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Buy a Business?!? That’s too Expensive!

December 5, 2013

That is what we hear from people, from time-to-time. And though we not say it directly to them, we believe that anyone that would make that kind of a blanket statement should not be in business! They do not have the objectivity and the understanding of business in general, to be successful in owning their own business.

Even as Business Brokers, we believe that there are SOME businesses that should not be purchased; they are much more cost-effectively obtained as a start-up. And there are SOME businesses that should not be sold; because of their reputation, debt, management systems, culture and other features, they would be more expensive to turn-around and make profitable, than if you a start-up of a similar business on your own.

But to make a generalized statement that suggests that ALL mature businesses are too expensive to warrant purchasing is absolutely ridiculous. It shows that the person making that kind of comment knows nothing about the costs of starting up a business.

And invariably, the person that makes that kind of statement has never considered writing a Business Plan, which is your key to understanding whether it is financially more beneficial to buy or start a business from scratch. You cannot look at a business’ P&L, or the Executive Summary about a business and make the off-the-cuff assumption that you would not buy that business. It takes careful study to determine whether that specific business acquisition makes sense.

To do a start-up, you need to understand that there are costs involved that demand your payment in advance. For example, if you are setting up a store, you will have to put at least one month’s Rent in the form of a Security Deposit, plus at least the first month’s Rent in place, at the time you sign the Lease. It can be three (3) months or so before you open your doors. So for a 2,500 square foot storefront, with a modest $25 per square foot Rent (including CAM,) your Rent can be just over $5,200 per month, and that means you would be required to have $10,400+ in place for the deposit and the first month’s Rent, then another $10,400 for the balance of those other months, prior to even opening the door. And that is just for Rent.
Utility companies will often require at minimum of a $500 deposit for new service. Telephone companies will ordinarily require a deposit, and installation of service will need to be paid either in advance, or just about the time you start your business.

If you are putting a Restaurant together, unless you lease a space that has already been set up as a Restaurant, your build-out costs can be dramatic. Retail Landlords normally provide you with a “cold, dark shell”, which means you get a space that has only minimal electricity for light, pipes that are present but not connected to anything usable, and perhaps no ceiling tiles or drywall…you have to put up your own walls! And in food preparation areas, wall linings and ceiling tiles need to be specifically manufactured for such purposes, according to most Health Department regulations. Those kinds of special materials are much more expensive than are used in most other commercial spaces. You are also responsible for putting in all usable electricity and plumbing, which is normally about the most expensive part of any Restaurant build-out. In Maryland, the kitchen needs three or four-section sinks for dishes, a separate sink for hand washing, a separate sink for vegetable washing, and a separate sink for mops. Then you have bathroom requirements, on top of all of that. None of that is cheap!

Depending upon market conditions, you may be able to delay making lease payments for three (3) months or so, giving you that time to do your build-out. But three (3) months can be a terribly short amount of time. You have not even thought about getting an architect in to look at the space, decided on appliances that will fit your space and need, getting that in and ready for installation, and then starting the build-out itself. And you probably need to pay the architect, the utility supplier and portions of the payments to the Construction Contractors in advance. If your build-out costs $150,000 in total, you will need to fork over at least 33% of that as a deposit. That is $50,000, in addition to the $20,800 already paid to the Landlord and $1,000 for Utility and Telephone deposits. That is a total of $$71,800, and you are at least three (3) months from opening your doors. If equipment does not show up, if getting permits takes time – and we have not even discussed that part of the process – and if other things occur that delay your construction process, the Landlord can (and will) demand you start paying Rent as agreed, even though you may be several months from opening. We are aware of at least two stores that are now in their sixth months of tenancy, but have not even started the build-out process because of a number of difficulties. So, there is another $10,400+ for two (2) months’ worth of delays that are theoretically beyond your control.
What about Furniture, Fixtures and Equipment (FF&E) that may be required for your business? Counters, chairs, tables, racks, computers, point-of-sale equipment, deposits on rentals or purchase prices for credit card equipment… Most of that will need to be paid in advance, unless you are already in business and have credit you can use from that source. Restaurant FF&E can be very expensive. The $80 microwave you buy for your home can easily cost $400 for a Restaurant. Signage is not cheap, particularly if it is to be illuminated because the electrical wiring is very specific and expensive. Inventory? If you are opening a Liquor Store, you could be looking at $100,000 or much more, and you will not get credit from suppliers for the same reasons suggested above.

There are a myriad of other expenses that need to be addressed, prior to opening. And all of these will need to be paid for in advance. Even if you borrow a portion of that money, you have to start making loan payments on a monthly basis, immediately. And start-up loans are not easily obtained.
And when you open the doors, depending upon the kind of business you open, the location, the competitive environment and your ability to do pre-opening promotion, the money does not necessarily roll in, immediately. Many SUCCESSFUL businesses can take eighteen (18) months or more just to break even on monthly Operational Expenses. And overcoming the original investment can take five (5) years or more.
Compare that to purchasing a mature business. There are a lot of “ifs” and “buts” and “depending ons” that have to be considered, and researching the validity of all of this is vital to the successful purchase. But IF PRICED PROPERLY, the acquisition is more easily financed and has a regular, historical Revenue that can be most frequently replicated, under proper conditions. Is it a guarantee of success? Absolutely not! Nothing is guaranteed in business. Starting your own business, even with the best planning, is not guaranteed, either.

But if the business you purchase is correctly priced and the Cash Flow is both validated and replicated by the new owner, you should theoretically walk into a positive Cash Flow scenario, almost from the first day. (Because of Accounts Payable issues, some businesses are normally characterized by a three-month or so lag in Income; so many, many businesses have some vestige of red ink in those first months. This is why people who purchase businesses can most often not go into the acquisition with no cash on hand – poor capitalization is the largest reason for businesses to fail, bar none!)

When you are buying a mature business, you are buying all of the equipment and such described above, but the “goodwill” that the business has built up over years, as well as the systems and infrastructure that that Seller has put into place, all of which is what equates to the continuation of Revenue that you – the business Buyer should enjoy. This is what you are paying for, in the way of a “premium” price.

Again, it does not guarantee you anything; but it should and in the vast majority of cases, does provide you with some semblance of assurance that the business will succeed, if you do nothing but replicate what the Seller has historically done.

Many Buyers improve on the businesses they purchase. Sellers frequently get tired or bored with their operations, and their ideas can get stale and stagnate the business. The Buyer can come in with a new attitude and new ideas that can refresh the business.

A real mistake is to take a prosperous business and do one of two things that can often destroy it. Some Buyers will look at a given business and think, “That Seller is just dumb; I am going to change everything and make a mint!!!” Or, they will simply take the historical success for granted and decide they really need to do nothing, assuming the business will run itself and they can simply put their feet up and let the dollars roll in.
Either way, people that fail frequently look for someone to blame – and they rarely look in the mirror. Those same people would almost certainly fail at no matter what business they operate. Buying a mature, successful business is not a guarantee, as we keep repeating. It is something that should be carefully considered and, if appropriate for your business concept, can make life easier, provide faster profitability and be no more expensive in total the total, long term investment to arrive at the same level of success than a start-up would offer. And frequently, it is less expensive, in the long run.

How do you know which is better: A start-up or an acquisition? By developing a Business Plan for the start-up and comparing it to specific measurement of a mature operation’s financial documentation. There is no real shortcut.

(Receive in-depth, personal consulting online, with The BAF Group’s principal at https://clarity.fm/donaldbarrick .

The BAF Group LLC is a full service Business Brokerage, with a history of more than a decade of service. Its Principal Broker possesses 25+ years of Business Sales and Divestiture. Although most of our work is involved in the Mid-Atlantic States, we have represented Sellers and Buyers throughout the Continental USA, and a number of overseas Buyers, as well. Some of our listings and additional information about us can be viewed at www.bafgroup.com. Thank you for your interest.)

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3 Comments
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