Re: Buying a business - need financing advice - Posted by JohnBoy
Posted by JohnBoy on October 21, 1998 at 19:13:05:
Whew! ok, sorry. I had to get up off the floor after reading this. If this business is grossing $330k with a net profit of $130k before taxes and has a selling price of $150k, then this sounds like one FANTASTIC deal! Why is the owner selling???
Who owns the real estate? Is it leased or owned by the seller? If it is leased, how much time is left on the lease? Will the landlord let you take over the lease? Will the landlord give you a new lease for a longer period if this lease has little time left? You say the owner has owned this for 5 years. Is he facing a new lease to sign with a hefty rent increase? This could be one reason he’s selling at a low price if his numbers are correct. Is his landlord willing to give him a new lease? For how long? For how much? The longer the lease, the better.
Does the owner have other flower shops? If so, are they all for sale or just this one? Does he have any employee’s? How many? Full time or part time? Does the seller work the business himself? With other family members like a spouse? If they work the business, how many hours a week are they working this business? Does their expenses show a salary for them as working managers? If not, this could be a reason they show good numbers. They might be doing all the work themselves and not showing any salaries for a manager or other employee’s. They would be just taking a draw against the income which shows as a profit. If this is the case, who are you going to have run the business? Yourself? If so, you need to account for your salary as an expense, not as part of the profits.
You say your current salary is $33k a year. How many hours per week do you currently work to make that $33k per year? How many hours per week will you be working this business? You need to account for your time as an employee and deduct that pay for yourself from the gross sales as a labor expense.
Lets say for an example that the seller is doing most of the work if not all of the work himself. He doesn’t show a salary as an expense. His pay actually comes out of the $130k net profit before taxes. So you go in and take his place. You end up working 70 - 80 hours per week. You are making $33k now for 40 hours per week. That’s about $15.87 per hour you make now. If you end up working the business yourself and put in 80 hours a week, you would take your current salary at $15.87 x 40 hrs. = $634.80…then you have an additional 40 hours at time and a half of $23.81 which comes to another $952.40. $634.80 + $952.40 = $1587.20. This is what you would account for as your salary working 80 hours a week to compensate what you would have made if you worked these hours at your current job. $1587.20 x 52 weeks = $82,534.40 per year. This would be an expense, not your profit if your working the business yourself. Take that $82,534.40 from that $130k profit and your true profit would be $47,465.60 per year. If you had to hire employee’s to run this, that would all be labor expenses you would have to pay out taking away from your profits.
Usually a small business would sell for around 4 years gross profits. If this $130k is his true gross profit then this thing should have a sale price around $450k - $525k. He’s asking only $150k??? Now if you take the above example and deduct your fair salary from that $130k, your true profit would be $47,465.60 per year. Four years gross profit of $47,465.60 would be $189,862.40. A lot closer to the $150k the seller is asking. Is this starting to make more sense to you now?
If you apply for a loan to purchase this business you will need to have a clear break down on all of these expenses to justify the money you will be borrowing from the lender in order for them to give you the loan.
If you have $30k to put down you could get a small business loan (SBA LOAN) to purchase this with. But since this is a creative real estate site that works in buying creatively we need to look at some other possibilities that may work with this deal.
Why is the owner selling?
He’s willing to carry 50%…what’s he need the $75k in cash for? Does he have a loan outstanding on the business?
What about the equipment like the coolers, counters, inventory, etc.? Does he own all this free and clear or have a loan against any of this? Or a lease with a buy out?
Whats he going to do with the money when he sells?
Does he lease or own the building the business is in?
If he owns it, would he consider selling it?
Whats the value of the improvements? (coolers, counters, etc.)
Depending on what the sellers plans are on what he needs the $75k cash for could leave him with facing a large tax bill at the time of the sale on this. (of course this is the sellers problem but it could be of a benefit for you to get him to work something else out) If the seller plans on retiring or buying into a different kind of business he will have to pay the entire tax on the the $150k when he sells plus recapture any depreciation he took against the equipment while he owned the business. This could wipe out a big chunck of that $75k he gets up front. The only way for him to avoid that tax would be to roll that money into another flower shop, otherwise the tax is due on the entire sale at the time of the sale.
Now if he was to “LEASE” you all the improvements as a separate equipment lease at 10% with a $1 buy out at the end of the lease, he could avoid the tax all at once at the time of the sale. This way he would only have to pay the tax as he recieves the payments each month from you.
You both should use a good attorney to structure a transaction like this. If it’s not structured properly the IRS could classify this as a covered up sale and you both could get into trouble.
Here’s how I structured the deal on the business I purchased.
The owner was asking $225k and wanted 50% down. He also owned the building the business was in. What we ended up doing was, we changed the name of the business. Basically he quit his business under his assumed name. Then he leased me the building the same as you would lease any other building you wanted to open up a business in. I took over the building doing business under my assumed name. Then we wrote up a separate lease for all the equipment. The lease was structured at $200k at 10% interest over 5 years with a $25k buy out at the end of the lease.
Technically the owner never sold me a business. He quit his business as if though he went out of business. Then he only leased the equipment to me for the amount he wanted from trying to sell his business. Since he didn’t actually SELL a business, and only LEASED me the equipment, he would only have to pay the tax on the equipment lease payments as he recieved them. No capital gains tax, no depreciation to recapture, and I walked in with 0 down.
If you end up getting a commercial loan, the interest rate will run around 9-10%. If the seller holds any paper the interest rate will be what ever you can get the seller to agree too. Usually a seller holding paper on the sale of a business wants 8-10%. But this will depend on whatever you both can come to terms on. How motivated is he to sell?