How to Buy a Business - A Case Study
Anatomy of a Successful Small Business Purchase
Although the names, location, types of businesses and other details have been changed for confidentiality purchases this Hub reflects real transactions in the world of buying and selling a business.
Susan, 45, had been employed in the corporate world for 15 years and had done well, worked hard and gotten good performance ratings. She felt like she would be with her company for a long, long time. She thought that right up until the moment when, on a Friday afternoon, she opened an email from the company CEO stating that the company had just agreed to be acquired and more details about what that means to individual employees would be forthcoming in the next few weeks and months.
This news wasn't a total surprise since there had been rumors for months but now it was real. Susan felt like her group might get consolidated and that, though she might survive, she was fairly certain that would require a move for her family. However, within weeks it became apparent that no one in Susan's group was likely to survive the merger and now they were just waiting on the details of a severance package, if there was to be one.
Susan began as many in her situation often begin, she updated her resume, did a quick analysis of her current financial situation and started thinking about where she might look for another job. She started going through her contacts and she quickly found out that another job at her pay grade was likely to be very difficult to find. In addition, she wondered what would happen if her job search went on for months or even years, would she need to use up her savings and 401k money just to live on while she was looking for work?
What other options did she have? One of her contacts asked her if she ever consider owning her own business. Susan had only occasionally given it a brief thought but decided to investigate it more closely.
Susan's financial situation wasn't great but wasn't terrible either. She had some liquid assets (about $30k cash), not much debt, pretty good credit and her 401k plan had about $125k in it. She considered her 401k sacred and had no plans to touch it until retirement. Susan's salary was $90,000 per year with the occasional bonus....although there hadn't been one for the last two years.
Susan had no idea how to find a business to buy or what questions to ask when buying a business so she did the obvious, she googled Buy a Business Houston Texas.
That's how Susan found us.
Arthur had owned his small manufacturing business, XYZ, Inc, for 30 years and was comfortable. It had been a good business for him. Arthur had recently turned 68 years old and, although he had hoped otherwise, his children had their own careers and weren't returning to run the family business.
Arthur was talking to his accountant about his taxes and mentioned he had had some health problems. His accountant asked Arthur if he intended to run the business until they carried him out on a stretcher or did selling the business make more sense for him? After talking with his wife Arthur decided selling the business was the right thing to do. He could get the value of his business to fund his retirement, relax, travel more and enjoy his family.
Arthur told his CPA he was ready to sell and his CPA referred Arthur to us.
That's how Arthur found us.
XYZ Company is a light manufacturing business that makes a variety of small parts used in the transportation industry (trucking primarily). Arthur hadn't really worked on growing the business or increasing the sales for the last 10 years. He had a variety of regular customers and didn't have any organized sales effort. At this point in his life he felt like growing the business would be more work than he wanted to do. He liked his 30-40 hour work week.
- XYZ did $1,200,000 in annual sales most years and didn't vary much from year-to-year
- XYZ's net profit available to Arthur was consistently around $180,000 per year. This $180,000 is often called Seller's Discretionary Earnings (SDE) because it includes Arthur's salary and all of Arthur's substantial benefits. Many of these benefits are in pre-tax dollars so they can't be directly compared to a salary that might be earned from working as an employee at a big company.
- XYZ didn't have any debts other than what was normal accounts payable owed to various material suppliers.
- XYZ was located in a leased building and Arthur did not own the real estate but leased it from a third party landlord.
- The Asking Price for the Business was established after analysis and was set at $675,000 - FYI- How we determined the asking price is too long for this post and I'll create another Hub to describe the business valuation logic and methodology.
How to Get an SBA Loan to Buy a Business
Susan came to us looking for a business to buy and based on her experience, skills, lifestyle and financial capability we decided to present XYZ company to her. (Here is a post about Confidentiality when buying a business). Susan liked the industry and the business location. We provided her with some high level financial reports for her review and Susan decided she wanted to look more closely at this opportunity.
We arranged for Susan and Arthur to meet to tour the business and for Susan to ask Arthur all the questions she felt were important. After due diligence was conducted, research and negotiations the final transaction that was completed and Susan purchased the business which she still runs today.
Selling price $655,000
Susan's down payment was $110,000 which she obtained, tax & penalty free, from her 401k plan.
Susan received an Bank Loan with an SBA Loan guaranty for $605,000 (the bank included some working capital to assure Susan's financial comfort). Terms: 10 years @ 6.0%.
Note: The SBA Loan of $605,000 and Susan's $110,000 add up to more than the purchase price so that Susan would have adequate working capital to operate the business after the purchase. At closing she had cash of $715,000 ($605,000 + $110,000) she then paid the seller $655,000 which left her with $60,000 cash ($715,000 - $655,000) in her banking account at closing.
- The business was earning $180,000/year.
- Susan's bank note payment is $80,000 per year. The business, technically not Susan, is paying off the SBA loan through the $80,000 a year payments.
- Earnings available to Susan in excess of debt payments = $100,000/year ($180,000 - $80,000)
- On a straight line basis Susan is building $60,500 per year in equity ($605,000 divided by 10 years). That's a 55% investment return per year on Mary's equity of $110,000, I doubt you can get that kind of return over 10 years in many other investments. Susan's investment is her $110,000 from her 401k Plan and her management ability to successfully operate the business.
- Susan was able to immediately replace her $90,000 per year, fully taxable salary with $100,000 per year of income that had significant tax advantages and can increase based on her decisions, not someone else's.
- Susan had no worries about being laid-off ever again. She did now have a business to run that comes with it's own worries but at least Susan feels like she is in complete control and can manage any problems successfully.
- When the day comes for Susan to sell the business she expects the value of the business to have far outgrown the value of her $110,000 had she left it in her 401k plan and relied on the luck of the stock market. Susan, like Arthur before her, is now in total control of her retirement investment.
If you have the skills to operate a successful small business the financial rewards can be tremendous.
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