Considering Buying a Business? Here’s How to Analyze It.

How to analyze a business to purchaseBy William Bruce

Are you considering buying a business but are not quite sure how to analyze it?  Here’s how to do it.

First, The Need for Confidentiality

Confidentiality is critical to the successful transfer of a business.  If word gets out that a business is for sale, several things start happening and none of them are beneficial to a prospective buyer.  First, key employees start looking for other jobs, fearing that a new owner may not retain them.  In the uncertainty, customers start looking around and begin shopping elsewhere.  Suppliers get nervous.

This is why a seller or business broker will ask you to sign a non-disclosure agreement.  In this agreement, you confirm that you will not disclose the fact that the business is for sale — except to your professional advisors.  And yes, your spouse is considered a professional advisor.  After all, he/she consults with you often on a professional basis, right?  Just caution your advisors on the need for extreme confidentiality.

If you show that you take the need for confidentiality seriously, you will be regarded as the professional that you are.

The Anonymous Customer

If you’re working with a business broker, he will probably have furnished you with a summary profile on the businesses.  The profile will contain the salient points of the business including gross revenue and earnings.  The first step in analyzing the business might be an anonymous visit posing as a customer.  We call this a reconnaissance run.

As you visit, first, note the location.  Is it appropriately located for the type of business?  As you’re driving into the parking lot, what does the business look like from the street?  What about signage and street identification?  Then as you walk to the entrance, what kind of an impression do you receive?

Once you’re inside, take a close look around.  If it’s a retail establishment, are the shelves full?  Is it clean and neat  Are there customers there?  Are the employees helpful?

What is the general feeling you received from your visit?  If you decide this is a business you want to follow up on, make a list of questions for the owner.  Make this list while your visit is fresh on your mind.  Include anything and everything you’re curious about.

It’s great if the image is good, but don’t despair if it’s not.  As one of my astute clients reminded me recently as I was lamenting the poor street image of one of my offerings, “It’s an opportunity for a new owner to make a difference.”

A word of caution:  While on this visit, don’t talk to anyone in the business about the fact that the company is for sale.  Chances are the employees don’t know it’s for sale.  And even the owner would not be free to talk about it at this point within earshot of customers and employees.  Chat pleasantly about the weather … or college football!  (‘Tis the season, you know.)

The Meeting With the Owner

The next step in this logical sequence will be a meeting with the owner.  If you’re working with a business broker, he will set up the meeting at a time convenient for both parties.  He will attend the meeting with you and facilitate the exchange of information.

Be sure to bring your list of questions.  Ask anything you want to.  However, it’s usually best, at this point, not to discuss the asking price of the business or the possibility of owner financing.  That comes later.  But ask anything else that comes to mind.  Nobody knows the business better than the owner.  If you’re meeting at the business, ask for a tour of the facility.

It’s important that this meeting remains informal and cordial.  Remember, you are both checking each other out.  If the owner is going to finance a portion of the selling price, he’s looking at you as much as you’re looking at the business.  It’s a two-way street.

At the end of the meeting, you don’t have to express any commitment.  Simply say something like:  “Well this has been very informative.  Thanks for your time.  Let me consider this new information.”  It might also be a good idea to convey to the owner that the information will be kept in the strictest of confidence.  He’ll appreciate your sensitivity to that issue.

Computing Discretionary Earnings

The next step is to determine the owner’s discretionary earnings.  After all is said and done, what you will be buying is the ability of the business to produce profits.

So first let’s define discretionary earnings.  Some professionals refer to it as adjusted cash flow.  Discretionary earnings are defined as that amount of cash left over after only the necessary operating expenses have been paid that is available for (1) owner’s remuneration, (2) return on investment, and (3) debt service, if any.

Another way to express it is that discretionary earnings are the total owner’s benefit from owning the business regardless of how the owner takes the money out of the business.

Discretionary earnings are not the same as net profit shown on the business tax return.  It’s not the same because of the bookkeeping practices of most business owners.  Simply stated, most business owners make strenuous efforts to reduce any taxable income by running some expenses through the business that are not really necessary to the operation of the business.  This practice reduces tax liability but it also oftentimes masks the true earnings record of a business.

In considering a business, your challenge is to determine its true discretionary earnings.  CPAs sometimes refer to this exercise as the recasting or normalizing of the financial statements.  If you are using a business broker, he has probably already prepared a recasting worksheet on the business.

Here’s an article explaining more about the computation of discretionary earnings.

To Pursue or Not to Pursue

After computing the discretionary earnings of the business, the next step is to determine if the cash flow is enough for you.

To do this, you need a fairly close approximation of what your debt service, if any, will be on the amount borrowed to buy the business.  After all, it’s the amount left over after debt service that will be available for you and your family to live on.

Your broker will have amortization tables available for debt calculation.  Business loans without real estate generally run seven to 10 years.  With real estate, the term of the loan can be up to 20 years.

The arithmetic from this point is fairly simple.  Just take the yearly bottom line discretionary earnings of the business and subtract the annual debt service.  If the remaining balance is enough to support you and your family, then this business might be one that you would want to pursue.

It probably should be mentioned that the above calculations do not consider any increases in revenue and earnings resulting from new ownership.  Historically, a business will experience a revenue increase of between ten and fifteen percent due solely to a change in ownership.  Nor does this calculation account for any new products and services or other changes that a new owner may plan to introduce.

Now it’s decision time.  If the business is of interest to you, and if it returns the amount of cash flow you need (or can be made to do so), and if you can envision yourself successfully running the business, then you may be ready to move on to the next logical step.

If you’re ready to pursue this business, my next blog post will outline an important step: The Contingent Offer.

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

Follow William on LinkedIn.

About William Bruce

President, American Business Brokers Association / Business Broker and Accredited Business Intermediary assisting business buyers and sellers with the transfer of ownership since 1986 / Author: How to Buy a Business.
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69 Responses to Considering Buying a Business? Here’s How to Analyze It.

  1. Ken Lewis says:

    Excellant blog. We operate a payroll service company and a full lines insurance agency. We are currently looking to expand both. I would enjoy the opportunity to look at the possibilities of purchasing an existing payroll company or an insurance agency.

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  5. Rick Matthews says:

    William,
    I always inteested in your insights as I find myself increasingly in the buy-sell cross hairs as an ad hoc broker. If I am goign to help buy-sell, I need to be the best I can be. Would like a copy of your booklet. Please send to:

    Rick Matthews
    CEO, Fractional Assets, Inc.
    600 Boulevard South
    Suite 104
    Huntsville, AL 35802

    Thank you!

  6. Rick:

    Thanks for your comments. I just emailed you the booklet.

    ~Will

  7. William,

    Good article. Very helpful.

    Jim

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  11. Ted Lick says:

    Will,
    I am in the due diligence phase of purchasing a minority share of a well established restaurant which has been successfully operating for 10 years. I am seeking assistance in negotiating the buy-sell agreement, and closing the sale contingent upon financing. I am very interested in reading your booklet, as well as learning if you may be available for consulatation.

    Sincere Thanks,

    Ted Lick

    • Ted, thanks for stopping by. The booklet “How to Buy a Business in a Safe and Organized Way” has been emailed. I’m available for consultation on issues that buyers face when considering a business. In fact, this is an increasing portion of my practice.

  12. Pingback: Thinking of becoming a business broker? Looking for business broker training programs? | William Bruce on Business: A Discussion

  13. Keith says:

    Ted, Good blog. Will you send me a copy of the booklet “How to Buy a Business in a Safe and Organized Way.” I am also considering buying an existing business and having trouble understanding how to assess the ability of the business to support the information the owner is providing me.

    Thank you,

    Keith

  14. Keith says:

    Sorry for calling you “Ted” obviously I meant William.

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  16. Can you please send me your booklet? I am just getting started in looking at an existing business that I am interested in buying. I may reach out to you for help if I pursue this.

  17. Tarun Bhalla says:

    William,
    Your articles are very informative. I am in the process of diligence for a franchise sub restaurant as well as a UPS store. I would appreciate a copy of your booklet, too.

  18. Marcelo zagia says:

    Hi.
    Great article.
    Im looking to buy a gas station. What shoyld i consider? Could you email me the booklet
    Regards
    Marcelo

  19. Nick C says:

    I’m looking to buy a business. Can I get a booklet? Thanks.

  20. Mark says:

    William, I’d love a copy of your booklet.
    Mark

  21. Karla Brennan says:

    HI William,

    I came across your website and articles. Very informative. Can I get a copy of your booklet.

    Thank you,

    Karla

  22. Simmonie Gordon says:

    I’d love to get your booklet. I’m looking at several business opportunities and I really appreciated this article. Thanks for taking the time to share your wisdom.

  23. Suzanne D. Fox says:

    Mr. Bruce,
    I am seeking to purchase an existing business in the healthcare business . I am new to this and want to seek best advise and read as much so I can make the best decision . Would you please send me you booklet . I have been reading your articles and may need your assistance for consultation .

  24. Barney says:

    William,
    Enjoyed your articles. I would appreciate a copy of your booklet.

  25. Benson says:

    Very insightful article. I’m in the early stages of exploring the possibility of purchasing an existing restaurant and would like a copy of the book. Also are you able to provide services in the North east region

  26. Magdalena says:

    Hi, i would like your booklet too, please.

  27. Trang says:

    Hi William. Very enlightening… I would like to learn more in detail and would like to see your booklet so I can make a better educated decision as a business person. Your assistance is much appreciated. Continue in doing great things. Cheers!

  28. Giri says:

    Hi Willam
    I am in process of becoming partner in business, this blog helped me understand basic knowledge. If i am not asking too much could you ps. share book.

    Thanks
    Giri

  29. Sunny says:

    Hello William, very Informative article. We are starting to learn more about available business opportunities in Southern California region, do you provide your services? Appreciate your time and if you can send us copy of the booklet as well. Thank you,

  30. Kevin Noell says:

    Hi William,

    Thanks for the valuable info. Could you please share the booklet as I am considering buying a restaurant business in TX?

    Thanks,
    Kevin

  31. Terrence Smith says:

    Hi William,the information you shared is great can you send me a copy of your booklet also.I may need to consult with you for more soon.Thanks Terrence

  32. William:
    Very good article. I enjoy your blogs, should do more myself.
    Leon Parker, CBI
    New Hampshire Business Sales

  33. Steve Bromberg says:

    Hello William;
    Lots of great information here. I am trying to help a client with the purchase of a large electronics distributor and I would love to take a look at this booklet as well. Thank you.

  34. Michael Rahach says:

    Hello William,

    I would also like to jump on the bandwagon, if you wouldn’t mind sharing. Sounds like a good read.

    Thank you, mike

  35. Alex S says:

    Hi William,
    Appreciate all the useful information you share through your various blogs/channels. Would it be possible to send over a copy of your booklet?
    Many thanks,
    Alex

  36. Ravi Gan says:

    Hi William,

    It’s a very good article. Can you please send me the copy of your booklet? I am particularly interested in getting your consulting expertise too, to know more about how to do price negotiation and understanding your background in assisted living business. I am trying to buy one in Aurora/IL area.

    Thanks,
    Ravi

  37. Luis says:

    Hi William
    Good article, please send me the booklet
    Thanks

  38. Martha B. says:

    Hi, I would love to get copy of your booklet. I’m looking into buying a franchise.

  39. Caryn K says:

    Good Morning! I would love to read your booklet as we are contemplating selling multiple qsr locations. Thanks.

  40. David Wood says:

    Should be aware of sellers motive and why he tends to sell business.

    • David, thanks for dropping in. The reason for selling is important. Retirement, health issues, family friction, and even burn-out after running the business for decades are all legitimate reasons.

  41. Jim Okun says:

    Great post William, found this as I’m looking to purchase a fitness center/gym. Would love to read you booklet as well, can you send when you get a moment?

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