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- 3 Critical Rules for the day after you buy a company – to make sure you don’t miss a loan payment
- What about flipping a small business compared to real estate?
- Managing your Business in 2 Hours
- How we buy companies for under $5,000
$50,000 Loan Needed
This article is in response to a question from a member. I’ve posted it here as a helpful example for you.
As I understand your question…
You have an opportunity to buy a machine shop but need $150,000 down. At this point, the most you can come up with is $100,000. The shop has good equipment that represents sufficient collateral to secure $50,000 of additional financing to make up the balance needed for the down payment. Your question is “How do I negotiate the $50,000 problem with the owner?”
Now I will have to make some assumptions here
Since I do not have the total sale price or who is carrying the balance due after the down payment. In this case, I will assume you are paying $450,000 for the shop and the current owner has agreed to carry the balance of $300,000 on a 5 to 10 year loan. You believe the price is fair and have committed to moving forward with the purchase. I will also assume you are paying 3 x annual profit and some value for the equipment, that is probably greater then then $50,000 you believe you can borrow against the collateral. The numbers are off a little here, but good for demonstrating our thought process.
So for our assumptions, you are paying $400,000 for the cash flow and $50,000 for the equipment that you believe you can borrow against at full value to make up the balance of the down payment.
First, let us cover your monthly payments on the owner carry back
A five-year loan will create annual payments around $70,000. If the shop is generating $135,000 in annual profit ($400,000 divided by your 3 times profit multiple) you are going to have a tough first year as that $65,000 of hoped for cash flow (after payments) is a little too thin for my comfort. Too many things go wrong in the first year and you are probably in for some unpleasant surprises anyway. However, it gets better.
My first suggestion is to get the payments down to 1/3rd of the current net profit or $45,000 per year . This can be done by reworking the loan to 8 or possibly 10 years. If you have asked enough questions in your buying phase you may discover that the owner needs $150,000 down to buy his vacation home, and would welcome a dependable 10 year retirement income from you.
If the owner insist on a 5 year payout, then ask for 10 year amortization with a balloon on the balance due on the 61st month. This will give you some breathing room (read that as time) to build the business up.
If they are still reluctant to extend your payments, your next offer is to put a clause into your agreement that if you are able to improve profits over the current level of $135,000 a year you will make an extra payment of ½ of the excess profits against the balloon at the end of each fiscal year. If profits do not go up you will still owe the balloon on the 61st month. At this point, you should be able to use your 5 years of dependable profit to borrow the balloon from your bank. I do not worry much about a balloon payment in 5 years as I have plenty of time to make sure I can get it done.
However, keep reading because profits are probably going to go up and you will most likely be fine.
Most owners believe their company is a gold mine in the right hands and they will probably feel comfortable that you are going to grow it. If they do not feel the company, has a bright future you may have uncovered a ‘red flag’ and may need to do some more investigation.
The good news is that 19 out of 21 small companies that we have acquired, and others that we have seen in our accounting firm, can suffer a 10% or more reduction in overhead without losing sales. You will want to comb the financials to find that 10% (or more) immediately. In one recent acquisition, we cut over 50% of the overhead in the first two months. Every dollar of overhead cut, drops right to the bottom line and that is why most of our acquisitions see an immediate jump in net profits.
On top of that, you may well find it easy to go back to the current top customers for more orders or referrals and increase sales by 25% without advertising cot. That usually works because once an owner has decided to sell they seem to stop doing the things that made them a success in the first place. So, my guess is they stopped ‘pounding the pavement’ in the past year and no one has been talking to the customers beyond simple order taking. It will be important to know that the business you are buying has happy customers or the easy sales bump will be a lot more difficult.
Between cutting cost more than 10% and increasing gross sales by 25% without advertising expense, you should see the company jump in profitability by 50% to 100% starting in just the first few months.
However, if the owner at this point in your negotiations says “5 years straight amortization or nothing” and you feel comfortable with the $65,000 of projected excess cash flow you can still move forward, but I believe you better know where you’re going to cut cost or have a keen marketing program ready to roll out the first day. Keep in mind income taxes are going to cut into that $65,000, based on your $135,000 of profit, not your cash flow after payments. Also, do not forget that if you borrow or lease back the equipment you are going to have to service that $50,000 loan as well.
Finding the $50,000 of additional down payment needed to close the deal.
Now the biggest obstacle in a case like this is the current owner does not want you to go to the bank for an equipment loan as the bank or a lease back financier is going to ask for a first lien on the equipment. That puts the seller in 2nd place in the event of foreclosure.
This equipment is critical for the operations of the business and must be in place if the seller finds they have to take back the business. They do not want to find an empty shop when they walk back in to repo your business. Nor do they want to pay your failed bank loans on equipment they already paid for once before.
80% of our success in life can be boiled down to two words
Those words are human engineering. The ability to get vendors, sellers, customers and staff to do what you want them to do. The easy answer is to always approach every negotiation with the other parties needs in mind. Give them what they need and they will give you what you need in return.
So now lets get to our original question. How do we get the owner to agree to your financing of the equipment to come up with the balance of the down payment.
The first thing I do when I have a problem, is give the problem away. Tell the owner you can not come up with more then $100,000 – do you have any ideas. You will be amazed at how cooperative they will be, as they have already spend days hammering out a deal and they don’t want it to fail any more then you do.
Now he may just say OK, I’ll drop the down payment to $100,000 and refigure the loan. EASY.
2nd idea. I can do the deal at $150,000 down, but I need you to do a lease back of the equipment for me at the closing. You will give me $50,000 for the equipment and I will lease it from you for the next 5 years. Now, I know this has the same net cash effect, but sometimes it makes more sense to the seller. Plus he now knows he can repo the equipment quicker – without getting a court judgment in many states.
3rd idea. Go to a leasing company or bank and tell them they will have the 2nd lien, but you will put up the collateral in your home or other asset as the primary collateral for the $50,000 of equipment.
4th idea. Bring in a short term partner – with a strong balance sheet to secure your $50,000 loan from the bank. But they will want to share in your upside. We did this in a print shop acquisition about 15 years ago and I got the guarantee for the $50,000 loan from my partner and I agreed to pay them 25% of all profits over and above the standard $135,000 a year the company was currently making, until the loan was paid off.
5th idea. Bring in a partner with the same payout ideas as idea 4. However, have an exit point where you can buy them out. Most partners investing in thin margin deals like this will want to see a 30% return on their 50,000 per year.
6th idea. Go back to your original down payment provider and ask for more cash, or bring in other relatives. This seems so obvious it should not even be on the list.