Here’s an email I received yesterday from a reader:
I am writing to get your advice (or maybe the advice of your readers) on how to go about buying out the current owner of the company I work for, or going out on my own.
Some history of the company I currently work for:
- They are a small communications company with less than 20 employees.
- The have been in business for close to 25 years.
- I have worked for them for 15 years.
- Current owner is nearing conventional retirement age 60+.
A little about me:
- I’m in my late 30’s and married. My wife is 2 years younger than I am.
- I have 3 young children.
- My wife works in Healthcare and makes $50,000 a year.
- I make between $55,000 to $65,000 a year.
- We have no debt, except our home and plan to have it paid for in 3 years.
Questions I have:
1. What is best way to approach owner and ask about buying him out?
2. If they do agree to sell, how do I figure out what company is worth?
3. Financing?
I’m posting this because I think our collective knowledge can help this read out a bit. I alone don’t have the experience or background to answer these questions by myself in a comprehensive and meaningful way.
I do have some general thoughts on the questions above:
1. I would approach the owner by telling him how you love the business, the company, the people, and what he’s created. I’d also say that you’re looking to grow/expand your responsibilities with the company (who can fault anyone for that?) and was wondering what the future might hold for you.
I’d then say something like, “In particular, I was wondering what your retirement plans might be and if you’d ever consider selling the company? Depending on what your vision for it and retirement is, I’m sure we could work out a deal that would be benficial to both of us.” Then I’d let him talk and go from there.
2. As for how to value the business, I Googled it and came up with the following:
The way I am most familiar with is the multiple of cash flow method. For example, if the business cash flows $100k a year and similar businesses are selling for 5 times cash flow, then $500k ($100k * 5) is a fair price. Of course there are a TON of factors that can make that higher or lower and you may need to get advice from an attorney or agent who specializes in selling businesses in your area.
3. If it was me I’d start by trying to arrange some sort of seller financing. Maybe you can pay the cost of the business plus interest to the owner over time. If he is ok with that, I’d start there. After that my next option would be to get a loan from a bank. If that didn’t pan out, you could always look for investors, but they will likely want either a portion of the business or a higher interest rate, so personally they would be my last choice.
So, ESI Money readers, what do you have to add? I know there are many successful business people who read this blog. What advice or questions do you have for this young man?
I have purchased one small business and spent three months when I was laid off from my corporate job evaluating other businesses for purchase about 18 months ago, so I know a little bit about this.
I am also most familiar with valuing the business as a multiple of its cash flow. It appears to be the most common way for what I’m assuming is a small business. You would be able to look up comparable sales in a service like http://www.bizbuysell.com or if you get to that point, you could hire a business appraiser to come up with a fair price. For financing, you have several options.
You would likely need to come up with some type of a down payment yourself, but then seller financing would be reasonable to expect for at least a portion of the sale and may be paid back over a shorter period of time, between 1-3 years maybe. An SBA loan may be applicable in this case and they will usually go up to 80% or so. They work best for traditional brick-and-mortar businesses and their rates are generally favorable. Talk to a local bank about this.
Another less understood but, I think, completely viable option, is to use your 401k or IRA balance to purchase the business. This apparently happens often. Here’s how it works. You create a c-corp legal structure. You roll your retirement funds into a self-directed IRA. Your IRA purchases stock in your C-corp. Now, your C-corp has cash. You use the cash to buy the business and you are off to the races. If you go this route, I would work with a lender that specializes in these types of loans. There is one in PA, Benetrends and another in Washington.
On the one hand, the IRA financing is risky because you are putting retirement funds at risk. On the other hand, if you know the business well, as you do in this case, the chances of losing your capital may be very low, that’s your call.
Best of luck, it’s an exciting time when you are thinking of buying a business and becoming your own boss!
When my husband went into business for himself, I ran the office part while I worked full time for a communications company. To protect myself and my husband I allotted a fixed sum I was willing to risk. I made sure I had Umbrella Insurance to protect us from losing our house. I sought an attorney and CPA to help me set things up. During the first two years we lived on my salary alone while the business was growing. He took reimbursement for his work expenses but until we had our customer base, he nor I took salaries. Instead we had the business pay us back the money we invested. We had also set it up as a corporation to protect us personally. That said, if you buy the business, could you, if need be, live on your wife’s salary alone? Is the business already a corporation? Does your boss do the books or do other employees? You probably already have a customer base so you will probably be fine and can take a salary. All the ideas others have expressed are excellent and worth consideration. How much business management experience do you have? Do you need some training? If not, GREAT! Since I am very familiar with communications industry and, later after my husband died, went into business for myself as a telecommunications consultant, I am going to assume you keep up with changes in the industry. That will be a strong marketing ploy you will want to utilize if the business does not have that already.
Donna,
Thanks for the reply.
We could live on my wife’s Salary but things would be tight.
The business is already a corporation.
The company outsources payroll and has a inside accountant(to handle day to day).
I have very little business managament experience, but am willing to learn. I open to any suggestions.
Is there a free small business counseling service near you? Do an online search for your state. I was a small business counselor within the communications company I worked for and later after retirement I worked as a business counselor at the Women’s Business Institute for a while in Maryland. Later I was executive director for our local chamber of commerce for 8 years and then retired for the second time at 61. I was 50 the first time but got bored and went back to work part time. Since I am unfamiliar with your state regulations etc , I do not feel my detailed advise is appropriate. But I am sure there are classes at a local college which will help, as well as, help via your local chamber or state. There are many free resources like SCORE or state sponsored Small Business Counseling through their economic development. I am glad you have knowledge of some of the inter-workings of the company and that it is a corporation. You are on the right track with doing research and thinking things through.
On the question of valuation – I would recommend bringing in a disinterested 3rd party to get an official valuation. There are companies that specialize in this sort of thing that are frequently used by doctors/dentists or other small businesses. They may charge between $500 and $3,000, depending on the complexity or cleanliness of accounting records, but it is money well spent to make sure both parties feel they are treated fairly.
I’d put some of the questions back on you. You have been working there for 15 years, which should make you one of the most senior employees. How well do you know the owner? Do you know what makes this person tick, and why they started the business? What is their vision for the business and are they looking to pass it on to a suitable caretaker or stay on as a passive or semi-active owner? Have they expressed the desire to retire?
Before you jump to the valuation and make any offers I’d take the time to understand the story behind the owner and the business. The reasons for running a small business often go well beyond the financial and need to be explored. I’d recommend doing your own research on valuations and comps but if the owner is looking to sell have them give their offer first and and ask them how they justify the number. This would be much more important than you throwing out a number, which could either be much higher than their expectations (meaning that you’ve left money on the table and raised their expectations) or the offer could be much lower which risks offending the owner.
This is a complex negotiation and as an insider you should have the upper hand. You will also hopefully know how the business cycles have been over the years, who the key players are in the company, and what the risks and opportunities are with the customer base and products / services being offered as well as the competitive landscape.
Good luck and get working on these answers! You can unearth a great deal but you have to spend time going through all the motivations and angles first.
-Mike
i get a feeling that this guy is not #2 in this company. otherwise, he would have a reasonable idea of the company worth by being part of discussions about company finances over this time. in that case, getting an impartial external appraiser would be very much relevant, but i’m not sure if that is affordable (only considering his salary, no idea of his net worth). another risk is that even if he buys out the company, he gets himself promoted to #1, which might mean being prepared for a lot of exits (not sure if that is the intent). i think trying to get a good idea of the current owner’s plans post-retirement would be the best start – for all you know he might continue to own it & hire a new #1.
Having purchased several businesses (and parts of several other businesses) I would encourage you to ponder a few questions (which you may have already done).
1. Is this a business you want to own?
2. What would it take to build it on your own?
3. What does purchasing this business gain you over building it on your own
4. Are there other similar businesses in the area you could look into buying (expand your options)
5. How can you deliver additional value to the existing customers (and potentially.. raise your income with the value delivered..but this is not always needed.. it can serve to lock customers in.. or other business reasons)
6. Where is the business heading currently (the good, the bad, and the ugly)
7. Will it require additional investment (getting current technology, expand offerings to keep clients etc.)