Resales...As Sure As Death and Taxes?
By Howard Bassuk

Nothing's sure but death and taxes, but when you're trying to get into business, you want your chances for success to be as high as possible. How can you best achieve that goal? For some people, the answer is quite easy...buy a resale of an existing business!

Many people buy franchises because they are "proven concepts". Depending on the particular franchise system being purchased, that statement can be very true. However, no matter how proven the system, each new franchise unit must also prove the location, so there is some element of risk.

That's why some people like resales. With a resale, you get both a proven concept, and a proven location. You can check everything from the actual customer counts, to the books and records of that business. It seems like a perfect way to get into business. Yet, for many, it is NOT the method that winds up being used! Why? There are a number of reasons.

Let's start with the COST of a resale. Most of us need a business that can make a certain amount of money, but we also have a limited budget to work with. "Good" resale businesses usually cost A LOT to acquire.

A rule of thumb, that I often hear, is that to buy a good resale you should expect to pay somewhere between 2 1/2 and 4 times its yearly net profits of that business. Therefore, if the business you are looking at makes a profit of $100,000 per year (including your salary), you can expect to pay somewhere between $250,000 and $400,000 for it! Sometimes, if it's a resale of a major name brand, the selling price can be even higher.

Not too many people have $250,000-$400,000 that they can, or are willing, to invest so they finance a portion of the sale price. However, when you finance, the interest and debt service you pay on the money you have borrowed will diminish the profitability of the business, until you_ve paid off your loan! This is usually 5 years, and that's a very long time to some people. The impact can be significant. Let's use as an example a business that you buy for only 2 1/2 times earnings. If it cost your $250,000 it should make you $100,000 when it is debt free.

But, $250,000 cash, plus working capital and other start up expenses is a lot of money, so you borrow $150,000 of the purchase price and pay it back over 5 years. For those 5 years, you will have to pay $30,000/year plus interest. All of a sudden, your $100,000 income drops to $60,000+! If your living expenses require you make $100,000 per year, you will be in trouble!

For some people, using the business's cash flow to help pay for it may make perfect sense, since eventually the debt is paid off and the income returns. This can be particularly true when you compare a resale to some businesses with high cost start-up. Even a non-proven unit can still run into hundreds of thousands of dollars, with NO guarantee of any return ever! At least with a resale, you know there will be some return right away.

However, be very careful not to fall into a trap here. Remember that with a business start up, unlike a resales, there is no automatic correlation between the cost of starting a business and the amount that business will eventually make. Therefore, if you find the right start up, it can have very high income potential yet still cost relatively little to start. In that case, when you are comparing a resale to a new business start up that has great potential, and good personal fit for you, it may simply not be worth the premium you have to pay to get a resale.

Most people that I talk to who want to buy a resale, tell me that their biggest problem with getting a good resale is finding one! They say that all the "Good" businesses are handed down to children, or purchased by "insiders".

If they_re right, and in my experience they are, it means that a lot of the resale businesses that are for sale are ones that are being sold in distress, because they are not doing well or are failing altogether.

This is one of the sad facts about being in business. Not all businesses work! For example, even if you spent $500,000 to build a beautiful store, or restaurant, your investment might have very little residual worth if the business does not make a lot of money. If you think about it, you will quickly realize that expenditures like counters, signs, displays, plumbing and electrical improvements that cost thousands of dollars each, are worth almost nothing in terms of used, or second hand value in a business that doesn_t have enough customers to succeed in its primary intended use.

Here again, beauty may be in the eye of the beholder. Sad though it may be, a tragedy for one person, can be an opportunity for another. If a business has been managed badly, there may be a great, opportunity for an astute and experienced investor and manager to make a "bargain" purchase.

This can also be the case for businesses that get started before the market around them is fully developed. If a business opens its doors before the rest of the local market it serves is also in place, there won_t be enough customers to make the business prosper. This can be a good buying opportunity for someone who can rescue an undercapitalized business owner and wait for the revenues to improve.

This is quite common in growing communities when stores and businesses open in new shopping centers, before many of the families the center will ultimately service have moved in. While the location may, in time, become a wonderful one, and the business be a real winner, it may be months, or even years before new communities become fully mature.

There are some people who specifically look for these type of locations. Although the original owner invariably tries to recapture his/her investment, ultimately he/she will take whatever they can get rather than lose everything. So, if a business has been poorly managed, or if its opening was premature, it is possible for a new owner to come in and "steal" the business for a very low price. As sad as this is for the original owner, there may be a wonderful return on investment for the better manager or the investor with a better sense of timing in terms of when the market is mature enough to have sufficient customers.

That's one of the reasons its so important that you only buy a business that fits your management abilities, skills, and talents, and that you be prepared to handle the length of time your particular start up business will require. Even if its a good business for someone else, unless it matches your abilities it could be a disaster for you.

Buying a troubled resale and making it successful isn_t as simple as just looking for a badly managed business, or one that opened too early and runs out of cash before the business has a chance to catch on.

In many cases, a troubled business may not be fixable no matter what you do and is no bargain at any price. This is particularly true in any business that is "site sensitive" (meaning that the location is important or critical to the success of that business) and you are in a bad location. Good management may not be able to compensate for a bad location.

If you are a "bottom fisher" looking for bargains, you_d better know exactly what needs to be done to fix that business before you buy it. Its a real dilemma for a lot of business buyers. Everyone loves a bargain, and invariably, the seller or the seller's agent will have some plausible sounding reason why the business did not succeed. Sometimes they may be true, and sometimes not.

When I first got into business in California, I thought everyone in Arizona was sick or had retired. Why? I looked at a lot of businesses that I was thinking about buying. Many of the "bargains" were explained to me with "The buyer was sick and had to retire to Arizona"! While I_m sure that happens sometimes, almost no one who puts blood, sweat, and tears into a business, will sell it at a price lower than what they think they can get. Would you?

What appears to be a bargain on paper could be nothing more than a discounted nightmare if it is not the right business for you, or if it is not fixable.

So, when you buy a resale, you need to ask yourself the same strategic questions you would when you are starting a business. For instance, if growth is important to you, are you buying into a business where there is room and ability for you to expand. If not, although that business may satisfy your short term income needs it will not match up with your long term investment goals.

Competition is another key factor in any buying decision. If you are buying an independent business, and the franchise and corporate chains are starting to develop in your market area, will you be able to compete in a few years time?

Similarly, if you buy a franchised resale, and there is strong entrenched competition from larger and more successful competitors, your profitable days may be numbered!

There are other considerations as well. When you buy a resale, make sure you will get the kind of training and support you need in order to successfully operate the business. The good news here is that most of the time an independent owner will be willing to stay around to train you, and in a franchise it will probably be mandatory that you receive the same training any new franchisee would receive. (The old franchisee will probably have to pay a small transfer fee to the franchisor to cover the cost of training you, and transferring the license to you).

Here are some more hints about how to buy a resale:

See lots of business brokers and also look at businesses not listed with them, and are being sold by the owner directly. When you are dealing with a business broker be aware that unlike buying a home where there is a multiple listing service, some businesses that are for sale are not available for sale through all brokers.

Work with the owner of the business brokerage firm if you can. Not only will he or she likely be quite knowledgeable, the owner knows all the listings that exist within his or her firm. A single agent may not.

Be clear about your goals. Clearly state them to your agent, or if you are purchasing on your own make sure that the business you are buying meets both your short term needs, and your long term goals.

Analyze the market. Is the market saturated by competition? Is the business in an expanding industry or is it stagnant, or even declining? (How would you feel about getting a great deal on an electronic typewriter company in today's computer age?)

If you are buying into a franchised system do the same due diligence you would do in buying a new unit for that system, particularly if you want to expand at some future date.

Know yourself. There are people who make a living as "turnaround specialists". These are people who come into troubled companies and try to make them profitable. It is a very specialized expertise. Do you have the skills needed to do that with a "bargain resale"?

Look carefully at the financials of the business, and the financials of the purchase. Does the purchase price seem too excessive? Can you handle the debt service if you borrow money to finance the purchase?

Research the business, the market, and your choices thoroughly before selecting the one that's right for you.

While it may be true that there's nothing sure other than death and taxes, a good resale CAN be a wonderful way to launch into a business career. You can learn the business from the driver's seat of a successful business, rather than learning it as you grow a startup. But no matter which way you go into business, remember two things: Know Yourself, and Buyer Beware. Make whatever choice you pick, a winner.

Joe Lamble is chairman of the FranNet Group membership committee, and owns FranNet of Mid America. Mr. Lamble has been involved in the franchise industry for many years, including local, regional and national sales management positions.