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Guidance on purchase price and operating capital for an existing franchise!

I'm looking to purchase an existing, but underperforming franchise for $75k. Sales are around $144k with net about $21K. I am leaning towards offering an all cash sale but some have told me to have the seller carry the note! Also, when getting the loan, besides purchase price and expenses, how much should I figure for operating capital?

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Answers (3)
David Collins
Glentyde Capital Advisors, Inc.
CEO / Owner
Mecklenburg County, NC

Paul, the numbers you've quoted represent a not-too-shabby ROI on their face, but of course...
• how wide or narrow is the disconnect between "net" and "cash flow"?
• (as Don has already alluded) how much of that net is simply paying for your personal labor post-acquisition?

On the other hand, your preliminary vetting of this biz might have left you with some strong convictions about this operation's real potential, and your ability to achieve same. But more to the point of your questions...

You should indeed strongly consider having a seller note be a part of the structure. For one thing, small-biz sellers typically can't match larger corporations when it comes to offering a high level of risk-mitigation evidence (e.g., audited financials for last X years from major accounting firm; large stable customer base with total revenues being insensitive to any given subset thereof; low volatility of net earnings; etc.). To compensate, small sellers frequently need to show their vote of confidence in the ongoing viability by taking back some paper.

For another thing, seller paper will give you a mechanism to help backstop the seller's promises. It's not uncommon for the note's terms to include provisions which modify your installment payments in the event certain of the seller's warrants prove to not have legs.

With respect to your operating capital issue, it's definitely a case-specific question, as already mentioned; it'll vary considerably across different types of operations. Cash flow projections will be your best weapon in deriving your best intel on this one.

But as a supplement to such forecasting, if the target company happens to be in an industry for which there is an active and robust trade group(s) or association(s), such groups can often be a valuable resource for statistics on such things as typical balance sheet numbers and ratios.

Best of luck with it!

Feb 1, 2013
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The BAF Group LLC
MD

Paul, getting a loan to purchase a business for less than $100k is going to be tough, particularly with a Net you suggest. The Seller may have no alternative but to offer a note. A big question is, is it worth it? At 20% down, with a 5% interest rate on a 7 year amortization, half of that Net is going to go to paying the note. Unless there is a reason you could turn that business around immediately, without investing anything further into it, you leave yourself absolutely no meaningful return on your investment. You could work for someone else at a convenience store and make more money than that, and to turn it around, in all probability, you will potentially need to put a lot of personal time into it, even if the long term goal is an absentee ownership. And in the transition of new ownership, there is sometimes a temporary turndown in business; how are you going to withstand such a turndown, with that little in cash flow to buffer you?

You may have thought all through this. And there may be reasons why my concerns are unfounded. But they are things for you to consider.

The amount of operation capital required depends on the business. Most estimates range from a low of three months to a more comfortable level of six months of operating cash.

Feb 1, 2013
Clarence S. Day III
Griffin Moor International, LLP
Managing Partner
Prince Georges County, MD

Hello Paul,

A lot goes into to factoring the right financing structure when making an acquisition. However, a good rule of thumb is to first find your anticipated return on investment (ROI) most likely captured by taking the current SDE and producing a post acquisition pro forma that includes cost reduction measures and performance enhancements. And weigh it against your cost of capital or borrowing cost if you attempt to finance the purchase. This is not the end all formula, however you gain an understanding of the investment return and can compare it against other "like" investments. I wish you well.

Jan 31, 2013