HOW TO BUY
A BUSINESS
USING LESS CAPITAL UPFRONT
"Funding to close is available if you know where to look."
It's common knowledge that you can get a loan to buy a business if you have a down payment of 5-25% and sign a guarantee for the loan amount.
2 things jump out and is the cause of why 90% of buyers fail to buy a business:
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The size of the business you can buy is limited by the amount of down payment you have and the value of your home aka collateral.
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The fear of bankruptcy or massive financial loss if business profits go south.
Here's how to buy a business with less capital by using the assets of the business to secure the financing instead.
You will use one specific type of business lender that will work with 3 types of deals.
FINANCING TYPE
Asset Based Lending (ABL)
3 DEAL TYPES
1. Leveraged Buy Out (LBO)
2. Underperforming Business
3. Distressed Business
1 - LEVERAGED BUY OUT
Using ABL for a leveraged buyout (LBO).
Asset Based Lending, or ABL in short, is business financing based on the asset value and credit worthiness of the business. Most businesses use ABLs for working capital loans, equipment financing or short-term capital needs. However, they can also be used for acquisition financing.
ABL loans usually need to be signed by the business owner with the loan taken through the business. A few nuances and know how is required to make it work for acquisitions and use the loan as a closing payment.
Depending on the asset values in the business and its financial performance, as high as 70% of the closing payment can be raised. In some cases like underperforming businesses below, 100%.
More typically, 50% of the closing payment can be raised from businesses with an ideal balance sheet. 50% is an ideal range because there are sufficient businesses for sale with the owner willing to finance half of the payments.
Financeable items on the Balance Sheet
Loan to Value (LTV) ratio:
Accounts Receivable – Up to 90%
Fixed Assets – Up to 50-60%
Inventory – Up to 50%
Real Estate – Up to 90%
How an ABL Deal Works (ABL amount in brackets)
Revenues - $1,500,000
EBITDA - $225,000
Accounts Receivable - $300,000 (90% @ $270,000)
Fixed Assets - $450,000 (50% @ $225,000)
Inventory - $85,000 (30% @ $25,500)
Total ABL Raised: $520,500
Closing costs: $50,000
Amount Available for Closing Payment: $470,500
Business Price: $225,000 x 3 = $675,000
Less Closing Payment: $470,500
Seller Financing Required: $204,500 (30% of purchase price)
The best part about using an ABL loan? You may be able to negotiate away unlimited Personal Guarantees so that your personal assets and liability are protected.
2 - UNDERPERFORMING BUSINESS
Buy and optimize an underperforming business.
Buying an underperforming business that has the potential to benefit from optimization improvements is a great way to pick up under-valued companies for less and turn them around for a bigger pay day.
Let’s look at a simple example.
Assume revenues to be $2.5 million for both companies.
EBITDA: Earnings Before Interest Taxes Depreciation Amortization
Company A
EBITDA: $400,000
Valuation: 3x $EBITDA = $1.2 million
Company B
EBITDA: $125,000
Valuation: 3x EBITDA = $375,000
In the above example, you could potentially acquire an underperforming company B generating $2.5 million in revenues for $375,000 instead of having to pay $1.2 million for company A assuming all other things being equal (e.g. assets).
Why? Businesses are valued based on earnings (EBITDA/SDE) and not revenues, or the size of operations, or the value of assets when not in liquidation. Buyers are looking for a return of investment which only earnings or free cash flow can give.
Note: EBITDA multiples can differ between two businesses based on differing fundamentals but let's assume it to be the same for illustrative purposes.
After purchase transaction of the business takes place, optimization improvements can be implemented on working capital, sales, expenses, and efficiencies. Some optimizations can result in 5-6 digit immediate cash increase (working capital reduction) and/or additional 6 digit of profits.
Once the business has been optimized, the Company can be flipped for a quick profit, kept for cash flow and/or to finance another acquisition.
Why it is better to buy an underperforming business?
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You may be able to raise the full closing payment with just an ABL loan without needing seller financing. This makes it easier to lock in a deal.
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Optimization methods may be able to unlock higher cash positions or more profits in a matter of weeks.
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You could flip it in as little as 6 months for a nice pay day.
Why do businesses underperform? Some of the common reasons are:
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Owners are burnt out.
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Wealthy owner neglected the business.
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The child of the owner who took over lack the interest and has other ambitions.
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Business outgrew the owner's business management ability.
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Owner is semi-retired and business is on autopilot.
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Slow to implement technology efficiencies.
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Owners have good sales or technical ability but bad business acumen.
3 - DISTRESSED BUSINESSES
How to buy and turnaround a distressed business.
Ever wonder how a business elite is able to buy a 200 employee company generating $20 million in revenues for $1?
There's a reason why its only $1 and it is done by acquiring a distressed business and financially turning it around.
Not all distressed businesses are good turn around candidates but when one is found, those with knowledge to do so stand to make bank.
Distressed turnaround requires finding a company that has good fundamentals but has been mismanaged, neglected, or insolvent meaning unable to pay their debt obligations (loan payments).
An ideal distressed candidate is a business with high revenues but low or no profitability. The reason for it's low probability must not be due to systemic conditions like poor economy, dying product or industry, or formidable competitors resulting in squeezed margins. The business must still be able to draw good sales but due to mismanagement, the bottom line (profitability) suffers.
Optimization improvements to working capital, expenses, and sales management can give a quick boost to the company’s bottom line within 120 days.
The areas of mismanagement are often in working capital, financial mismanagement, weak expense management, weak sales or marketing that cause cash flow problems by not converting sales into profits.
In a distressed deal, the investor is not actually “buying” the business for $1 but “inheriting” the problems (and/or debt) which the average business owner was not able to solve.
Turning around large distressed corporations can be complex but is generally simpler for small businesses. The optimization techniques are straight forward and relatively easy to implement but still do require more sophistication that an average LBO acquisition.
How A Distressed Business Acquisition Works
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Negotiate a distressed business sale price and terms. A deal that has more debt/liability than assets can potentially be negotiated for $1.
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Renegotiate debt with lenders and get them to take a “Haircut” to reduce outstanding debt. Often works as lenders rather receive something than lose the entire loan due to bankruptcy.
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Optimize the business using 9 optimization techniques over 120 days.
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If possible: Negotiate a new customer contract to boost sales using your network of contacts.
While taking on distressed deals will require more complex work, the payoff can be much more if you work on larger deals. However, you will also need an experienced partner or mentor for your first deal unless you have a strong background in business, finance, and accounting.
What's Your Plan For The Next Few Months?
Start your business acquisition ASAP with deal document templates, Excel cash flow calculators, a step by step checklist, and more. No need to read a 400 page textbook or 40 hour course, I know you're busy.
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