Business Acqusition No No's
At Deion Associates & Strategies, Inc., we frequently have the opportunity to assist clients in the acquisition of assets or businesses. Recently, a business associate asked us to assist one of their clients in the acquisition of a business. The business was a stand-alone day care facility grossing approximately 640K annually with an approximate cash flow (before owner compensation and taxes) of approximately 148K. The sellers owned the building and real estate and were not selling these assets. The current rent expense was $6,400 per month and the owners were willing to provide a 10 year lease for use of the building and real estate. The sales price for the business only was 385K. The potential buyers had approximately 42K as an equity investment into this transaction and were looking to fund the purchase package via bank financing.
Upon performing some initial due diligence to provide some realistic financial projections we uncovered some distressing information. Prior to applying for bank financing, the buyers had entered into a binding purchase agreement with the sellers for a purchase price of 385K. This occurred prior to our involvement. Subsequently, they did apply to a bank for a loan, and after a financial evaluation of the business was performed by the bank, the bank expressed an interest in lending 371K for this acquisition. This was significantly less than what the buyers thought they would receive in financing. This would result in no available working capital from the loan proceeds, and after legal and accounting fees and loan guarantee fees were paid for, it was evident that approximately 20K would be needed from the equity investment just to cover the initial purchase, leaving them with only 22K in available working capital. Since the buyers had pre-agreed to a purchase price prior to obtaining a business evaluation or bank financing, there was no ability (or willingness on the seller’s part) to re-negotiate the sales price.
Additionally, we were able to obtain the proposed 10 year lease for the real estate and discovered that the rent would be increased from $6,400 per month to $7,376 per month for the first 2 years (this was a $976.00 per month increase, or an annual increased expense of $11,712). The 10'th year rent would be $8,492.10 per month ($101,905.24 annually).
The loan payment would be approximately $4,500 per month (54K annually). And, the owner expected to draw $3,440 per month (+ taxes of $1,000 per month). With a payroll that averages around 25K per month (low: 22K / high: 34K), the increased rent, loan payment and other expenses, an optimistic projection of available working capital would be approximately 13K per month. Buyer’s initial thought that they would have at least 42K of available working capital was soon eliminated. This venture would start out seriously undercapitalized, and at the end of their lease, they will have paid off the seller’s mortgage, but, the buyers would end up owning no assets.
So, we have the following observations:
Obtain business evaluations and appraisals prior to negotiating a purchase price
Obtain a letter of intent from your potential lender identifying terms and loan amount
Do all of your due diligence prior to entering into a binding purchase agreement
Obtain lease terms and amounts (if applicable)
Perform accurate and realistic financial projections
Provide for adequate working capital (2 months expenses at a bare minimum)
This scenario is not all-inclusive of what needs to be done when purchasing a business. It is just a snap-shot of one example we came across. There is an extensive list of issues which need to be addressed when performing business acquisition due diligence.
If you would like to further discuss this issue or any other business issues, don’t hesitate to contact us at: Deion Associates & Strategies, Inc.
