For many first-time buyers, purchasing a business can feel overwhelming. This is often accompanied with a fear of overpaying for a business, not having enough money, or understanding if the business is a good investment. In this video, Mike Lenz (DealBuilder Co-Founder), explains the “3 Pillars” that a buyer must achieve when purchasing a business.
1. Living Wage
You need to eat, right? You still have to pay rent or your mortgage. Still need to put shoes on the kids, maybe put them into minor sports, or get them into that ballet class. After you buy your business, life still goes on. It doesn’t pause until things settle in your professional life. So, you need to take a look at your own life and say, “What do I need to make?”
And that's the important word: need. It's not what you want to make. You probably want to make a million dollars a month and who can blame you, sure it’s a bit greedy, but these are your wants. All jokes aside, you do need to make some type of livable wage.
If you were going to start a business from scratch, you would invest a whole whack of dough and then wait for awhile before money trickles in. The beauty of buying an existing business is that you'll have cashflow day one. But - how much do you need to make to support your needs? How much can you get by with? How much can you take care of your family with?
2. Service Debt
So here's the thing. If you're going to buy a business, you probably want to buy as big of a business as you can, because the bigger business makes more money. And if it loses a customer or two, it probably is not going to make much difference. Lastly, chances are the reason it got big is because it's doing a good job. But you only have so much money, right?
The fact is, if you have a hundred dollars you're not going to buy a hundred dollar business. You're going to buy something bigger than that because you can get a loan. You can get financing to purchase a much larger business than what your hundred dollar business will buy.
From that money, the profit that the business makes you needs to fulfill the amount you determined as your living wage. You also need to have enough money left to service the debt you incur to purchase the business straight forward It has to come from that money. It's not about you adding more money in there, otherwise you're just making a bigger purchase price. That is the profit in the business: return on invested capital.
3. Return on Invested Capital (ROIC)
The third thing that you need to accomplish is having some return on the money you have put into the business. When you buy a business, you need to be able to take a look at it and say, “Hey, I could have put my money somewhere else, but I put it into this business and I saw rate of return.” You expect that it will grow. It will have some type of increase in value.
When buying a business, it is important to remember the 3 pillars of any business sale. Your ability to earn an income, an ability to pay any debt incurred to fund the acquisition, and the ability to receive a return on your capital investment. Sticking to these guiding principals will allow you to stay disciplined in your search for a business and help you find the right business for your goals.