Business for Sale Insights - Business Buyer
Investing in Commercial Property (Commercial Real Estate)
Broadly speaking real - estate can be classified as commercial, industrial and residential. Commercial Real Estate is property used solely for business purpose. It is any property used to produce income. Examples of commercial real estate include malls, restaurants, convenience stores and office spaces. Industrial real estate is used for manufacturing and production. Businesses that occupy commercial or industrial real estate usually lease space. Commercial and industrial real-estate is usually owned by investors who own the building and collect rent from each business (tenants). Similar to buying a business, investors should complete due-diligence before investing in commercial property. Key element of due-diligence include Location, Property Type, Budgets and several other factors listed below.
Location is a critical element of commercial property investing. Investors must understand the soundness of the location, demand / supply dynamics and vacancy rates. Additionally, investors should ensure that job market, economy and population growth in the area is favorable. Without sufficient research they may land up buying property in micro markets with high vacancies.
There are different types of commercial property available including retail, office space, industrial, multi-family and land .The most popular being retail and office space. Investors looking for retail space have several options including free-standing street outlets and shops in malls. These outlets can be as small as 500 - 1000 square feet. Shop in malls belong to a strata and are pre-sold to individual investors.
Industrial and commercial properties may have capital appreciation and rental yield. Rental yield is the annual rent divided by the value of the property. Rental yield is critical element for valuing a property. A low yield implies the property is overvalued. Rental yield varies by country and market. For example, commercial properties with rental yield of 11 %to 12% is considered correctly valued in major Indian cities like Mumbai and Bangalore. Commercial property with yield less than that is considered overvalued.
Due - Diligence
In addition to the above factors Investors should check the credentials of the developer, potential infrastructure development in the area, access to public transport and quality of property management. In case of a retail store front -age and visibility are critical.
The buyer usually provides the seller a due diligence checklist. The checklist includes request for information related to tenant information, building information, operating information, financial information and other miscellaneous items. Tenant information include rent roll showing the rents paid. Rent information must include tenant's name, suite number, size of premises and several other attributes. Operating information should include financial statements of the property for the past three years, current operating and capital expense budgets for the property, utility bills for the last three years, tax bills and more. Financial information includes understanding the break-up of cash flows. This includes collecting data on vacancy factor, maintenance expenses, property tax, building insurance, lease term, lock-in period and expiry dates for leases, long-term capital appreciation potential, cost of refurbishment and potential for refinancing. Additionally, the buyer should obtain new third party inspection report and title report.
Whatever information is provided by the seller, they usually include a provision in the purchase agreement stating the information contained in the documents must be verified by the buyer. It does not constitute a representation of warranty of the seller as to their accuracy.
Inspirational Business Quotes
In an interview Thomas Edison said, “None of my inventions came by accident. I see a worthwhile need to be met and I make trial after trial until it comes. What it boils down to is one per cent inspiration and ninety-nine per cent perspiration.”
The same idea as quoted by Steve Jobs.
You know, one of the things that really hurt Apple was after I left John Sculley got a very serious disease. It’s the disease of thinking that a really great idea is 90% of the work. And if you just tell all these other people “here’s this great idea,” then of course they can go off and make it happen.
And the problem with that is that there’s just a tremendous amount of craftsmanship in between a great idea and a great product. And as you evolve that great idea, it changes and grows. It never comes out like it starts because you learn a lot more as you get into the subtleties of it. And you also find there are tremendous trade-offs that you have to make. There are just certain things you can’t make electrons do. There are certain things you can’t make plastic do or glass do. Or factories do. Or robots do.
Designing a product is keeping five thousand things in your brain and fitting them all together in new and different ways to get what you want. And every day you discover something new that is a new problem or a new opportunity to fit these things together a little differently.
And it’s that process that is the magic.—Steve Jobs
Business Buyer Checklist
Determine Baseline Deal Structure
The buyer should determine his budget and come up with a baseline deal structure prior to shopping for a business. There are several elements that constitute a deal including cash at closing, seller financing, mezzanine financing, seller retained equity, and earn-out.
Cash at close is the actual cash that will be transferred from the business buyer to the business seller when the deal closes. Seller financing is a loan provided by the business seller to the business buyer. Mezzanine financing is a hybrid between debt (loan) and equity financing. It is a variation of debt financing where the lender has the right (option) to convert the loan to an equity interest if the company defaults on the loan. As the name suggests, Seller Retained Equity is the equity retained by the seller in the business after the owner (management) of the business changes. Once a business buyer has determined the baseline deal structure and cash on close amount he should get approved for financing before approaching a business broker or business seller.
It is getting harder and harder to get credit in the current environment. Therefore most business brokers and businesses sellers require the business buyer to verify their ability to purchase a business before getting into lengthy due-diligence process. The buyer should be clear on what the sources of financing are. The average first time buyer is an experienced professional in the mid 40’s, so a large portion of financing may come from personal savings or home-equity. Additionally, the buyer should be clear on how much of his funds he can use for down payment. In some cases there may be an option to ask for seller financing. The buyer should be clear on the terms for seller financing before approaching the seller.
Build a Team
Purchasing a business is a complex transaction, so the business buyer should engage a business broker to assist him with the process. TheBuySellBusinessess.com website can help buyers and sellers connect, but businesses then need to engage a broker to complete the transaction. In addition to business brokers the buyer may also need to engage an attorney to evaluate the term sheet, stock purchase agreement, leases, franchise agreements etc. The buyer should engage an accountant to review the books for structure the business deal.
Typically, purchasing a business implies purchasing the operating assets only. That said purchasing a business can be extended to include the corporation and fixed assets. In some cases buyers may not want to purchase account receivables (AR). The buying party can include or exclude any assets in the agreement. The buyer should know upfront the industry he wants to focus and if he is in the market to buy an operating business or to buy an operating business with fixed assets.
Sources of Financing for Businesses
Businesses for sale can be classified by deal-size. Businesses that are valued below $ 2 Million are classified as main-street businesses, businesses valued between $2 Million and $5 Million are classified as lower middle market, while businesses that are above $5 Million are classified as upper middle market. This blog tends to focus on main-street and lower middle market businesses.
Main-street and lower middle market businesses need to raise money for several reasons. Some common reasons are business growth and expansion, working capital fluctuations, refinancing existing loans, replacing existing equipment, and paying the owner. Financing for growth and expansion is the most common reason for main-street and middle-market businesses.
There are several sources for financing business operations or businesses acquisitions. Some of these sources are:
- Friends and Family
- Government grants
- Crowd sourcing
- Trade credit
- Personal credit cards
- Personal loans
- Business credit cards
- Bank and Credit Union loans
- Asset based lender
- Angel Investment
- Venture capital
- Private equity investment
- Mezzanine lender
Bank loans are the most common source for financing business acquisitions and business operations. Asset based lending is also commonly used. Asset based lending refers to lending secured by an asset. If the loan is not paid the asset is taken over by the lender.
Angel investment, venture capital investment and private equity investment plays a key role in raising money. These investors provide capital for ownership equity or convertible debt. Interestingly, business and personal credit cards are also commonly used for short-term financing of business operations.
Mezzanine lenders provide the additional (incremental) funding required for completing a business acquisition or business expansion project. It is usually structured as a hybrid between debt and equity financing for business expansion. Mezzanine financing may be debt financing, but gives the owner the right to convert debt to ownership equity in the company at a set price.
Management Buy Out (MBO)
With Management Buy Out (MBO) the management team of a business purchases the business from the current owner. The purchase may be financed using Personal Savings, Bank Loans and Venture capitalists.
Given the demographic situation where thousands of baby boomers are retiring each day, management buyouts are almost certainly expected to grow significantly. Senior managers in many businesses will lean forward to buy the business they work in when owners retire. In many cases the buyouts may be leveraged management buyouts (LMBO) where buyers use company assets as collateral to secure financing. Usually, MBO’s are funded using personal assets, external financing (Private Equity groups) and seller financing. Management Buyout (MBO) is different from Management Buy-in (MBI). With management buy-ins (MBI), a team of outside managers buys a business.
Usually the management team knows the business and its prospects very well, so the risk from transition is reduced significantly. Furthermore, the team can use its expertise in the business to grow the business rapidly after the buyout. That said, it is still critical for the management team to complete feasibility analysis of the initiative, complete a business plan, pick a great management team and remain low-key. Additionally, the MBO team should be completely transparent with the owner and take permission before disclosing and confidential information. Feasibility analysis and business plan are also critical to raising money for the buyout / buy-in.
Some of biggest mistakes in MBO / LMBO are:
- Over valuing and / or over paying for a business.
- Taking on too much debt financing.
- Not getting the right M&A advisors involved.
- Not creating a strong board of advisors and board of directors.
- In ability to anticipate deal breaker issues and address them.
- Not being persistent because M&A deals are seldom smooth and straightforward.