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Evaluating Business Acquisitions Through Profitability

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Comparability in businesses is virtually an oxymoron. Every business is different, including franchised businesses. Having owned a franchise personally, I can tell you that although our services were the same as other franchisees, our employees, our clients and our profitability were certainly unique.

As you evaluate various businesses for the purpose of acquisition, although there is recognized differentiation, still there should be consistency in how profitability of businesses is calculated. Using a homogeneous method of profitability comparison, will allow you to fairly judge the value of businesses, despite their differentiation.

The comparability standard we use in general terms is: Total Owner’s Discretionary Cashflow. Specifically, we use EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), adjusted by owners discretionary expenses. If you are not familiar with the term EBITDA, don’t worry, any financial adviser you employ in the due diligence process will be. Effectively you are evaluating the business profit on a pre-tax, pre-interest, pre-depreciation and amortization basis. Add to that the owner’s salary and other non-business essential perks and you have a picture of the business’s “Total Owner’s Discretionary Cashflow”.

Having arrived at the discretionary cashflow figure, you can then calculate your own personal financing costs to acquire the business, plus any capital requirements you forecast the business to need (i.e. additional equipment and inventory, or capital for growth purposes). Going through the above exercise on all businesses you evaluate will allow you fair comparability across various industries.

Profit alone however, is not the sole indicator of total value. Although profit is typically the focal point of what buyers are looking for, the income statement analysis should be accompanied by an analysis of the balance sheet. Given comparable discretionary cashflow, a balance sheet with substantially more assets will attract higher value. Why? The buyer will have more tangible assets to continue running and growing the business, and any lenders used in the acquisition process will be happier to lend with a stronger asset base.

What are owner’s discretionary expenses? Basically any expense that is not required to operate the business is a discretionary expense and should be added back to the cashflow of the business. Examples of discretionary expenses would include personal vehicles, personal travel and other entertainment that are non-business related. We’ve seen everything from the building of a vacation home in Belize to girlfriends in Las Vegas that ended up as ‘business” expenses. It’s important to weed out the discretionary, from the truly legitimate business expenses, in order to fairly understand the full profitability of a business.

 

-Bradley G. Marlor MBA, CBI is a Managing Partner at Utah Business Consultants and a Certified Business Intermediary with the International Business Brokers Association. Utah Business Consultants is a full-service Business Brokerage and Valuation firm.

Should I Buy a Business that has Customer Concentration?

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Over the years we have been engaged with a healthy number of businesses vexed by customer concentration. We have seen many more we elected not to represent. Those we elected to pass on had concentration issues with little to no defensible position relating to concentration. One letter from a concentrated customer ending its relationship and the company would be toast. The final answer of whether or not to acquire a business with customer concentration should be prefaced with answers to the following questions:

1) How deep is the customer concentration? In selected industries, concentration of 10% or more might be considered high. However, generally 20% or more concentration should be cause for concern. If a customer generating revenues of 20% or more is suddenly lost, unless immediately replaced, it would have a serious to devastating impact to the bottom line. Concentration over 50% should be dismissed as an unacceptable target unless very unusual circumstances exist.

2) How easily can the customer leave? If the business servicing the customer has proprietary assets – – tangible or intangible, it can make a big difference. Simply having a “good relationship” with a customer is not enough. Differences in pricing can quickly change the mind of a customer; there is little security in a longstanding relationship where pricing is concerned.

3) What are the gross and net margins of the company? This question should be obvious. The higher the margins, the higher the degree of comfort should exist in the target company given higher levels of customer concentration. Higher margins may be indicative of proprietary products or services that allow the target company to operate very profitably. It may also indicate the targets ability to quickly replace lost clients.

4) One final question is whether the business can expand out of the concentration issue? In other words, can the business continue to grow, thus diluting the concentrated customer? Most business owners don’t want to lose their golden customer, but instead of growing the rest of their customer base (including new customers) they allow the concentrated customer to absorb more and more of their products or services.

Customer concentration can transform an otherwise profitable, successful company to an unattractive target. Buyers should be careful of courting a concentrated target company; sellers should start today on diluting in order to strengthen marketability.

 

–Bradley G. Marlor MBA, CBI is a Managing Partner at Utah Business Consultants and a Certified Business Intermediary with the International Business Brokers Association. Utah Business Consultants is a full-service Business Brokerage and Valuation firm.

It’s Better To “Cash-Out” Than To “Burnout.”

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Burnout can come with a business that’s successful as well as one that’s failing to grow.  The right time to sell is before the syndrome becomes a threat to the effective management of a business. What are the warning signs of burnout?

That isolated feeling. The burnt-out owner has been “chief cook and bottle washer” for such an extended period of time, that even routine acts of decision-making and action-taking seem like Herculean tasks. These owners have been shouldering the burdens alone too long.

Fuzzy perspective.  Burnt-out owners are so close to their work that they lose perspective. Prioritizing becomes a major daily challenge, and problem-solving sometimes goes no further than the application of business Band-Aids that cost money in the long run rather than increase profits.

No more fun. Of course, owning a business is hard work, but it should also include an element of enjoyment. The owner who drags himself or herself through every day, with a sense of dread–or boredom–should consider moving on to a fresh challenge elsewhere.

Just plain tired. Simply put, many business owners burn out from the demands placed on them to keep their companies operating day after day, year after year. The schedule is not for everyone; in fact, statistics show that it’s hardly for anyone, long-term.

The important point here is for business owners to recognize the signs and take action before burnout begins to hinder the growth–or sheer survival–of the business. Many of today’s independent business owners feel they’ve worked hard, made their money and sense that now is a good time to “cash-out” and move on.

By:  Bradley G. Marlor MBA, CBI

Utah Business Consultants

Weighing Your Options: Buying vs. Starting a Business

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So you’ve been in Corporate America too long; you can no longer stomach the grind, the stress, and the hours.  You’ve been padding your corporation’s pocket, yet your pockets are seemingly empty.  Something has to change.  You realize that changing companies might provide a different view, but what you really yearn for is a whole new landscape, the ability to create and mold your environment to your own advantage.  And you want to feel duly compensated for the brainstorms, the headaches, and the emotional wear and tear. What are you waiting for? You have the skills, why not start your own business?

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Business Value Maximization

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Vision is important in any company, large or small. If you have no idea of your end goal, the beginning of your business is likely to take off in the wrong direction. If you haven’t considered how you are going to exit your company in the future, you should – now.

The journey to value maximization commences with the starting transaction. Confidence in your business progression comes with forward-thinking strategies and a solid understanding of the sales process. The following are several crucial steps to establish that understanding.

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Are There Any Good Businesses To Buy?

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Here are some responses to that question:

First: The Small Business Administration reports there are over 5.7 million businesses in the U.S. with at least one employee other than the owner. Formal and informal surveys indicate that approximately 20% of all businesses are for sale. For many reasons, of the 1.1 million businesses that are for sale, about 20% of those will actually transact a deal. On the Utah front, the Utah State Department of Commerce reports about 170,000 total businesses. Extrapolating, there are close to 34,000 businesses for sale in Utah. Not all businesses are “openly” on the market; business brokers, others by owner, represent many.  However, you do the math, at any given time there is an impressive number of businesses on the market. …Read More!

Friends and Family: A Financing Option For Small Businesses

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The first job facing many prospective business owners is rounding up the cash necessary to make the purchase.  They may find that banks have made borrowing difficult (or all but impossible), and that even SBA loans have requirements too stringent to meet. One viable option is obtaining financing from the seller; another is to seek help from family and friends.

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