with existing agreements and a product line that already sells, said Scott Axon, senior broker with Sunbelt Business Advisors.

Picking the right business

The chief criterion for business selection, according to Axon, is the inspiration factor. That which generates a genuine enthusiasm to head to work each day should be the No. 1 criterion would-be buyers consider when selecting a business, he said. People often ask about market position, profit-ratios and other related issues, but those are secondary concerns, he said, because without passion it's not "a great long-term solution for them."

In determining the "ideal deal" potential business owners are after, they should consider not just their level of risk aversion and what they can invest, but what they expect to make from the operation, said Bill Martin, co-owner of First National Business Corp.

"They're not buying businesses that cause them to make less than they used to make on their jobs."

Money to buy

The funds necessary to purchase a business are tied to the type and nature of the business, Axon said. Cash flow, on-hand inventory and real estate or other assets are factors lenders take a close look at. He said down payments typically range from 15 percent to 50 percent per business.

Martin added: "Banks typically expect today for the buyers to have about 25 percent of (the purchase price) in cash. So even though we can accommodate people with relatively small amounts of money, the average sale is going to take $70,000 to $90,000 down."

On April 30, 2002, Bruce Erdel bought Christian Publisher's Outlet with the help of David Hamm at Sunbelt. Erdel was looking for a Christian-based business with name recognition, strong financial performance and consistent cash flow. Erdel had extensive accounting experience, but the transition to new business owner was an eye opener.

"Make sure you do not underestimate the need for upfront working capital. Your need for funds does not stop at just buying the business," Erdel said. Working capital requirements to get CPO rolling involved sending the state three months of sales tax receipts as a deposit, since it was an existing business. He covered this with a surety bond. There was a deposit for the rental agreement and City Utilities needed a two-year deposit based on usage.

On-hand cash was necessary as well in working with vendors, Erdel said, since he was new to ownership and unknown to them. "You do not want to get off on a bad foot with these people and not pay your bills, because you're going to be put on credit hold real quick. With CPO it was an agonizing thing, because CPO's a pretty good size store here. When I started fresh, the credit limits went way down."

Credit terms changed immediately. What were previously 60- to 90-day terms went down to 30; what were $10,000 credit limits suddenly were $5,000, Erdel said. With the credit limits going down and the payment requirements going up, "there was a greater need for capital than what was needed by CPO in the past." With on-time payments, however, he was able to hike his inventory volume to necessary levels for the Christmas season.

Other risks

There are a host of considerations to mull over before business selection should be finalized, Axon said. Sharp buyers will want to know the local history of the business and its capitalization structure to make sure it's not over leveraged and struggling with debt.

Martin steers clear of matching clients to businesses that are in financial trouble, even though he gets calls for these, he said. People think they're inexpensive, but they're tough to get financing for, he added.

Rather than pair a potential buyer up only with a business that appears to be a logical fit, Martin shows them every business they can afford, even if it's not what they called about. This leaves the decision entirely to the client, he said.

"Somebody might not want to own a liquor store or a bar for personal reasons, whereas the next guy that comes in doesn't want to own anything else," Martin said.

Martin's experience has been that the majority of buyers he works with acquire something different than what they initially contacted him about.

Workable financing is essential for the would-be buyer, Axon said. Payback schedules, interest rates, whether the business is owner-financed or handled through a commercial lender all contribute to how the deal will play out in the end. If payments are too high, it reduces the likelihood of long-term success, he added.

Sometime serendipity

In May, Jan Gammon became the sole proprietor of Paper World, a shop specializing in paper products, writing implements and related merchandise. The store is at 2726 S. Glenstone in Brentwood Center. She bought it from Jennifer Baldwin, who was closing shop after nine years.

In Gammon's case, there was no business search.

"It came to me, actually. I didn't go out and search (for) it," she said, having been a frequent patron at the store. "When I saw that she was having her closing business sale, I panicked." For Gammon, the decision to buy was determined by her interest and appreciation for paper products; she had no previous retail experience.

Before presenting businesses for people to consider, Axon evaluates their backgrounds and work resumes. Just because a white-collar, behind-the-desk, keyboard operator enjoys weekend yard work and tearing down a lawn mower doesn't mean buying a hands-on repair service is the best fit.

From the inside

While dealing with the financial side of business operations was made easier from Gammon's previous accounting experience, managing inventory, product ordering and mastering her computer system were all an education for her. "(It was) a real learning curve at first. There's more hours involved than what I anticipated," Gammon said.

Determining what operating funds were necessary, Gammon estimated what Baldwin had in inventory prior to the sale and started with that amount. She's been able to handle any reorders since then through current sales, she said.

Erdel was most surprised at how the credit terms vendors made with him as a new business owner created a challenge to keep his store sufficiently stocked with merchandise. Most people are unaware of the variables involved in acquiring and operating an existing business successfully, he added.