Buying a business or property

BY JAY BRIJPAUL

The best way to financial independence is to step out of your comfort zone and work for yourself. Some may start a business from scratch, while others prefer to buy one that is already established. Buying a business can be risky, it is comparable to climbing Mount Everest for the first time without a guide. Here is a road map to help:

Know the trends. Many times, buyers are locked into businesses with negative cash flow. I recall an incident in which a buyer bought a grocery store. It was a busy outlet that catered for the West Indian community. Around the same time, large Asian supermarkets such as Oceans were about surfacing. These supermarkets offered huge discounts and a wide selection of goods. As a result, the new owner of the grocery store simply could not compete. Sales plunged quickly and they were forced into bankruptcy.

Buy a turnkey operation. The term ‘turnkey’ means that the business is fully operational from the moment you buy it. A restaurant for example has an established clientele. The customer is greeted at the entrance and ushered to a table. The order is taken, and the chef prepares the meal. The meal is served, and the bill is paid. An operation such as this is complex and involves many aspects, from training the staff to cleaning the restaurant after it closes.

Buy a well-suited business. Many businesses fail because it is not a good fit for the buyer. Most people excel in areas that they naturally enjoy. For example, I love real estate and customer service comes naturally to me. Profitability is impressive and it might make good business acumen to a new buyer. The question is, do the new buyers like sales, or to work on weekends? If the fit is wrong, the buyer will resent it and the profits will evaporate.

Look beyond the numbers. When buying a business, look at the numbers and then beyond. Most businesses will provide a financial statement, an overview of the entire operation. It is imperative for the buyer to ask for multiple years of financial statements. In most cases, these are unaudited, and it is smart to hire an accountant to review it. In my practice, I came across businesses where the financial statements painted a different picture than the truth. I recalled a hair dressing salon where a large percentage of transactions were made in cash. I asked my client to stake out the site and count the number of people entering at various times in the week. The traffic count portrayed a very different picture.

Know what you are buying. A business can be asset-based or have intangible assets such as goodwill. Goodwill assets can come in many forms such as a business’s reputation and clientele. A retirement home for instance, would require an appraiser for the real estate portion, and a second appraisal for the equipment. When buying a business, look at the client base. If most of the business is coming from a few loyal clients, then a change in ownership can ruin that relationship. Similarly, look at the suppliers.

Don’t overpay. A rule of thumb is to use this formula, V = I/R, or, value is equal to the net income divided by the capitalization rate. The capitalization or cap rate is the rate of return an investor would like to have on an investment. If the investor is borrowing money at 4%, then the investor may want to see a return or cap rate of 6%. Let’s look at an apartment building; we can calculate the yearly rental income and expenses before mortgage payments. This would give us the net operating income. The net income divided by the cap rate would give you an estimated purchase price. For example, if the net operating income is $50,000 and the rate of return is 5%, then, the value of the building is $50,000/.05 = $1,000,000

Get professional help. Every business may entail various professionals. A gas station for example requires a realtor to stake out the business; a structural engineer to establish that the building is safe; an environmental inspector to make sure that there are no environmental issues; an appraiser to determine the market value and a lawyer to oversee the entire process.

Seller help can be good, bad or ugly. I encountered a transaction with a plaza that had an anchored tenant. The seller offered to give financing at a lower than market rate. We would have saved money because we did not need a structural engineer, an appraiser or environmental inspection done. We ultimately declined his offer. It turned out that the site was contaminated by a dry-cleaning business and that the anchored tenant had a clause in the lease agreement that the corporation can terminate the lease anytime by paying six month’s rent to the owner. With the seller’s financing, we could have bought the property and all the problems that come with it.

When investing in a business or buying a commercial property always make the offer subject to having everything checked out. This is known as the due diligence period. Always have an escape route just in case. Good luck.