There may be some advantages to becoming a first-time entrepreneur in 2021. Opportunities currently exist that would not normally be available for start-up businesses. However, the unknowns that business owners face make it difficult to evaluate these opportunities. Determining the current value of an established business requires slightly different underwriting and due diligence procedures than those that are applied when markets have been stable for an extended period of time.
I am assuming that entrepreneurs/prospective buyers have experience in the industry that they select for this undertaking. Perhaps they have lost their job because of the slowdown in business, or perhaps they have always wanted to be an owner rather than an employee. The loss of a job has turned passion into a need. But what are the best options?
Buying an established business vs. starting from the ground up.
Should an entrepreneur consider starting a new business venture in her field of specialization during a pandemic? It might be advisable to consider acquiring an existing business rather than starting a ground-up operation. Let’s dig into it.
In 2021 some businesses will be offered for sale that would not have been available if we had not been faced with an economic slowdown. Current owners/sellers may have pandemic blues. Many long-time business owners may be considering retirement or they may decide they do not want to face future uncertainties. Existing businesses may be available at attractive prices.
In a stable economy a new entrepreneur might not be able to consider the purchase of an existing business because the price of the acquisition would be prohibitive for a start-up with limited capital. Pandemic blues may result in reduced sales prices for existing businesses. I suggest prospective buyers search for local businesses that match their qualifications and experience. The question that you have to address: How do you value a business that is currently losing money?
During an era of economic stability, a seller would provide a prospect with historical tax returns, a current profit and loss statements and a balance sheet. A qualified business broker can guide a seller as to how to price a business using a realistic capitalization rate. However, in most businesses, 2020 financials would not be consistent with previous years financials. How can a prospective buyer determine the right price for an acquisition when the historical financials are inconsistent and the future is uncertain?
How do you evaluate a purchase?
There are many different ways to evaluate a purchase during a pandemic. I would recommend that a prospective buyer consider an asset purchase. The review of a current balance sheet, both the assets and liabilities, will provide a capsule of what is owned and what is owed. A buyer should start by looking only at the assets; cash, receivables, and inventory in order to determine value. The buyer and the seller can agree upon the value of good will as part of the purchase price. Receivables and inventory may have to be adjusted to establish their current value, which may be less or more than book value. The seller should be responsible for all corporate debt which might include PPP and EIDL loans that have been obtained through the SBA in 2020 and 2021. In addition, there may be long term third-party debt. If the existing debt cannot be paid off, the terms of the loan agreement will determine whether the sale is a “go” or a “no go.”
I would advise buyers to prepare a three-year cash flow projection, anticipating a slow economic recovery. It is always best to be conservative when preparing financial projections, but you must also consider who the reader is. The presentation can be adjusted to the reader’s needs. The banker, the investor, or you, the owner, all have different perspectives.
Every acquisition requires the following due diligence:
A review of the existing leases: Are the terms of the lease in line with current rental rates? Most landlords do not want to lose tenants in 2021. There may be an opportunity to renegotiate lease rate and terms.
A meeting with existing employees: Will retaining them be helpful or harmful to the business?
An investigation of available financing: Many lenders are offering below market rates to buyers of existing businesses. The SBA loan programs offer loans as high as 90% of the purchase price. A borrower must have a good FICO credit score to be eligible for the SBA loans.
A review of all obligatory contracts: Insurance; installment loans; employment agreements
Good luck and stay tuned!