Buy a business

Why should I buy a business instead of starting a new one?

Buying an existing business has a much higher rate of success. Statistics vary on this, but this holds true by a dramatically high margin, usually stating that 70% to 80% of startups are not around by year three or at best year five. Our local branch of the Business Development Bank of Canada who are the only lending source in our area for transactions that require less than $750,000 in funding recently told us that their failure rate target, that is loans that do not get fully repaid, is 4%. Their realized failure rate is less than 2%. 

There are many reasons for this. Existing businesses have proven track records and cash flow from loyal customers on day one of new ownership. They have the advantages of a position in the marketplace, mentorship from the seller of the business, more favourable financing available to existing businesses, and qualified and effective staff already in place. And, the previous owner has made mistakes that you don’t have to make because you will have access to valuable knowledge they have gained about the business.

What type of business should I look for?

There is much to consider but first and foremost ask yourself this question: “What do I want to do all day?”

To be successful in a small to medium size business, no matter the success of the previous owner, it is unlikely that you will experience the same success if you think going to work is drudgery. Don’t get caught in the trap of thinking that it doesn’t matter what the business does if it is profitable or is capable of being scaled into a multinational business that will put you on the cover of Report on Business. If you’re reluctant to get out of bed in the morning because the thought of going to work in your business repulses you, you will not meet with success. You should want to get up in the morning excited by the prospects of the day, even the tough days, because there will be tough days.

Understand what is truly involved in the particular industry or type of business you are considering. There are many misconceptions about what is required to run certain types of businesses from a day-to-day operational perspective.

Financial considerations start with another question: “How much money do I need to make to operate this business?” Note that the question is need, not want. What you want to make comes later when you have mastered your business, started to grow it and have paid off the money you borrowed to purchase it.

Your Chinook intermediary will be an invaluable resource to help you explore these and other questions that will help you find the business that is right for you.

Why is confidentiality so important to the seller?

In almost every case, confidentiality is very important to a seller. It can be damaging to a business if its potential sale becomes public knowledge. Customers may not be reticent to buy from a business that is up for sale, competitors could use the information to their advantage and/or start unsubstantiated rumours, and employees often experience anxiety which may cause them to leave. Suppliers and lenders to the business may also try to change their relationships with the business.

How do I know if I can afford this business?

We work with financial institutions as we are preparing to go to market to figure out what a reasonable down payment would look like for each business. Typically a small business buyer in British Columbia will require between 25% and 50% of the asking price in cash to complete a deal. This will vary depending on industry, company, the net worth and credit rating of a buyer and industry experience plays a part as well.

Exactly how much money do I need to purchase a business?

The answer to this question is found in the relationship of the purchase price to the amount of money available for the new owner to service the debt they incur to purchase the business.

The SDE (see below) is the amount of money available to you as the new owner. You need to pay yourself a living wage from that. You will also need to service any debt you incur to buy the business with those funds as well.

Let’s say the SDE of a business is $135,000. You have determined that you can live on $75,000 pre tax dollars. That leaves $60,000 left to service debt. It is never wise (and the banks won’t allow you) to use all of that for debt service. So, a more realistic number for debt servicing might be +/- $40,000. The length of loans for business purchases at this size are typically 4 to 5 years in length. A loan of $175,000 at 7% over 5 years services at $41,583. A business with an SDE of $135,000 will typically sell between $250,000 and $325,000 depending on a myriad of factors. Therefore, to buy this business you would need to have between $85,000 and $106,000 if you include some money for closing costs - lawyers and accountants.

How much of a down payment do I need if I am looking to finance? Can I get pre-approved?

Pre-approval for an acquisition venture is not a normal practice in Commercial Lending, unfortunately. There are too many moving parts when it comes to the acquisition of a business. Financial institutions take into account the collateral to a lesser degree, and focus instead on: industry, cashflow, business plan, experience, economic climate, etc.

They will look at each scenario differently, and the interest rate applied to the loan would be directly related to the risk rate the bank applies to each particular case. In addition, each financial institution will have a different risk appetite depending on their risk portfolio, industry and expertise. In other words, while some may be very open to financing cash flow based transactions, others are more comfortable with real estate.

As a rule of thumb, banks would like to see at least a 25% financial commitment from you (that’s a start). If the business is hospitality related (restaurant, coffee shops, tourism related) the downpayment required could be much higher, given the inherent risk that exists in this industry.

Is the price of the business fair?

Fairness is like beauty, it’s in the eye of the beholder.  Most business acquirers feel the asking price is too high, most business sellers believe they should get more. At Chinook, we try to balance the interests of both parties by relying on market based comparables leavened with return on investment capital and debt servicing calculations.

This means we try to find other similar businesses that have sold in terms of both industry, revenue and geography and then compare the subject business to those comps. This gives us a pretty good idea of range. Then we tighten that range by having the seller answer a number of questions that buyers typically ask. eg. How dependent is the business on the owner? Is there significant customer concentration? etc. Those answers inform the asking price.

Then we ensure that at the asking price of the business, a purchaser can service debt, pay themselves a decent salary, and make a return on their invested capital.

Where can I obtain financing to help me buy a business?

A variety of sources provide financing for the purchase of a business, including commercial lenders, asset-based lenders and seller financing. The availability of financing is dependent on a number of factors. The assets of the business, its historic financial performance, availability of availability, the business plan going forward, and the suitability and credit worthiness of the buyer are all typical small business lending criteria. When seller financing is used, the seller of the business takes back a promissory note for part of the purchase price of the company. That note is usually secured by the business itself and a general security agreement against the buyer. Seller financing is a good indication of the seller’s faith in the continuing operations of the business.

Why should I use a business intermediary?

Professional business intermediaries and business brokers, like those at Chinook, have experience and expertise that will help a business buyer through the many facets of a business sale. They are ready to help you keep your goals front and centre as you work your way through evaluation, valuation (which is a different matter from evaluation), negotiation, due diligence and closing. From writing the offer to helping find financing, you will find great value in working with a Chinook representative. As a plus, unless you’ve hired Chinook for one of our specific buy-side services, this is of no cost to the buyer as the seller almost always pays the commission from the proceeds of the sale.

How are businesses valued?

The value of a business is rooted in what a buyer is willing to pay. The opinions of neither the seller nor the advisor, valuation specialist, friend, business broker or someone who just sold a similar business  matter. That said, a buyer should come to the decision of how much to pay by considering how confident they are in the future earning potential of the business. After all, that is the point of buying a business. The business will have to pay for itself while paying you, the new owner/operator, as well. If you are looking at a business brought to market by Chinook, you will find that it is priced to do both of these things.

What is SDE?

SDE is an acronym for Seller’s Discretionary Earnings, and is a metric for determining the historical cash flow of a business. It is a recasting or normalizing process that starts with the net profit of a business, from either the business tax return or the year-end income statement. Simply put, SDE represents the total financial reward available to a single person who is fully engaged in the operations of the business.

What is EBITDA?

In its simplest definition, EBITDA is a measure of a company’s financial performance, acting as an alternative to other metrics like revenue, earnings or net income.

EBITDA is how many people determine business value as it places the focus on the financial outcome of operating decisions. It does this by removing the impacts of non-operating decisions made by the existing management, such as interest expenses, tax rates, or significant intangible assets and makes it possible to compare companies in different jurisdictions on an apple to apples basis.

This leaves a figure that better reflects the operating profitability of a business, one that can effectively be compared between companies by owners, buyers and investors. It is for that reason many employ EBITDA over other metrics when deciding which organization is more attractive.

What does EBITDA stand for?
E – Earnings how much money a company makes.
‍B – Before
I – Interest the expenses to a business caused by interest rates, such as loans provided by a bank or similar third-party.
‍T – Taxes the expenses to a business caused by tax rates imposed by their city, state, and country
‍D – Depreciation a non-cash expense referring to the gradual reduction in value of a company’s assets
‍A – Amortization a non-cash expense referring to the cost of intangible (non-balance sheet) assets over time

Will the employees stay on after the transaction?

In almost all cases, the answer is yes. We’ve seen very few transactions where the employees leave when an owner exits.

Will I get training from the seller? And, if yes, for how long?

Yes, normally sellers’ will offer as much training as a new owner requires. Some portion of the training is included in the sale price. Typically any extended training is offered under some type of contractual agreement.

When can I have access to the financials and tax returns?

Most often, accountant prepared financials statements are available after an NDA is signed, but tax returns are provided after an accepted offer is made. Buyer’s should work on the “trust but verify” principle, where the default position is to believe the seller, but use due diligence to ensure that everything that has been presented is true and verifiable.

What is vendor financing?

Essentially, it is the seller becoming a bank for the buyer. This is a loan by the former owner of a company to the new owner of the company.

A portion of the total purchase price is a loan from the seller to the buyer. The buyer pays back that loan with interest from the proceeds of the business on terms agreed to by both parties. Vendor financing is looked on very favourably by bankers as it gives them confidence to make their loans and, sometimes, can make the difference between getting a deal done and not. Bankers like to see 30% of the deal vendor financed, however, we typically see 10-20% vendor financing in the marketplace. Note: this varies from deal-to-deal for multiple factors.

What is goodwill?

The difference between the price of the business and the value ascribed to the assets and inventory.

Do I need a deposit?

Yes. Although deposits are fully refundable if the deal cannot be completed, they provide a loud statement of good faith from the buyer that they are in earnest and are determined to see the deal through.

How do I verify the numbers?

Verification is part of the due diligence process. You can ask your accountant or financial advisor for help, review the General Ledger (GL) information, ask for receipts for large purchases, review financial statements, review bank records, review T4 summaries, see tax returns, or review GST and PST returns. Bottom line is that you don’t proceed until you are comfortable that all information is accurate.

Do I need an attorney or accountant to buy a business?

Buying or selling a business is a complex transaction that few people encounter in a lifetime. Though technically it is possible to complete a sale without professional advisors, Chinook strongly recommends buyers and sellers each have their own legal and financial advisors, who have experience in the purchase or sale of a business.‍‍

‍Buying a business is best done with a team of trusted advisors. Feel free to get a copy of our book that discusses this. That said, it is prudent to manage your use of them to avoid unnecessary cost. Imagine the steps of a business purchase like a staircase: you plan to ascend to the top because you believe your goal of owning a successful business is there. With each step, the business in question becomes clearer. Each step you ascend has a cost to it. Take and pay for each step in turn. Don’t pay for services of a step that happens higher up the staircase until you have determined the view of the business from the step you are standing on warrants that you continue to your goal.

Bear in mind that any advisor will have his or her specific point of reference about the transaction and, to protect you, will present you with the most cautious of opinions or a string of worst case scenarios. However, you will have to make the decision for yourself. Take their advice, mull it over and compare it to your own experience. Then, with your own goals in mind, make your decision.

I do not have representation, can you recommend legal or financial counsel?

Your Chinook representative can provide you with a list of accountants and lawyers who are experienced at putting together successful business transactions.

When can I visit the property to view in person?

Typically, a visit with the owner comes after reviewing all the marketing and financial materials provided by the Intermediary. We normally work with a buyer so that they understand the operations of the business and can see themselves at the helm. We also want them to understand the reasonableness of the asking price before setting up a “buy-sell” meeting. If you as a buyer think a business is worth 200k and the seller thinks it is worth 450k, then there would be no need for a meeting as the two parties are too far apart. If you however think the business is worth 400k, then a meeting with the owner may persuade you that you’ve missed some element of value or the vendor may be persuaded to sell at slightly less than asking price after hearing your concerns.

What if my accountant says buying a business is not a good idea?

Most accountants on the buy side advise their clients that the business is overpriced.