Buying a woodworking business

[Erik Loza]

Less risk with 40 tiny customers than 4 large ones.

This is my thought, as well.

Being in the business, I have seen/heard a lot. Let me float out there another scenario that I have seen happen a number of times. Employees leave and take all the accounts with them. Or worse, the guy who sold the business suddnenly "starts a new venture" and guess where those accounts go? Again, not saying this will happen. Just that I have seen it before.

Erik

[Kent Adams]

This is my thought, as well.

Being in the business, I have seen/heard a lot. Let me float out there another scenario that I have seen happen a number of times. Employees leave and take all the accounts with them. Or worse, the guy who sold the business suddnenly "starts a new venture" and guess where those accounts go? Again, not saying this will happen. Just that I have seen it before.

Erik

Very true about taking the accounts. When you invest in a business with primarily 4 large customers, you're really investing in those companies and if you don't know their financials, you're really blind on the investment. That's why the bank won't consider their A/R, the bank has no way of determining the credit worthiness of those vendors.

[Mike Schuch]

I'd ask to do a full analysis of this guy's books, bank statements, taxes paid, etc. before getting too invested in this.

I have studied many small business valuations (medical /dental practices) from accountants and lawyers. I have yet to see a single one worth the paper they were written on. A valuation is just ones persons opinion and that is all it is... just an opinion! Please don't make the mistake of believing a valuation just because it was done by an accountant or lawyer. Read the small print on every valuation that says you can't sue even though they just pulled all the numbers out of their butt!

[Larry Copas]

I went to a bank repo auction of a mouldng company last month. Weinig Unimat 30 EL moulder, Diehl SLR, Cemco 36” WB, and Goodspeed Intorex CNC lathe were the major machines. Enough other machines to fill I would guess a 15,000 or bigger square foot building. Machine condition ranged from fair to good. Buyers were other moulding companies and the scrappers. The equipment went for a few cents on the dollar. A guess on my part, but I think 30K would have bought every machine in the place along with a few thousand knives and a big parts inventory.

The first thing to be auctioned off was the building and grounds. No serious bids so the bank kept it.

[David Kumm]

The reason for asking for tax returns is that financials can say anything and few small businesses have a good double entry set of books at that size. What is reported to the IRS is what a buyer is willing to pay for. If the seller tells you he makes more than he reports, don't believe him or pay him for it. Businesses that small often utilize realtors to sell but they usually overprice and overpromise. Better to deal directly with a seller. My point regarding the schedule C is to understand that the seller's salary is included in the profit number. Often sellers think they should get paid a multiple of that profit rather than only the excess over an appropriate wage. If a corporation, it is seldom that a buyer is willing to buy the entity but rather buys the assets and forms a new entity. Usually LLC or maybe an S corp. Accountants get paid more for doing S corp work so beware if they recommend one. A corporation is usually the last option for businesses of that size. Dave

[Greg R Bradley]

.....Another red flag, if I were the buyer is the amount of free cash flow he's quoting you. Is this over his current 12 months or does this go back 3 years? He's selling less than 1.5 x EBITDA. If my EBITDA is $200k a year, I would sell for not less than $1 million or 5x EBITDA.

..... I'll offer a strong opinion, based on 25 years financing businesses, this guy is either a liar (about his free cash flow) or is a moron if he's selling it that cheap. My bet is he's a liar and is probably only making $75k tops if I'm being generous, more likely $30-$50k a YEAR.

Kent,
As an investment banker, can you find anything wrong in the following logic?

If he is making $75K per year then that is really only a reasonable SALARY for the work he is doing. The profit of the business is then zero. The value of the business should be based upon zero profit because a buyer that can't do that job would have to pay someone $75K to do it and even be lucky to find someone that would do it well. Nobody pays $300K to buy a JOB at $75K with the risk of making less or loosing it all and going broke.

[Kelby Van Patten]

If my EBITDA is $200k a year, I would sell for not less than $1 million or 5x EBITDA.

You lost credibility here.

Very few small businesses sell for a 5x multiplier. 2x-3x is the norm.

http://www.allbusiness.com/the-essence-of-business-valuations-part-iii-the-price-multiple-4967438-1.html

http://www.thebizseller.com/business-valuation-model.htm

There are plenty of other resources on the subject, but they all say the same thing.

[David Kumm]

EBITDA is a favorite term now and used as a one size fits all approach. In an equipment heavy business, depreciation can be a reasonable estimate of normal replacement costs. If depreciation is disregarded in valuing a business, capital replacement cost must be substituted for it or plans for failure should be formed early. Dave

[dirk martin]

This is my thought, as well.

Being in the business, I have seen/heard a lot. Let me float out there another scenario that I have seen happen a number of times. Employees leave and take all the accounts with them. Or worse, the guy who sold the business suddnenly "starts a new venture" and guess where those accounts go? Again, not saying this will happen. Just that I have seen it before.

Erik

He's building a new house, and moving out of state.
His customer's are local.

[Kent Adams]

Very few small businesses sell for a 5x multiplier. 2x-3x is the norm.

http://www.allbusiness.com/the-essence-of-business-valuations-part-iii-the-price-multiple-4967438-1.html

http://www.thebizseller.com/business-valuation-model.htm

Kelby, I'm not familiar with those websites, neither of which appears to have any resources. However, my experience is in financing business acquisitions, not writing for blogs or websites. Multiples are industry dependent. Try to find a business to buy that is highly profitable at a 2x multiple. If those deals exist, they don't make it to my desk because there is no need for financing if the acquisition costs can be repaid in 24 months. BTW, I don't think they exist (highly profitable businesses selling at a 2 multiple). Your mileage may very and your certainly welcome to believe the opinions of the authors on those websites.

In our OP's scenario, the seller says he has $200k net free cash flow a year and is willing to sell at $300k. That's not a reasonable multiple under any circumstance I can think of, but its closer to the multiple pushed by that website than it is to mine.

[Kent Adams]

EBITDA is a favorite term now and used as a one size fits all approach. In an equipment heavy business, depreciation can be a reasonable estimate of normal replacement costs. If depreciation is disregarded in valuing a business, capital replacement cost must be substituted for it or plans for failure should be formed early. Dave

EBITDA multiples have been around as long as I can remember, but its not a one size fits all and the multiple has a lot to do with the industry. Some industries have higher multiples. Regardless of equipment, a buyer should be looking at future cash flow, and have the reserve required for capital expenditures when and if needed. Straight line depreciation is one way, a good one, to judge future capital requirements. The buyer should consult a CPA for that, because just looking at depreciation expense on equipment from the tax return may not yield an accurate value of the equipment because of accelerated depreciation that's been allowed over the last several years.

[Kent Adams]

Greg, there are rules around owner salaries and what can be declared reasonable by the IRS. W2 wages can be taxed at a higher rate than dividend distributions an owner might take. This is one reason why S Corps came into more favor after 1986 than C corps and its rare today to find a closely held business that is a C corp.

Salary without a net profit for future capital expenditures would not be a business I'd want to buy. There needs to be profit after the owner pays himself so he can reinvest that money into new equipment and keep up with increases in fixed costs.

[Robert Engel]

You've gotten some excellent FREE advice by a couple very knowledge sounding people.

First, I'm no Donald Trump, but I own a personal service type business where "I" am the business.
Second, don't think you don't have any competition. Clients will desert you in a heartbeat and go to the cheaper guy.

All I would say is:

1. Due diligence + Trust but verify. Don't try to do this yourself. Don't get awed by the machinery. You need a CPA, a banker and a lawyer.

2. Are you just looking at $$ signs or is there a fire in your belly about this venture? If you're just doing it for the money you will never be happy.

Would he be willing to lease the business to you for, say a year?

[David Kumm]

Kent, you and I are saying the same thing but you are much clearer. My point is to be beware of one size fits all approaches. Find good people with expertise to judge the particular situation. The key is finding good people as there are lots of bad accountants and advisors. Better to pay extra for a successful one. If an accountant is too dumb to know how to make money for himself, he is unlikely to make much for you. Dave

[Val Kosmider]

The selling price includes all machinery, but not the building.
.

So, there's another good piece of change...plus the cost to move everything and set up a new operation....downtime...gives customers a GREAT opportunity to bolt. Assume you are going to lose at least one due to changeover--guy who has stayed with the owner, even though his pricing or whatever was not as good as another offer....and now that the door is open, out he goes.

You will be fine...just be smart first.