Advice on business purchase

Discussion in 'Growing and Managing a Business' started by getupandgo, Apr 5, 2011.

  1. getupandgo

    getupandgo
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    Hi.

    I've been presented with an opportunity to purchase a laundry business and would like a sanity check on a few things.

    I haven't seen the formal accounts yet but these are the figures that I have been given.

    The asking price is €75,000 which basically includes 7 machines (2 washing machines, 2 dryers, 2 ironing rollers, 1 steam ironing station) and the goodwill. The machines are all over 4 years old. There is no lease it's just €850 per month on a five year contract with the landlord. I'm told the landlord would renew or extend the contract if I required.

    Turnover
    2007 - €70,356
    2008 - €82,718
    2009 - €90,210
    The current owner has only owned the business since August 2010 and their turnover for 2010 August to December is €32,183. I haven't seen or been given and figures for 2010 Jan to July but have no reason that there would be anything sinister about them. There is a genuine reason for the current owner wanting to sell after such a short time of owning the business.

    There is a vehicle registered to the business but they want an additional €12,000 for it so I'll decline that.

    The business currently has 13 commercial clients which should stay on.

    Annual overheads are €33,454 which include the wages of one full time staff and one part time staff but do not include any wages for the owner. The owner does not work in the business, just cashes up at the end of each day. I will initially be relying on the business for my source of income.

    If I purchased this, I would be using my own cash, so no loans.

    I have a few ideas of how I could improve turnover but would need to validate them to make sure they would work in the real world.

    So my questions are.
    1) On first glance do the figures stack up? I've never purchased a business before so I'm not sure how a business's value relates to turnover or profits. It seems that I'm basically just paying for goodwill.

    2) As the machines are all over 4 years old, would these already have been depreciated off in the accounts so effectively don't add any value to the business or do they still have a value as an asset? Brand new these machines are worth €40,000. I'm still in the process of finding out their secondhand values.

    3) In my mind a business should make enough profit to repay the investment within 3 years. Is that realistic thinking?

    4) Is there anything I should specifically be looking out for in my due diligence?

    Many thanks and I look forward to hearing your views.
     
  2. firstchoicecar

    firstchoicecar
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    On your question #2,yes they have still value.Since this machine is already 4 years old it should be depreciated.
     
  3. ArcSine

    ArcSine
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    Just random observations, in no particular order...

    • The current owner's 5-month revenues are only ~76.8K, annualized. This runs contrary to the 3-year growth trend. Have you looked into that?
    • Whether or not the machines have been fully depreciated on the books is irrelevant in determining the value of the business. More relevant* is their current market value, which you said you're investigating.
    • With the machines having seen 4 or more birthdays, you may need to add some repair and/or replacement costs into your expense forecasts.
    • But going with just what's given, there's about 85K / yr in revenues, and ~ 44K / yr or so in expenses. That's roughly 41K a year in profit. In turn, that's ~ a 55% annual return on your 75K investment....none too shabby!**
    • The "rate of return" methodology in the preceding point is usually a better way to look at it, vs. the "payback period" you ask about. It's helpful to mentally figure how long it should take to recoup your investment, but don't rely on that as your primary valuation methodology...it has significant shortcomings.
    • Supposing the landlord chooses not to renew at 850 / month, research the market rates in the area to see what your rental expense might jump to if Landlord decides he needs to "reprice" the deal to more of a market rate.

    * The relevance of the machines' current used-market resale value isn't so much to the value of the business as an ongoing concern, but rather to give you an idea of how much of your 75K you could recoup if revenues went disastrously off a cliff, and you had to close up shop.

    ** Technically, some part of that profit is just paying you for your time and effort in managing the biz, and hence shouldn't be counted in the "rate of return" calc. But you indicated that it's an operation you can manage by remote control, and I've assumed your time and effort to be negligible in this quick calculation.

    Repeating a bit, but specifically addressing your first question: A business's value (assuming you're planning on operating it rather than liquidating it) relates much more to its net cash profits, than to anything else. So the most critical aspect to determining its value is to forecast the expected revenues and expenses as best as you can. This would usually include a variety of scenarios (e.g., sales up, down, sideways; expenses higher or lower than expected; all that stuff).

    That then segues to your fourth question...your DD should include whatever investigations and verifications you need to pursue in order to feel that your turnover and expense forecasts have a good amount of reliability in 'em.

    For example, you mention that the existing base of 13 commercial clients should remain in place. You don't have to sell me on it; just make sure that you have actually seen something that has you strongly convinced of it. The loss of just one or two key customers can really torpedo profits.

    Here's hoping your DD finds the historical financials to be spotless, and that the seller has no dirty laundry! (Sorry, couldn't resist....)
     
  4. Fergal

    Fergal
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    Welcome to our Business Forum getupandgo, thanks for posting your business questions and I'm delighted to see that ArcSine has already given you some excellent advice.

    One thing I would add is a suggestion is that you ask to view the bank accounts of the business. This would help give you a good understanding of how the business is operating financially and whether or not the owner has been able to take money out of it. Unfortunately owners who plan on selling a business can massage the formal accounts to some extent, to make the business appear more successful than it really is - I don't mean to suggest that the current owners are doing this, but it is something you need to be conscious of nonetheless.

    Have you done some analysis to estimate how much it would cost you to set the business up from scratch and to compare those costs with the selling price of the existing business? It is often worth paying more for an existing business because you are getting access to the current customers and the goodwill. However, it is very beneficial to kno how much more you are paying and to evaluate whether or not you are getting good value in return for this extra investment.

    I'd echo what ArcSine said and also recommend that you investigate why the business has not continued to grow in 2010. It would also be helpful to get the missing figures from 2010 and to look at the sales the business has been achieving for the first three months of this year.

    You should probably have a legal professional take a look at that contract and give you an expert opinion on it. The last thing you need is to purchase a business and then find out that the landlord demands you vacate the premises.

    When speaking to a legal professional also ask him / her about any legal issues that you could inherit by purchasing the business. Try to find out if there are any legal actions or proceedings relating to the business.

    Again to echo ArcSine I'd recommend that you test that assumption. Do some research to see how long those clients have been with the business and if the turnover from each of these clients been increasing or decreasing in recent times.

    Good luck with it all and please do post back to let us know your thoughts and how it is working out for you.
     
  5. smith360

    smith360
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    You have to be up front and honest with yourself when you are going to buy a business; you've got a lot of homework to do!
     
  6. flintheart

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    Arcsine and Fregal has explained almost everything that you should esquire about. I agree with them on the point about analyzing the bank statement for the business and about the clients. It is must to see the profit or loss from the existing client.
     
  7. getupandgo

    getupandgo
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    Thanks for the replies. Some good points raised by Arcsine and Fergal.

    To answer some of the questions raised:
    The current owner's figures when annualised don't look that good because they are the winter month figures. The business is located in a town that is swells dramatically during the warmer months (May to Sept) so this is when most of the money is made. E.G. Aug 2010 taking were 12K, but Dec 2010 was only 3K so I think they are on target of coming close to the same sort figures as the previous owner did in 2009. I have requested the figures for the last quarter to see if the what the trend is.

    Retaining the current commercial clients is a concern as most are restaurants and in this market the umber of restaurants closing is quite high, although saying that the ones that are clients are old established businesses. The contracts with the commercial clients are just rolling contracts on a monthly basis. I do intend to expand the commercial side but that is all speculation and finger in the air guesswork as to how much business I can get.

    My main concern is being able to recover my investment within a reasonable (3 years) time. So the business should pay for itself after I have taken a wage.

    Fergal, I did consider the idea of opening from scratch and did some very rough calcs to see what it would cost. At the end of the day I could probably start up a little cheaper (using secondhand machines) but then would have to go out and find and train staff and develop a client base so at the end of the day may be no better off and would take a year if I'm lucky to build it to the same size.

    I'm still trying to get an indication of the value of the machines and doing my projections and forecasts based on the info I have. If it looks like it may be a viable business then I'll request formal accounts to firm up the figures.
     
  8. Fergal

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    Good to hear back from you getupandgo, thanks for that. Sounds like you have everything under control and I look forward to hearing more updates from you.
     

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