Buying A Small Business - Does The Purchase Price Make Sense?

When considering the purchase of a business, how do you determine if the price is sound? The following formulas can help quantify that answer.

While this is not meant to be a foolproof analysis, it can help validate the purchase price based on real-life criteria. It takes into account that you:

• need a livable salary
• will have debt payments
• will need working capital at time of purchase
• will need cash for a down payment
• should expect to receive a reasonable return on your cash investment (ROI)
• will want a safety cushion to fall back on

For a simple assessment of a business opportunity, let's assume the following scenario:

• Asking Price for a janitorial company is $500K.
• The janitorial company and the buyer are both qualified for SBA financing.
• Current Federal Prime Rate is 5.25%.
• A SBA loan can be obtained at 7.25% for 10 years.
• Working Capital needed is $25K.
• Seller's Discretionary Earnings is $178K.
• Expected Return on Cash Investment (ROI) is 25%.
• The owner is paying his nephew $20K more than a regular employee could expect to earn.
• The current owner is taking a salary of $60K.

A 20% cash injection as a down payment is a typical SBA requirement, which means $100K in liquid funds is required. Based on a $425K loan ($500K purchase price - $100K down payment + $25K working capital) at the assumed terms and by using an amortization calculator, you would find that the annual loan payment would be $59,880.


Working capital consists of operating expenses such as inventory costs, rent and utility deposits, escrow fees, loan costs, and short-term liabilities. A quick estimate of working capital can be achieved by using the Current Assets less Current Liabilities garnered from the company's balance sheet.


The Table for Seller's Discretionary Earnings delineates the owner's total bottom line benefit as a result of owning the company. This is the total non-business related benefits going to the owner and family members on an annual basis. One-time, non-recurring or unusual expenses are typically things such as a new phone system, website development, outdoor signage or moving expenses. See the Table for other items that are used to arrive at SDE.

Fair market wage is an amount that the owner would pay a hired employee for a particular job. For instance, if the owner has been paying his nephew $40K for a job a new hire could do for $20K, the excess wages of $20K would be added to the benefit column in the SDE Table. As for paying yourself a salary, you can determine what you consider fair wage for what your role would be in the company -- or you can put all of the other numbers into the equation and see what is left for salary. If it adds up to your satisfaction, then so far....so good.

ROI for the purposes of this exercise is calculated by multiplying the cash investment by a reasonable interest rate that should be expected on the investment. This is a subjective percentage and a change in this number can substantially change the result of the analysis.

Investment options, such as putting your money in U.S. Treasury bonds has little risk, therefore only 4.5% interest is received. The stock market option, on the other hand, has a higher risk with a higher average ROI of 11% (source: Ibbotson Associates). Venture Capitalists investing in risky internet start-up companies might look for 45%+ ROI. None of these options, however, puts the investor in the driver's seat -- there is absolutely no control over the performance of the funds in which they invest.

Historical data indicates that a 25% ROI is reasonable for a medium to low risk small business acquisition. The greater the risk of the business, the higher the rate of return should be.

As evidenced by the 25.8 million small business owners across this country (source: US Small Business Administration), there are many people who choose to have complete control over the ultimate success and performance of the money they invest through business ownership.

Let's plug all the numbers into the Final Analysis Table to determine the soundness of the purchase price of the business opportunity at hand. The return on the cash investment was calculated by multiplying $100K (cash down payment) by 25%.


After deducting wages, debt service, and a return on your cash investment from the earnings, the business still generates $33,100 in additional funds to take vacation with the family, or increase marketing efforts for the business. You almost have enough to hire a manager to run the business for you. Now would you buy this business under these circumstances? It would appear, yes!

Of course this is a simplified assessment and not all factors are considered, such as growth potential, equipment condition, and other issues that should be considered when determining risk and working capital that might be needed to keep the company viable and growing.

Houston From A Chicago Point Of View

I found this post by Chicago Addick interesting and comical as he describes the wonders of Houston from a Northerner's point of view. The writer seemed amused, amazed, appreciative, and condescending all at the same time:

Houstonians spend more time in their cars than their homes and perhaps then understandably spend more money on their car loan repayments than their mortgages! Houston sprawls for over 600 miles and is connected by a spaghetti of freeways and highways.

Two million people live in America's fourth biggest city that grew from wilderness to a booming economic centre. Only New York is home to more Fortune 500 company headquarters.

In 1901, a year after displaced Texans from coastal Galveston moved inland to Houston following a deadly hurricane, oil was discovered at the Spindletop oil field near Beaumont. Much money was then invested in the ship canals and later into the formation of the Port of Houston, now the largest in foreign imports in the US, which includes nearly all European cars sold in this country.

In 1950 Texans found air conditioning, something that if it were to disappear tomorrow, then so would Houston. With air conditioning came an impetus for companies and employees to migrate from the cold manufacturing 'Rust Belt' states such as Ohio, Michigan and Indiana to the warm south. The energy sector grew and the space industry began with NASA's space centre being established in 1961. Now known as the Lyndon B. Johnson Space Center, the huge complex situated southeast of the city is also the base for the Mission Control Center that coordinates and monitors all human spaceflight for the United States.

In 1961 to commemorate Houston's new space age the Astrodome opened, which was the first ever roofed stadium in the world. Sadly locals now call it the 'Lonely Dome' as it is rarely now used. There is talk of it being turned into a hotel as preservationists fight against calls for it to be demolished.

The Houston Astro's baseball team now play at Minute Maid Park, or the 'Juice Box' as fans call the 41,000-capacity stadium with a retractable roof which we saw wide open as we drove by on Friday evening as they entertained the Rockies. Minute Maid Park is actually wired for wi-fi, can you image how that would change blogging on the Addicks?

The countries 4th biggest city is well served by sports teams, sorry franchises. The Houston Texans are the NFL team, you may remember the Houston Oilers like I do, well they decamped to Tennessee in 1997, changing their name to the Titans. The beauty of franchises eh?

The very good Rockets are the basketball team with the amazing 7ft 6in Yao Ming and the Houston Dynamo's are the MLS soccer team and the defending champions incredibly winning the MLS Cup in both seasons since their formation. They average 18,000 playing at Robertson Stadium within the University of Houston campus.

Houston's sprawling landscape has mainly been allowed to happen because of the lack of zoning regulations. Therefore multiple districts have grown in different parts of the city, and with public transport being restricted to the odd bus (I saw one all weekend) and a light rail line that runs for 8 miles from the University of Houston to the business district Downtown, which is kind of an anomaly as there is more than one business district, SUV is king helping make Houston one of the most polluted cities in the US.

Downtown however has the largest assemblage of prominent companies and buildings including the JPMorgan Chase Tower, the 36th tallest building in the world (above). Many of the buildings are connected by an extensive network of pedestrian tunnels and skywalks, air-conditioned of course!

We didn't spend a lot of time exploring the main districts, spending the majority of the weekend in the car, do what the locals do, see? Trouble with that is that I never really got a good feel of the place because you just don't see anyone.

One area we did get a perspective on was the Galleria, part of what is called Uptown. Uptown is the centre of Houston's shopping and where most of the hotels are situated. The Galleria is Texas' largest mall and contains 375 stores. Okay before I lose your attention....

On Sunday we drove out to Old Town Spring, half an hour north of Houston, which was a step back in time to a charming old Texas town known for it's antique shops. The place was packed with people travelling into Old Town Spring to witness the annual Texas Crawfish Festival. Live music, fried food, fairground rides and rodeo was what people were here for and of course crawfish. I'm not sure if you've ever eaten crawfish but they are shrimp-like creatures boiled and seasoned but a bugger to shell, messy and not exactly filling once you've swallowed one!

There certainly were some sights to behold at the Texas Crawfish Festival, the crawfish were certainly not the only crustaceans boiling in the midday sun. As I said in the car on the way back to civilisation, I'm reasonably well-travelled but I will never cease to be startled by the way some people live their lives in parts of this vast country.

On Saturday we drove out to Montgomery, a tiny place (pop: 489) but the birthplace of the Lone Star Flag. We made a short stop for a malt shake in Huntsville and bizarrely watched a rugby match for a while before carrying on to Lake Conroe for lunch. It's a pretty lake, man made and running through the Piney Wood Forest about 60 miles from Houston. This area is a booming suburb and I'd imagine in a city known for it's grisly traffic, this part of the I45 Freeway is a busy road during the week but at least you have to pleasure to drive past the aptly named Addicks Humble (below).

Conversely the River Oaks neighbourhood is very walkable. A stroll around some of the residential streets will remind you, in case you'd forgotten, where all of that money goes after you've filled the car up. Ex-Enron chief Jeffrey Skilling was a resident of River Oaks, one of the wealthiest zip codes in the USA, but he now lives in a Minnesota prison.

River Oaks Country Club was hosting an ATP tournament the weekend we were there, and my mate blagged his way in amongst the stetsons.

There is lots of window shopping here and some of the cities best restaurants. We went to Mark's on Sunday night, and although my tuna was a bit overcooked, although a good deal tastier than a crawfish, the service and the 1920's renovated church in which the restaurant is set was fabulous.

The back of the car is not the best way to judge a city but there is no other way in this huge patchwork quilt of locales which all conspire to make this spirited oil-fired city a melange of industry, architecture, shopping and space each connected by a myriad of big, big roads.

Got Business? Houston Does -- Here's Why!

The Houston metropolitan area ranked fourth in the nation for overall population growth between 2006 and 2007, according to new census data released last month. The increase is attributed to our job market and booming economy.

We have full-occupancy in our Class A office space, and we have experienced the #1 job-growth rate in the country (U.S. Bureau of Labor Statistics) due to the opportunities available in our expanding market.

Barton Smith, a University of Houston economist, said about two-thirds of Houston growth is from migration from other states.

"That only happens when the economy is doing substantially better than other places," Smith said. "Houston's economy is going to continue to outperform the national economy in a significant way, so when unemployment starts to creep up in other parts of the country, many people are going to leave Michigan and Ohio and Florida and look for jobs here."

Many Texas cities enjoy a strong economy and low unemployment and as a result Gov. Rick Perry announced March 10 that an estimated 370,000 Texas businesses will be getting a tax cut of $90 million.

"I believe in truth-in-budgeting: when government levies a tax and collects more money than is needed, we must either stop collecting the tax, return the money or both," said Perry in a press release. "Thanks to our healthy economy and low unemployment rate last year, the state collected more money for the unemployment trust fund than we need, which is why I'm directing the state to bring that tax to a screeching halt for this year."

In 2007, Texas created more jobs than any other state in the nation, resulting in record-low unemployment. Texas economy is strong for a reason. Lower taxes and friendly policies lure business. "Houston is probably the state's biggest economic hot spot thanks to its sheer size and broad-based growth and booming energy industry," says senior economist Rakesh Shankar in his Texas economic forecast through 2008 for Moody's Economy.com.

Case in point, The Wall Street Journal recently wrote a comparative analysis piece examining the differences between the economic vitality of Texas and Ohio. In this editorial, the authors discuss the approach each state takes with regard to their economic policies and how policymaking impacts the business climate and overall economic health of a state.

This article points to the fact that Texas has gained 36,000 manufacturing jobs since 2004, while 200,000 manufacturing jobs have left Ohio since 2000. Many of the businesses that have left Ohio are simply relocating to more business-friendly states, like Texas. In fact, Houston is the #1 manufacturing employer in the nation!

The editorial cites several reasons to explain why Texas' economy continues to grow while the economies in Ohio and some of its neighboring states are becoming more unstable. One reason is the affordable cost of living in Texas. Unlike Ohio, which has one of the highest personal income tax rates in the country, Texas has no personal income tax. Also, Texas is a right-to-work state, whereas unions still heavily control a number of industries in Ohio.

"If we are to continue to prosper, we must preserve our business-friendly climate in Texas. This means we must keep taxes low, maintain a reasonable regulatory climate, and promote and reward free enterprise," says Republican Texas State Representative Ken Paxton.

This kind of thinking has long been part of the Texas mantra. So I feel it apropos to finish this Houston's Got Business post with a June 14, 1916 quote in New York Times article, "Houston Tax Plan Brings Prosperity." The article quoted J. J. Pastoriza, then Tax and Finance Commissioner of Houston:

"Never tax anything which is produced by the industry, enterprise, or ingenuity of man, because to do so will tend to decrease the sum and increase the cost of such products. The fewer restrictions, both as to taxes and regulation, which a city places upon business or products, the faster, greater, and wealthier will that city grow. The power to tax is the power to destroy as well as the power to build up. Houston decided to use this power to construct and build a great city, rather than to retard or destroy one."

Inc. Magazine - "It's a Seller's Market for Buying Businesses."

It's all about supply and demand.

Potential buyers and sources of capital for the acquisition of profitable privately-held companies is plentiful while the supply of businesses on the market is not. This makes a profitable, established business a hot commodity and in demand. Inc. Magazine spells it out in this month's issue, "The Most Valuable Businesses in America."

During my first conversation with Darren Dahl in February, in preparation for his writing the article for Inc. Magazine, he wanted to understand what drives the value of a business and why some businesses are more desirable than others.

I first described the Houston marketplace, which enjoys one of the top economies in the nation. Location, location, location is always a value driver, and a business location is no exception. I've been writing about Houston's hot economic climate for over a year now and told Mr. Dahl that Houston is a "bulls eye" target for business acquisitions because of it. We cannot satiate the marketplace of buyers because there are not enough businesses currently for sale.

Good businesses are in short supply. The number of buyers looking to buy a business far exceeds the number of businesses available. So when a new business hits the market it will usually sell very quickly if the owner's expectations are realistic, if their financial history and data are upward trending and in good order, and is marketed properly.

We have buyers lying in wait for businesses such as these and are ready to act quickly when one comes along. They know that if they don't pull the trigger, they will miss out to someone else who will.

One of our "Serial Entrepreneurs," as described in Inc.'s article, agreed to a conference call with myself and Mr. Dahl, and pretty much described what makes him tick and what he looks for and why. Entrepreneur Gary has been working with Don Piercy, one of our staff of professional brokers, for several years and has four businesses in his collection and is currently in the process of acquiring his fifth. We thank Gary for taking time out from his very busy schedule to share his viewpoints.

In continuing the issues surrounding value, while a price tag can certainly be put on any item for sale, including a business, price doesn't mean value. Value is in the eye of the consumer. It is the perceived benefits that the business represents to the market of buyers that makes it valuable. Perceived benefit, or value, looks different depending on who's looking. And, ultimately, the price that will actually be paid will be determined depending on how MANY are looking. Which means if lookers are plentiful, demand is high. The price will reflect that demand.

I further explained that while the reasons that business owners of small privately-held enterprises sell do not vary significantly, the reasons for buying do. I described the various categories of buyers and their respective acquisition criteria and told Mr. Dahl that the price each type of buyer is willing to pay directly correlates to their motive for the acquisition. This is why it is important for business owners to know who the most likely buyer would be for their company prior to going to market.

It was then that Mr. Dahl decided to focus part of his article on the buyers rather than just the attributes of the business. Inc. Magazine's article covers the U.S. market as a whole and does not describe all buyer types. But it definitely describes the current Seller's Market that exists for profitable businesses for sale today.

In closing and of particular relevance, is that 8,000 Americans are turning 60 every day, which means about 20% of businesses owned by boomers will be on the market within the next couple of years. About 65% to 75% will be exiting within a decade, which means we will experience what is expected to be the greatest wave of business transfer activity in U.S. history. The future large-scale baby boomer exit will make for a buyer's market for businesses rather than the seller's market that exists today.

Not only is this important for those owners of small businesses who are considering their exit, it is essential to the economic vitality of our country that these firms successfully transfer to new ownership. The estimated 25.8 million small businesses in the United States have a huge impact on our economy. Outlined below are powerful statistics that speak to the importance of the continuity of these enterprises. Small businesses --

• Have generated 60 to 80 percent of net new jobs annually over the last decade
• Employ 50.6 percent of the country’s private sector workforce
• Represent 97 percent of all the exporters of goods
• Represent 99.7 percent of all employer firms
• Generate a majority of the innovations that come from United States companies

Source: U.S. Small Business Administration

Read Inc. Magazine's Full Article

Selling Your Business - Exit Strategy Seminar

Certified Business Brokers (CBB) will host a breakfast Exit Strategy Seminar on April 10, 2008 in Houston's Galleria Area. The seminar team will consist of CBB's M&A Group, Merrill Lynch Wealth Management Advisors, as well as Tax, Legal, and Accounting professionals. The seminar will cover key issues surrounding the successful sale of a privately-held company:

• Maximize your company's value.
• Who would be the most likely buyer?
• Understand the sale process.
• Plan for retirement.
• When is the right time to sell?
• Minimize post-sale taxes.

The seminar is free. Breakfast will begin at 7:00 AM and the presentation will begin at 7:30 AM and be completed by 9:00 AM. For details about location and to reserve your seat, please email rose@certifiedbb.com or call our office at 713-680-1200.

People put tremendous thought into launching a business. They should put equal planning into selling one.

Typically, business owners are so busy handling daily operations that they give little thought to what they’ll do when it’s time to retire, sell, or turn over control. Suddenly, that day arrives.

Which means these business owners are not completely prepared for the sale of their business. Making the shift too quickly or without proper planning can make a difference in the proceeds received from a sale. This affects retirement, estate taxes, sales taxes and even the business’s worth at sale time.

It is all about planning, preparation, timing and execution.

We will discuss the current Houston economy and the current business transfer marketplace. We will walk through the sequence of events involved in the entire sale process from valuation, right-timing, to what to expect after the sale.

Merrill Lynch Wealth Management Advisors will discuss retirement strategies and how to best invest your after-sale proceeds to sustain your lifestyle through your retirement years. Tax, legal, and accounting professionals will be addressing those aspects of the business sale transaction.