In the last two months I've reviewed two really poorly produced cash flow statements that people were trying to use in business plans to obtain financing.
I hate seeing people waste their time and energy.
Tell me this:
If I made a short online course about how to do small business cash flow forecasts correctly:
I just finished reading this great book from Jen Sincero. I give it 5/5 stars.
You are a Badass is a fantastically succinct dive into the world of self improvement via planning, reprogramming your mind and understanding the Law of Attraction.
This book contains all the best parts of five or six of my favourite books including Think and Grow Rich by Napoleon Hill.
If you're sick of your life and want to address the poor programming you likely adopted growing up and change your attitude about what is possible, this book is for you.
The actions required are spelled out simply and are easy to undertake. I've been practicing personal development for years and I can tell you that I'm adopting some of the ideas in this book.
You are a Badass will be a book that I will be re-reading every year or two.
I'm asked my opinion of attempting a turnaround play on a small business. I'll tell you what I think and who may be in a good position to succeed in such a strategy.
Transcript:
Hey everyone it is David
Barnett once again and this week I am answering the viewer question: Is it a
wise move to buy a failing business and turn it around? In my opinion, no it is
not wise at all. Here is why, there are industry associations of turn around
experts and they are successful less than half the time. My advice to everyone
out there when they go looking to buy a business is to find a business that is
profitable number one and number two does have problems that you know how to
solve. What does this do for you? It creates an opportunity where you have a
positive cash flow from day one but you are able to employ your knowledge and
skills to fix the problems and improve the business. And it is in improving the
business and expanding the cash flow that you make your big gain or profit as a
business owner.
Businesses are valued
on multiples of cash flow, so if you can buy a business that has a cash flow of
$100,000 you get in there and you fix it so that your cash flow is $250,000.
Your gain is $150,000 a year while you own the business but your real gain is
that you have increased the businesses value many fold over by that increase in
profitability. So if you bought the business for 3 times cash flow, you bought
it for $300,000 and now you have increased that cash flow to $250,000 now it is
worth $750,000, more than double the price you paid for it. So, buy a business
that is profitable that has problems that you know how to solve. So that you can
improve it, this is the safest course of action.
The only scenario that I can think of
where it might make sense to buy a failing business would be in a
strategic acquisition. So, let’s say you own a business, let’s say it is a
paving business or a roofing business or something like this maybe commercial
glass. So you own this business already and another failing competitor is going
to close if they can't find a buyer and you look at that business and you say.
If I had their customers and I got rid of all their overhead and administrative
staff because my staff can do the work and I got rid of their facility and I
got rid of whatever expenses that you can look at that you can get rid of and
add their sales to your existing business. Then perhaps there is an opportunity
for you to buy that failing business and do well with it, by doing a
consolidation between the two companies.
But that is the only
kind of scenario I can imagine where I would actually recommend someone buy a
failing business. And in that case it would be very clear that this failing
business would have no good will and you would simply be paying for whatever
tangible goods that you are acquiring; equipment, machinery and inventory and
on top of that you would probably be buying it at a discount. Because, if you
didn't buy it they would probably end up closing and going out of business and
you could just buy all of that stuff from the auctioneer later on anyway. So,
and you empathize to buying it before close would be to get the customer list
obviously and try to maintain those relations and not have a disruption in
service to the customers.
Anyway, I hope that, that
answers your question: Do I think it is wise to buy a failing business and turn
it around? No, no I don't. I will see you next time and as always if you enjoy
the video please like and share, that is how I grow my viewership and to make
sure you don't miss out on anything make sure you are on my email list and
we'll talk to you next time.
I take some time to discuss a business purchase that went bad. Why? How could things have gone better and what does the broker need to do to ensure success next time?
Transcript:
Hey
everyone it is David Barnett once again, I wanted to make a little video here
about deferred revenue or what can sometimes be called a liability hidden in
plain sight. And the reason I am making this video is because I had a
conversation with a business broker recently who was telling me about a deal of
his that had broken down and was looking for my advice in preventing this from
happening again. But first before we can get into the story let me explain to
you the concept of deferred revenue. It is basically how we treat sales for
which were paid today but we have to deliver service over a period of time.
So, I have got a simple
balance sheet here created and as you know assets always equal liabilities and
equity when you are talking about a balance sheet. Let's consider for example a
simple service business; let’s say house painting. SO for example I am going to
paint a room in your house and I am going to charge you $120 and of
course the cost of the paint that's on a separate statement, that is on the
income statement were our income and expenses are listed. This is our
balance sheet so let's say that I charge you $120 so now my cash goes up by
$120 because I have accepted this money from you and let's say that I owe the
paint store $60 so now I have got an account payable of $60. And I made a
profit of $60 on the paint job, so my owners’ equity goes to $60. So you see a
balance so $60 and $60 is $120, my cash has gone up, my owners’ equity has gone
up and by taking the paint from the paint store but not paying them yet for $60
worth of paint my accounts payable have gone up as well so they balance.
Now let's take for
example a fitness centre, so a fitness centre typically sells
membership and they might sell an annual membership let's say for 12
months and for the purpose of ease that it is going to be $120 for an annual
membership. So how do we represent that on the balance sheet? Let's say if you
were to buy an annual membership for $120 on January 1st. Well our cash would
still go up by $120 but what would happen on that day because we haven't
delivered a year worth of fitness services. Is we would have what we call deferred
revenue or deferred income of a $120. Now this can be called deferred
revenue, deferred income it depends on your industry where you are in the world
etcetera. But the idea is this is a liability for a service that we have yet to
deliver to our customer. No let's fast forward one month; what happens when we
go from January 1st to February the 1st? We have delivered one month worth of
that service, so our deferred revenue or differed income goes down by $10 and
our owners’ equity can go up by $10. The cash didn't change because we
accepted that cash from January 1st. so as time goes on this deferred income or
deferred revenue obligation, the liability associated with delivering the
service will go down as we deliver the service.
The problem is most
small businesses don't involve this level of sophistication in their
book keeping. So if you were to look at the books of most small fitness
centres they would simply record on January 1st. a sale of $120; they wouldn't
go through the process of recognizing liability associated with having to do
with the services associated with that customer or of course the year.
Now back to my story,
in this particular case it was a business that sold equipment that came with
one year of warranty protection provided by this seller the dealer; so in the
balance sheet that was presented as part of the package of information given to
buyers. There was a balance sheet that was showing the current status of the
company but there was no differed income or differed liability there. In the
documentation it said that all sales were given a twelve month warranty. So the
buyers looked at the income of the business; they looked at the normalized
income that the business broker was presenting. They use that as a basis for
evaluating what they thought the business was worth;
they negotiated back and forth with the seller and they arrived
at a price. Once, they had that deal in hand they then went to due diligence
which is the normal process. Their accountant started to investigate the
numbers and said wait a second do you guys realize that if you buy this
business and you take over the clientele you are going to spend money paying
technicians to go and do warranty work for these customers that paid the seller.
And you are not getting part of that revenue; they then went back to the seller
and said look we need you to be responsible for the warranties that you issued
for the sales that you made. And they tried several different things.
They said let's calculate
what we feel this liability is worth and we can adjust the price of the
business. They said why don't we simply build you back against the vendor take
back note at $25 an hour for the tech work for what
the technicians have to do to have to go service those warranties for
which you were paid for. They tried several different things and you know what
the seller came back and said every time? No, I am not going to compensate you
for those warranties because; the warranty was disclosed to you upfront. You should
have taken it into account when you take
your offer. So basically, we have two people that now get entrenched in their
positions and neither one is willing to budge because both feel they have sort
of the moral high ground or both think that they are right. The seller said
that he disclosed it upfront and the buyer says I didn't realize there was this
cost associated with it at the time.
The business broker is
asking me how can I get over this jam and I said one way to get the buyer and
the seller to move again is for one of them to move. So, either the buyer has
to really swallow the cost he wasn't thinking he was going to have
to inquire or the seller is going to have to agree to a lower price. Or is
going to have to agree to compensate the buyer for warranty work one to the
clients that bought before the transaction. How could have the broker have
avoided this problem? Easy, in the normalization of the financial statements
this is typically done before a business is presented to a buyer. Business brokers
and sellers are usually focused on removing none necessary expenses; like if a
business has to pay for the owner's daughter cell phone. They are quick to add
back and say this isn't a real business expense; because they are looking for
ways to enhance the value of the company. They want to show the biggest
possible income, but where business brokers sometimes fail is that they don't
look at the other side of the coin. They don't say what additional expenses is
a buyer going to have to undertake because they are in a different situation
from the seller.
Maybe, the seller owns
personal owned tools or equipment that are used in the business. Now, those
tools and equipment aren't included in the sale so a buyer has to
either buy them or go rent them for example. And that's going to impact
the income of the business; I said to the broker is that you need to normalize
that balance sheet and you need to disclose on that balance sheet that there is
a liability associated with the sales that have already been made. Even if you
have to calculate that figure on your own based on how many warranties were
outstanding and just saying on average they require five hours of labour to
maintain the warranties and using $25 an hour here is the figure.
In the case of the
story I am telling you about that calculation added up to about $30,000. So, it
was significant it was about 10% of the purchase price of the business. Anyway,
I just wanted to share with you one of these hazards that can potentially
happen in business that actually get prepaid for things that they
do. Because, it is something we are not always looking for; usually
businesses sell products and services and then have to wait to get paid but
there are certain businesses that are in this prepayment sort of category which
is great for their cash flow but has a business buyer you need to make sure
that you understand what liabilities potential you are agreeing to take on when
you buy the business.
We will talk to you
later and if you enjoy the video please like it and share
it amongst your own social networks; that is how I grow my
audience and don't forget to sign up for my email list. People on the email
list get to see things before other people and they also get access to all of
my great deals, offers etc. Thanks a lot and we will talk to you
soon.
I got an opportunity to make a small private loan the other day and ended up holding this diamond ring as collateral. My first-ever pawn type deal. Watch:
Learn more about private lending as a way to invest by reading my book Invest Local: https://gum.co/quoB
Learn step-by-step how to successfully invest in small businesses via loans and leases with my online course: www.LocalInvestingCourse.com
A great question this week about business brokers. Phil wants to know how its possible to trust a broker's advice if he's buying a business when its actually the seller that pays the broker.
Let's learn about an important lesson when it comes to building your business-buying team.
Transctipt: Hello it is David Barnett
once again and with another viewer question; this time about buying a business
and using a business broker. And the question that Phil asked is if
business brokers are paid by sellers how then can I trust their advice to me?
What a great question. And quite frankly, it depends on the kind of business
broker that you are using. Business brokers are paid by sellers and in most
places they act in a dual agency role; meaning they have both responsibilities
to the buyer and the seller. So that duty or that responsibility means that
they are supposed to give good advice to both parties. But come on let’s be
honest; if a business broker is starving and is absolutely desperate to close a
deal that person might say or do anything in order to entice a buyer to enter
into a deal. So how do you then protect yourself or off set yourself against an
unscrupulous broker who may act unethically?
The answer to that
question is by building out the rest of your team. So, on your team you have
got the broker but you also have a lawyer an accountant and you need to make
sure these people are familiar with business transactions. You
are also going to be able to get certain partnership type advice out of people
like a banker for instance who is going to look at your deal. If the banker
isn't going to make the loan and thinks it’s a bad deal he is going to tell
you. Now let’s get back to the broker, if the broker knows that you are no
dummy and you have a field of advisors that are going to give you good advice.
Then he knows that he is not going to be able to pull the wool over your eyes
and trick you into buying a business that you shouldn't buy. So,
ultimately the reason that a business broker, a good one, is going to give you
reliable advice is because they know if they try to do something unethical,
unscrupulous they ultimately will end up wasting their time because they deal
won't close; that's that.
I
learned very quickly when I was a business broker that if the buyer
wasn’t right for the business or the business wasn't right for the buyer or
there was something fishy going on with the seller. That, I just didn't want to
invest any of my time in trying to work on the deal because I knew that
ultimately it wouldn't end up happening. So, most buyers have this team
of people; the lawyer, the accountant, the banker, etcetera. All these people
looking out for their little piece of the overall deal, offering advice to the
buyer.
So, who then, can fall
victim to an unscrupulous broker who may be acting unethically? It is
the all-cash buyer; and I saw this several times with new immigrants from Asia.
They came into town with a whole bunch of money, didn't pay or didn't want or
didn't know how to find good advice. And ended up dealing with intermediaries
who weren't fully qualified to sell businesses. People like real estate agents
or some other kind of intermediary who was just trying to play match maker. And
because these people were paying all cash, there was no buffer; no other person
who could interject and stop the deal from happening. No banker that you will
that would say no to an advancing the loan.
I actually know of
several deals that were really bad deals; and the reason they got done is
because the buyer had a million dollars in the bank. You don't want to put
yourself in a position where you are using all of your own money to pay for a
business. You need to use vendor financing. I made several videos on this
channel about why vendor is a critical component in controlling risk
in buying a business. And you need to make sure that you have your own field of
team members and advisors aside from the broker. Now if you are dealing with a
good business broker; I would say yeah, you can rely on their advice especially
if they are a person who does a lot of deals. Because, doing a lot of deals
means they are going to have money in the bank; a lack of money in my
experience is the biggest motivator that people have to do things that they
wouldn't normally do, unethical things.
So a busy broker with money in
the bank is going to be less motivated to do something unethical and they are
going to have a greater appreciation for their own time. And they are going to
realize that a bad deal just doesn't get done. So, Phil I hope that that
answers your question and as always if you enjoy my videos and like my stuff
please like and share that is how I grow my audience. Thanks and I will talk to
you soon.
Talk about applying yourself.. Once Chris Pritchard read Invest Local he started looking for 'widgets' that he could sell on notes and begin building a private investing portfolio.
He decided to focus on raw land and with some supplemental training began buying low and selling on notes. Learn more by reading Invest Local and watch the interview...
This week I'm asked what amount of vendor financing is ideal when doing a business transaction. Listen to me talk about the largest and smallest amounts I've seen done on deals.
Transcript:
It is David Barnett
once again and this week the question I received was is it normal when you buy
a business for the vendor to finance to 20% of the purchase price? Now I have
done other videos about vendor financing or vendor take back notes. And this is
the first time I have had a question about the normal level of financing that
we might expect for a seller to do. The reality is that the amount of financing
that a seller has to do relates to two things; number one
how quickly does the seller want to move the business? The biggest impediment
to selling a business is the access to financing. So, when I was a business
broker and I had sellers that wanted to sell a business very quickly. I would
advise them that if they were more willing to hold more paper on the deal or do
a bigger vendor take back. Then we would likely be able to sell the business
faster.
The second
consideration involved is how many and
what kind of tangible goods are included in this business sale? The amount of
tangible goods included in this business is going to determine what kind of
traditional or institutional bank financing that we are going to be
able to obtain. So, if there are hard assets in the business such as equipment,
machinery, vehicles etcetera. Then we are going to be able to bring a
traditional bank lender in; that means we are going to be able to get more
traditional financing. We don't have to ask the vendor for as much vendor
financing; now in the question it mentions 20% but in my experience I have seen
across the spectrum. Equipment intensive businesses where the buyer had lots of
money, the buyer was able to get bank financing. And basically asked for
10%-15% vendor financing just to give them a little bit more security and to
give them all the positive advantages that I talked about in other videos about
why you need to do a vendor take back when you are buying a business.
In other cases I have
had service oriented businesses without a lot of equipment and material and
they have sold with, I have had one that sold with 75% vendor financing. So,
quite literally the buyer put in 25% and the seller finance the balance. There
was even a period of time back after the financial crisis of 2009 were we did
several deals in my business broker shop, without any banks involved at all.
They were entirely deals with buyers and sellers where the buyer would put down
money, either from saving or perhaps from a personal debt tool like a line of
credit for example. They would put down their money and the vendor would
finance the balance; and most of those deals it was between 40%-60% vendor
financing, so there is no hard and fast rule when it comes to the amount of
vendor financing that you might expect in a deal. Basically,
it's completely up to negotiation and it is important that when you
are buying a business that you ask, ask for the world. They are just going to
say no, that is fine, that is part of negotiating.
And from the seller's
point of view offering a greater amount of vendor financing can help sell the
business more quickly. But more importantly, it can help you actually sell it
for a value closer to its true value. Because, the difficulty of course is
always getting financing for that goodwill component and no bank is
going to finance a 100% of the equipment for example. So the buyer needs to
have some equity to offset what the bank is going to give him and in order for
a seller to enjoy that last little bit of value to bring the price of the
transaction up to where it should be if it is a profitable business. The seller
has to be there to finance it, there is just no other place to get the cash and
I have often had sellers tell me that they didn't want to finance a buyer when
they sold their business.
And I advise them that,
quite frankly what would happen is because they weren't willing to finance
buyers wouldn't be able to put a deal together. The business would sit on the
market for years and years and eventually the seller would start to lower the
price to the point where they would end up with the same cash on closing as
they would have if they had sold years earlier and would have been willing to
accept some amount of vendor financing. So, it is really a win win tool for
both; it can help secure the buyers position, it can help offset some of the
risk by transferring it from the buyer to the seller. I have
explained that in other videos and really buyers should be asking for as much
vendor financing as they can get. And sellers should be using vendor financing
as a way to get the price that they are after.
Anyway, I hope that answers the
question and don't forget if you enjoy my videos and you like what I have to
say please share and like the videos that is how I grow my viewership and to
make sure that you always get the latest stuff that I put out. Be sure to put
yourself on my email list. I send out an email every week.
