After reading this article, you’ll be ready to start applying your knowledge and achieving your American Dream of business ownership. This comes with some serious effort on your part; however, by reading this article, I assume that you have decided to embark on this long journey and begin to make a change in his life. I’m going to introduce you to some easy ways to get the money you need through the modern miracle of leverage. We’ll start with an approach that allows you to make the business truly pay for itself without digging into your wallet.
Question: Is it true that the method of taking money out of the company’s cash flow is reserved exclusively for financial gurus?
Answer: It is partially true. Most leverage techniques have that reputation. And frankly, they shouldn’t. If more people knew about them, many entrepreneurs would have been in business a long time ago. These techniques only seem to be reserved for financial experts because [the techniques] they appear more frequently in strategic financial markets. You hear about many large acquisitions worth billions of dollars. However, you will never hear how it happened or what was involved. This information is never made public. As will be mentioned in Strategy 4, by developing a strong network with corporate leaders, you will definitely have access to that valuable information even if you are not working in the field.
These are actually hidden secrets that I am revealing to you right now. The power of information will allow you to go far. However, it is up to you to make the effort to find out more about the company you wish to acquire. Remember, the most powerful tool you have while dealing with the seller is to show him your industry knowledge and how it can be beneficial for him (and you of course) to sell him the business. And trust me, you too can use these powerful yet simple tools right away.
Question: What is the simplest way to explain how to use a company’s cash flow for financial purposes?
Answer: Let me start by giving you some perspective on how much money we’re really talking about. One expert explains it this way:
“The amount of cash that the average business puts in their cash register for just two to three weeks is usually enough to cover the down payment to buy that business.”
Think about it. Cash collected in a matter of days is often enough that, with a little creativity, you can use it to satisfy the seller’s down payment. That can work no matter what type of business you’re looking for. Since there’s no law that says you can’t “borrow” that money, all you have to do is figure out how to use the cash raised to pay for the business once you’ve acquired it. This is easy if you have a CPA to calculate your cash flow to know how to approach the seller with your proposal.
Question: How does the process work?
Answer: Some steps are required. You, or your CPA, must determine the net cash flow generated during the first few weeks of business by determining the difference between cash receipt totals and operating expenses.
Question: What are the proper procedures for evaluating a business and what should I prioritize in making my decision?
Answer: There are several methods used to evaluate companies. Generally, cash flow, assets, or replacement values, or a combination of these, are considered when determining the value of a business. Listed below are several valuation methodologies commonly used by valuation firms.
Replacement cost analysis:
o Generally, the value of a company is not related to the replacement value of the company’s assets. Sometimes the replacement value of property, plant and equipment (PP&E) is much higher than the fair market value of the operating business. Sometimes the value of goodwill such as customer relationships, corporate logo and technical expertise are much higher than the replacement value of PP&E.
Often, you can choose a particular industry by expanding facilities you already own, investing in completely new facilities, or buying all or part of a new company operating in the industry. The decision of which investment to make depends, in part, on the relative cost of each. Of course, an investor will often consider capacity utilization, location, environmental, political and legal issues, among other things, in determining where and how to invest. These issues may outweigh the importance of replacement cost analysis; in such cases, this valuation method is not used to determine the fair market value of the business.
Asset Valuation Analysis:
o Typically, it is possible to liquidate a company’s PP&E assets, and after paying off the company’s liabilities, the net proceeds would accumulate in the company’s equity. It is necessary to determine whether such a liquidation analysis should be carried out assuming a rapid or orderly liquidation of the assets. However, even assuming an orderly liquidation of a company, it is generally the case that an operating company will be worth substantially more. It is not appropriate to use the asset valuation approach in this case because the company is operating successfully; In such circumstances, in the industry in which the business operates, the fair market value of the business will almost certainly exceed the value of its liquidated assets. The sum is more valuable than the parts. It is appropriate to value non-operating assets using an asset appraisal approach to determine their value as part of the fair market value of the business.
Discounted Cash Flow Analysis.
o Another determining factor in the value of a company is the expected cash flow. Discounted cash flow analysis is a valuation method that isolates the company’s projected cash flow that is available for debt service and provides a return on equity; The net present value of this free cash flow to capital is calculated over a projected period based on the perceived risk of achieving such free cash flow. To account for the time value of capital, it is usually appropriate to value the cash flows of the business using a discounted cash flow approach.
Total capital invested.
o Each valuation method of a company or its business units assigns a value to the total invested capital. These various values are compared to arrive at a final fair market value. Often it is appropriate to weight the various implied values for total invested capital based on the relative effectiveness of each valuation method used for analysis. When the value of the total principal invested has been determined, any claim to that security that has a greater claim than the common shares is subtracted to determine the fair market value of the common shares. These other claims include the fair market value of all debt, outstanding preferred stock, outstanding stock options, and stock appreciation rights. Non-operating assets that have not been previously valued must be accounted for and added to the total capital invested. These generally include cash and the fair market value of any non-operating assets.
Terminal value.
o An owner can expect cash to flow into equity for an indefinite period of time. Although valuation models often use predictions of future cash flows, it may be necessary to represent the value of cash flows that can reasonably be expected to extend beyond the horizon of the projections. This value, known as terminal value, is often calculated by multiplying the fifth year cash flow by a multiple. Selected multiples typically use the median multiple of total capital invested in comparable companies selected in the comparable public company analysis. The selected multiple may be discounted to reflect company performance or size characteristics relative to comparable companies. This is quite similar to dividing cash flow by the weighted average cost of capital and including a growth factor.
Question: Well, that’s all great. However, how will that help me in buying the business?
Answer: You negotiate a deal that allows the seller to receive the down payment directly from the cash flow once he has taken over the business. If this sounds too good to be true, here’s an example of its feasibility:
An enterprising young couple, Sandy and Kevin, wanted to buy a restaurant and bakery in Northern Virginia. Although they were bright and energetic, and had some experience in the food industry, they greatly lacked the ability to pay the $100,000 that the seller wanted to take off the total price of $500,000. (The restaurant’s annual sales totaled $1 million, some of which came from a trading business that sold its freshly roasted coffee to local grocery stores and gourmet coffee shops.)
Fortunately, the seller agreed to contribute and finance the difference of $400,000 over five years at 10% interest. This happens often, especially with a lot of persuasion. However, the couple’s problem was to raise the remaining $100,000. Kevin’s parents believed strongly in the abilities and determination of their son and daughter-in-law and decided to loan them $20,000 to pay back at their convenience. That certainly helped, but they still needed $80,000. To achieve this goal, the couple’s CPA developed a cash flow statement for the first month of their clients’ new ownership. Their vendors would not require any payment for a month, so Sandy and Kevin would not have that expense. However, operating expenses such as rent, payroll and utilities had to be considered.
Looking at the numbers from the financial analysis, Sandy and Kevin were convinced that they could easily get $80,000 out of their business in four weeks. But the big question was: How could they convince the seller (who was expecting a $100,000 check at closing) to wait three or four weeks for his money?
This is where creativity, persuasion and seriousness were required. Strategizing with the attorneys and their CPA, Sandy and Kevin devised a plan that allowed the seller to retain the final sale documents for four weeks. During that period, they would pay the seller approximately $20,000 per week. If they missed a payment, the seller would have the right to renege on the deal. The seller agreed to this proposition and gave Sandy and Kevin their American dream without cash.
This example represents more than 80% of all takeovers and acquisitions. In the worst case, the seller may not be cooperative; in this case you must understand that he was probably never seriously interested in selling his business. The seller may have been waiting to see how far he would go during the negotiation process, which brings us to the next question.