The reading level for this article is Expert
Is there a small-business owner who has never considered selling his business? Probably not. Is there an individual with some money, talent, or an urge for independence (often only the last) who hasn’t thought about owning his own business?
The number of small businesses actually bought and sold, however, represents only a small fraction of those who have felt these urges. To many people, the desire to buy or sell is only a passing thought.
Others find various ways to solve their problems or satisfy their ambitions. But sometimes an individual doesn’t follow through because he finds the prospect of buying or selling a business too baffling.
The objective of this section is to describe the process of buying and selling a small business and to establish some guidelines. It will not remove the difficulties, but it will make them more manageable.
A Look at the Buy-Sell Process
It will be helpful to take a detailed look at what happens when a business is bought or sold. First, consider some of the thoughts that go through the minds of the buyer and seller during the decision-making process.
The seller: (Before the transaction ) Shall I sell my business? What is it worth? How can I find a buyer? (During the transaction) How much shall I tell this guy about my business? Will he raise his offer? What terms shall I insist on? (After the transaction) Should I really have sold? I wonder if I could have got more money. Wonder how the business is getting along.
The buyer: (During the transaction) Shall I buy this business? I wonder why he really wants to sell. How much can I afford to pay? Where can I get the rest? How far will he reduce his price? (After the transaction ) Now that I’ve bought it, which new idea shall I try first? Should I have known that would happen? It’s going to work out just fine-isn’t it?
These are typical thought patterns. They mark the flow of decisions in the transaction. They also reflect the doubts and hesitancy involved in the decision-making.
A Step-by-Step Account
The following step-by-step description of buying and selling a grocery store is basically the story of an actual case. To make it more typical of all buy-sell transactions, some questions and problems from other cases have been worked into the account.
Bill Smith wants to buy. Bill Smith had worked several years in grocery stores in Whitton, a city of 400,000. He had started as a carryout boy and progressed through every job in a store operation.
Bill was anxious to own his own store. He and his wife were in their early forties and eager to establish a business of their own. They had saved about $ 16,000, and Bill was confident that he knew enough about grocery stores to handle the operation. His wife planned to take care of the bookkeeping.
The Smiths had followed up many leads from the classified section of the newspaper. In every case, they found the business either too run down to salvage or too large to finance. Bill had also talked to a few real estate agents who specialized in business properties. But the agents’ listings had not turned up anything that interested the Smiths.
In August, Bill learned from a food salesman that Sam Brown was trying to sell his store. Sam’s Market was a small store on the other side of town, It had been operating for many years.
Sam Brown wants to sell. Sam Brown had been thinking about selling his business for several months. He was reluctant to do it because the store had been established by his father. Yet he was finding the long hours he had to spend in the store a real hardship.
Furthermore, during the last 4 years, business had declined from a high of $400,000 gross sales to less than $200,000. The main reason for the decline in sales, in Sam’s opinion, was the competition from several new supermarkets in his area.
Finally, he was concerned about a space of about 1,100 square feet at one end of the building in which the store was located. Sam owned the entire building and had been unable to find a tenant for this space for more than 3 months. Now a discount paint company had offered him a local franchise.
Sam believed he could use the vacant space for this operation and handle the business with much less effort than he was putting into the grocery store. If he could sell the grocery business and lease that part of the building to the new owner, he would have a comfortable arrangement.
The transaction. After talking to the salesman, Bill called Sam and expressed an interest in the store. They arranged several meetings to discuss the situation. Bill learned that Sam wanted to sell in order to take advantage of the paint-store opportunity. When Sam announced that he was asking $50,000 cash and $600 a month rent, the conversation went like this:
Bill: Could I spend some time with your books?
Sam: I can’t let you do that. Most of my personal affairs are in those books. Besides, I don’t want to be giving away everything about my business to someone who might be a competitor someday.
Bill: But I have to have something to go on!
Sam: Well, you ask me what you think you need to know, and I’ll tell you – if I can.
During the discussions that followed, Bill learned the following facts about the store:
The modern fixtures and equipment had cost $60,000 new. Now 6 years old, they had a depreciated value of $30,000. The inventory had a wholesale cost of $20,000. Gross sales were running about $16,000 a month with a gross margin between 14 and 16 percent. In the past, annual sales had been as high as $400,000. The 3,900 square feet of store space appeared well organized.
From this information and his observation of the store, Bill figured that he could increase sales to $40,000 a month within a year by more aggressive sales promotion – handbills, radio spot announcements, an extra large neon sign, and more personal service. This meant, in Bill’s opinion, that inventory would need to be enlarged to $24,000.
To better the profit, which had been averaging 2.5 percent of gross sales including Sam’s salary, Bill believed the average markup should be raised from 18 percent to 20 percent. An additional increase in profit could be realized, according to Bill’s analysis, if he reduced the staff by one full-time and one part-time clerk.
Bill was unable to borrow the difference between his $16,000 savings and Sam’s asking price of $50,000. Several banks turned him down before one agreed to lend him $20,000 at 11.5 percent interest with monthly payments over 5 years.
Sam refused Bill’s offer of $36,000 but offered to carry part of the price. After several more discussions, agreement was reached on the following terms:
$22,000 unsecured note, payable monthly over 5 years at 12 percent interest.
$400 a month rent.
Bill planned to use the $12,000 cash left from the bank loan to increase inventory and provide working capital.
The store changed owners about September 1. Bill discovered that the inventory was worth only $16,000 at wholesale cost. He immediately used $8,000 to increase his shelf stock. Sales during the first few months increased to $30,000 a month, and Bill felt sure he could reach his goal of $40,000 a month. Profit, however, was running only 2 percent of gross sales in spite of Bill’s attempt to increase margins and reduce costs.
A sad ending. Six months later, the doors were closed on Bill’s Market. The remaining $12,000 inventory was sold to a wholesale outlet for $ 10,800. The fixtures were sold for $16,400. Bill was trying to find a way to pay his debts and forget the loss of his life’s savings.
Four months later, Sam still had not been able to rent the space formerly occupied by the food store. He had little prospect of recovering his loan to Bill, and he had lost over $4,000 in rental income. He was undecided what action he should take.
The Big Question
Bill and Sam each thought he had received a fair value. But the final result showed that neither one had made a right decision. Both lost savings and income. What went wrong? How do you go about buying or selling a business?
An important question? To the Bills and Sams – past, preset, and future – few questions could be more important.
A difficult question? Either buying or selling a business requires personal, financial, and management decisions. At no steps along the way are the decisions easy to make. But it will be helpful to establish the basic steps or elements in a buy-sell transaction and then to examine each of these elements.
Read on, as we will examine these elements in the next four sections of the Buying a Business Series.