Building vs Buying a Small Business. 

Transcript:

The following is a full transcript of this episode. This transcript was produced by an automated system and may contain some typos and some other minor inaccuracies.

Henry Lopez (00:15):

This is Henry Lopez. Welcome to this episode of The How of Business. My guest and friend David Barnett is with us today. Welcome, David.

David Barnett (00:24):

Hey, how’s it going, Henry? Great to be back.

Henry Lopez (00:26):

Thank you. Welcome back. I’m doing well today and thanks for taking the time to be back on the show. So what we’re going to focus on today is what we’re entitling build versus buy. So if you’re thinking about investing in a small business, you essentially have two options. You can build your own from scratch as I’ve done as David has done, including perhaps even a franchise. Go build a new franchise location or you can buy an existing business and that might include a franchise as well. So those are basically our two options. Build our own with somebody’s help perhaps, or buy an existing business. And David Barnett is an expert on the topic of buying and selling small businesses. That’s what he does for a living now, is provide that guidance, that education, and we’ll talk more about that. For those of you who may not know, David, we’re going to deep dive into this topic of Build versus Buy.

Henry Lopez (01:17):

If you want to receive more information about the How a business including the show notes page for this episode, and you’re going to want to go there because we have a special download, special offer on a special guide that David is making available for my audience. And if you want to continue to support the show, including joining my Patreon membership where you’ll get discounts to my workshops and be able to join my monthly group coaching session, just visit the how of business.com. Also, wherever you’re listening to this episode, I encourage you to subscribe so you don’t miss any future episodes. Let me tell you briefly about David Barnett. David Barnett has been working with small businesses for over 20 years. He’s helped them grow, he’s helped entrepreneurs buy and sell them and he’s helped people finance them. David is the author of over seven books about small business transactions and local investing. He’s the host of a very popular YouTube channel with hundreds of videos, literally hundreds of videos about buying, selling, financing, and managing small and medium businesses. You can learn more about David, including all of his books, his courses, his other resources to help you buy and sell a small business at David C. Barnett, two Ts at the n david c barnett.com. He lives, lemme see if I don’t butcher the name of the city. He lives in Moncton, new Brunswick, Canada. Did I get that right?

David Barnett (02:39):

Yeah, you did. Yeah,

Henry Lopez (02:40):

Not too bad. He’s been on a guest on my show several times. If you go to the archives page on my website and click on buy sell business, you’ll see I think three different episodes. We’ve done webinars together. He’s my go-to resource for buying, selling. You and Mike Finger are my go-to knowledge base and resources for this topic of buying and selling a business. So look at those episodes if you want to learn even more about buying and selling a business. So with that said, David Barnett, welcome back to the show.

David Barnett (03:15):

Welcome. Do you know if it’s the fifth appearance? I get a jacket when I appear five times.

Henry Lopez (03:19):

Even that works know this is the fourth. So you just get a pin, a little pin that I will send a little lapel pin that I will send you sometime in the future.

David Barnett (03:27):

Right?

Henry Lopez (03:27):

Perfect. When I get it made in the meantime, I’ll send you a special graphic like your graphic. When I promote the show I’ll have a special badge on it.

David Barnett (03:37):

Okay, that sounds good. Sounds good.

Henry Lopez (03:38):

But you’re not quite a number five, but you’re getting there. I think it’s only you and a couple of other people that have been on my show this many times. So that speaks to the wealth of information that you always bring and you are very sharing of you share that information, which is what’s great about what you do. But let’s get into it. I thought I’d start with this question. Let’s start with at a high level, why should I consider buying a business an existing business and we’ll delve ve into the details versus building my own at a high level? Let’s begin with that.

David Barnett (04:12):

So basically in order to have success in business, you need a product or service that people want. You need to be able to deliver the product or service in an executable fashion and you need to have enough customers to pay for the direct costs and all of your overheads. And so when you start a business, you don’t have the customers and you may have kinks in your systems, you may have problems with your product that need to be addressed and worked out for the market to fully accept it. And then you have to find those customers. And for most people, when you open a business, if people are already consuming that product or service, then presumably they’re dealing with someone else who’s serving them. And so in addition to making the offer, you also have to convince them to leave the known commodity of the current service provider and come over to you. These are the big hurdles that people have when they start a business. When you buy a business, the previous owner, the seller of the business has worked out the kinks in the product and service delivery. They already have customers and there are employees there who already know how to do the work. And so you may have to invest more money in the moment you buy a business rather than starting one, but the next day you start making money as long as it’s a good profitable business.

Henry Lopez (05:28):

Yeah. Great. So let’s start to unpack that and I want to start with the last point you make because that’s something, I’m sure you hear it more than I see people making the mistake of thinking that, and I want your thoughts on this, that they’re going to buy a business that has not been profitable, that’s failing and somehow they’re going to turn it around. So what do you say to people when they’re looking at a business that’s not profitable, Dow?

David Barnett (05:50):

Well, people get attracted to these things because they think they’re going to get some kind of extra special deal

Henry Lopez (05:56):

And

David Barnett (05:57):

Really the best deal is to acquire a business with a cashflow that can afford to pay for itself. So even though you may end up paying more dollars to buy it, if you can borrow some of that money and the business is able to pay that debt off for you, then that’s actually the lower risk route. There are statistics floating around, but there is an organization out there of professionals who are turnaround specialists and they are very, very proud of their success rate. And I don’t have the exact number at hand, but I believe it’s somewhere south of 20% and they are really proud of this. Their

Henry Lopez (06:34):

Success rate is less than 20% and they’re experts at that

David Barnett (06:38):

And they’re experts at it. So if you are an expert in a given industry, if you’ve got 30 years experience in a certain kind of thing and you see this operation and you can see clearly that what the mistakes are and what needs to be addressed, then maybe this could be an exception. Maybe it’s a deal for you if you’re already in that industry. If you are a business owner in a given industry and you have a failing competitor, maybe there’s a way to salvage their inventory, their equipment, their customer list, fold them into your operation, make them a branch location perhaps. Maybe you can look at the way they’re running their business and remove a lot of overhead If there’s duplication with your own business, there could be options. And so really I guess the answer is it depends on who the buyer is, but in general, if you are looking to buy a business, which is going to be an investment and become your job by going there every day to work, it’s far less risky just to go and buy something that makes money.

Henry Lopez (07:34):

Yeah, yeah, no, well said. Thanks for clarifying that and good perspectives there on a business that may not be profitable. Alright, so we’ve talked about some of the advantages, the obvious ones, it’s existing clientele, we can measure that. We can look at the financials and we’ll dive a little bit deeper there as to what to do during due diligence. You’re not having to go see if you can take market share from someone else. That business already accomplished that by and large, it’s a profitable business ideally. So my time to cashflow is immediate ideally. What else do we maybe not think about? That’s an advantage. We’ll talk about the disadvantages in a moment, but what else could fall in the category of an advantage of buying an existing business?

David Barnett (08:17):

Well, just to be able to look at the track record and also finance ability. So there are various programs and sometimes there’s government economic development agencies out there who go out of their way to try to help people startup businesses. And this is really required because it’s so hard to get a business started when you talk about an existing business with a track record that has a history of profitability. There are lenders willing to make loans on that. They view that cashflow as an asset and now you have to qualify too. They’re going to examine the buyer, they’re going to examine the, you manage your own finances, they’re going to look at what your habits are and they’re going to look at your work history to make sure that there’s some kind of alignment between the experience you have and what the business does. But it’s much easier to obtain loans and to get capital for something that’s already functioning and making money.

Henry Lopez (09:14):

Absolutely. That’s been my experience as well, David. I’ve bought and sold businesses of my own and helped client, not as many as you have, but that’s what I’ve seen that especially for a first business, it helps tremendously that there’s a real financials, therefore that lender to look at. That’s been my experience.

David Barnett (09:35):

Yeah, absolutely.

Henry Lopez (09:37):

The other thing that comes into play, and it’s come into play two times that I’ve bought a business is seller financing.

David Barnett (09:46):

Well, and that leads into the finance ability of buying a business. So in addition to bankers liking the fact that there’s this established cashflow, there’s another whole category of lender, which is the seller, and this is something you don’t obviously get when you start a business because there is no seller who can do financing for you. And the vendor financing is great because it provides a lot for the buyer. Not only is it a source of financing, but it helps to align the interests of the buyer and the seller in the same direction. It gives the seller a reason to want you as a buyer to succeed and that then opens the door to their desire to be willing to coach you, give you advice if you call them asking about the client that maybe was there a few years ago that potentially you could get back, you can hear the backstory. You’ve got this connection with history through the seller. And today, especially in this environment of rising interest rates, loans at the bank are typically for Americans, especially under the S B A program, they’re going to be floating variable rate loans.

Henry Lopez (10:53):

And

David Barnett (10:54):

So with a seller, you can negotiate anything the two of you can agree to. So you could have a longer term, you could have a fixed rate, you could have a rate that appears to be low today, you could lock it in at 7% interest or something like that. It really is whatever you negotiate. And a lot of the times over the course of the negotiation, this back and forth between the buyer and seller, we’ll sometimes see a lot of things. And these different things could be the structure of the deal asset sale versus share sale could go back and forth during the negotiation and the amount of seller financing and in particular the terms of the seller financing. I’ve seen things go back and forth where the seller will want a higher price and the only way the buyer is willing to meet that higher price is to have a greater degree of seller financing.

David Barnett (11:40):

And the other key thing that you can’t get from any other source of credit is that you can put performance terms or conditions on the seller financing. So you could have various mileposts or performance requirements that could cause part of that note to be clawed back. A good seller note is always subject to offset in the case of a material misrepresentation or an undisclosed lien or liability. So if you buy the business and it turns up there’s some kind of problem, which really should have been dealt with by the seller, you as the buyer have the right to offset those costs against what you owe the seller. So it kind of also acts as a warranty against all the things that were told to you in the lead up to the sale as well.

Henry Lopez (12:25):

Yeah. You touch on something there that I want to highlight. I think it’s sometimes people think that because you can structure whatever you want that’s legal, which is pretty much, much whatever you guys agree to get an attorney involved here to draft this, agree to the principal terms and then get an attorney because there’s all of these clauses that have to be properly executed and agreed to and signed to make sure that all of that is enforceable, right?

David Barnett (12:53):

Absolutely. Yeah. Typically a team to buy a business is going to include an attorney, an accountant, you need advice on how to structure your affairs. Sometimes you need to create an entity to be the vehicle for the acquisition, whether you’re doing an asset or a share sale, you may need to have an intermediary entity created that will later then maybe merge with the company that you’re buying. And so all these kinds of tax strategies and initial setup things have to be done correctly. That’s where a CPA is going to come into play. And then depending on the nature of the business, you’re going to have a whole host of other people too. You could have mechanical specialists if there’s a lot of machinery in the business. I had a client who bought a restoration and repair business, one of these companies that goes out after flood or fire to restore buildings. And he did a whole whack of financial due diligence to make sure that all the numbers and statements and everything he was provided were accurate. But with that purchase, he got 10 vehicles and he never did any mechanical due diligence. And it turned out that two of those vehicles actually had some pretty expensive deferred maintenance that a visit to a mechanic shop would’ve uncovered. Interesting. So really the types of due diligence that you do should cover all the major areas of potential problems in the business

Henry Lopez (14:22):

When it comes to that. It’s such a great point. I look at it, it’s almost like buying a physical property. You got to remember to do those inspections as well as the financial inspections. Alright. But the point here is from an advantage perspective, and to me this is up high on the list because again, in my experience that’s what I’ve been able to do. That flexibility potentially being able to negotiate and structure something that’s a win-win is huge as opposed to going through the more structured, perhaps even more expensive regimen of a bank load or an SS B a load. Right?

David Barnett (14:59):

And

Henry Lopez (14:59):

SBA, for example, is not going to care if the business doesn’t do so well two years from now, I still got to pay that debt, right? They’re not going to agree to any stipulations related to a downward performance or some undisclosed issue that affects my performance. Yeah.

David Barnett (15:15):

Once you sign with what we call an institutional loan, so something from a bank, then yeah, you’ve guaranteed it personally. You owe the money, it’s got to be paid back. Often these things go together. Believe it or not, a lot of lenders don’t want to make a loan unless they also know the seller’s making a loan

Henry Lopez (15:31):

Because

David Barnett (15:32):

That’s a huge indicator for the lender. They understand all these aspects that we’re discussing.

Henry Lopez (15:38):

And

David Barnett (15:38):

So when you meet a seller who out and out refuses to finance any part of the transaction over at the bank, it raises a red flag for them. They start to wonder what may not be disclosed or what does the seller think is wrong with the business or with this particular buyer? Because in order for a seller to be willing to do seller financing, they have to know that the future prospects of the business are good

Henry Lopez (16:03):

And

David Barnett (16:03):

They have to meet the buyer and feel and agree that the buyer is going to be a capable operator. And so that vote of confidence that a seller can give to a buyer is a great advantage to a buyer. It can let someone know, Hey, this person knows the business and they believe in me.

Henry Lopez (16:23):

And it can be a great advantage to the seller as well. I get it as a seller having sold the business that ideally I would love all my cash at the table and then I walk away and never have to worry about it again. I understand that motivation. I’ve been there. I think though you touched on it, there’s many ways to arrange this such that it is beneficial to everybody, including perhaps me paying a little bit more of a premium total price because you’re making this accommodation. Often what sellers who are adamant against it, if it’s not because they’re not bullish on the business anymore is because they want that cash. They need that cash to go retire, to go do whatever it is they want to do next. So if you can understand what is really the challenge, often you can work something out to make that happen for them.

David Barnett (17:11):

Usually it’s just simply ignorance. So a lot of people who put a business up for sale, they may have started the business and they could have started the business decades ago, they’ve never been involved in a business transaction before.

Henry Lopez (17:22):

Yep, good

David Barnett (17:23):

Point. And they honestly just don’t know that this is normally how things go down. And so when they approach selling the business, they think it’s selling any other big thing they may have sold like an RV or a house or a car. And so they imagine that they’re going to make a deal and they’re going to get this big check. And so this is where it’s important that people’s expectations are correctly set. So if somebody goes and visits with a qualified business broker, that broker is going to explain to them, Hey, this is normally how deals go down. You’re going to be expected to finance part of the transaction. For sellers that are really informed, they’ll understand the difference between, you gave an example, Henry, if you were buying a business for me and you gave me a down payment of your own savings and asked me to finance the rest, that would mean that I would be able to put a lien on the business. I would’ve a guarantee from you. And if for some reason you didn’t pay me, I could take the business back.

Henry Lopez (18:20):

That’s

David Barnett (18:20):

A very different position to be in. If versus for example, if you put some money down, then borrowed from a bank and then had me hold a note behind the bank. And so I know that because the bank is ahead of me in the priority, my options if something goes wrong in your business, are quite limited.

Henry Lopez (18:40):

So

David Barnett (18:41):

Sellers will often agree to small amounts of seller financing if they know that the bank is going to require it. But if you have a significant or substantial down payment, oftentimes you can get a seller to finance the balance if they see that you’re the right operator and they see that what you’re putting down is significant and it’s a material amount for you that you wouldn’t want to lose.

Henry Lopez (19:05):

Agreed. Agreed. Alright. So we’ve touched on, as we’ve been talking about this, some of the disadvantages of buying an existing business, like hidden things that we don’t know about that we don’t want to cover until later. You mentioned the equipment example could be other things that again, we have got to try to cover in that contract or loan agreement, but nonetheless, there are things that can happen. What else have you seen that could potentially be a disadvantage to buying an existing business?

David Barnett (19:33):

Well, it’s impossible to get to know the business as well as the seller knows it in any sort of due diligence. I keep pointing out to people that businesses are not real world things. You can’t actually take a photograph of a business. You could have all of your plumbing trucks lined up with all of the plumbers standing beside them and take a photo and I’ll say, no, it’s a photo of some vans and some people, right? Or if you take a picture of your flower shop, I’ll say that’s a photo of a building a system, sorry. A business is a system. And what it is is an orchestration of people and capital in a place with systems

David Barnett (20:12):

Controlling the choreography of how these people interact. And the goal is to have these interactions occur and produce a positive cashflow at the end of the day. And because it’s simply a system, it’s extremely fragile. And so it’s hard to get your hands around, it’s hard to fully analyze everything that’s going on in the business and you really have to get into it to fully understand it. And so one of the things that I’ve seen people have a challenge with is they’ll have an idea of what it’s going to be like to be the owner and operator of the business. They’ll daydream about it, then they’ll get into the business and then within some period of time afterwards they’ll realize, I don’t like this. And here’s the issue with businesses as an asset class, they are highly liquid. So I used to be a business broker and I had some files that were on my desk as long as three years where I had multiple attempted transactions that didn’t go through. And finally they were sold. So those were cases where sellers took three years to sell their business. If the new owner decided after six months, the six months that they didn’t like, it could take them equally the same amount of time to

Henry Lopez (21:24):

Sell it. So you said, I think I heard you said they are liquid. I think you were saying illiquid, illiquid, illi.

David Barnett (21:32):

Sorry.

Henry Lopez (21:32):

Not as liquid as we would like for them to be when we want to get

David Barnett (21:37):

Rid of them.

David Barnett (21:38):

And there is a spectrum. So for example, a business that requires an owner with some kind of technical certification, some kind of dentist office or architecture firm that’s going to be highly, highly illiquid because not only is there a smaller pool of buyers, but those buyers have to be qualified in a certain way. But at the other end of the spectrum, you can have things like small sandwich shops, convenience stores, pizzerias, which would have a much wider potential audience and they would certainly be more liquid. But you’re not talking about something as liquid as a publicly traded stock where you can just make a decision and execute the order and it’s gone.

Henry Lopez (22:21):

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Henry Lopez (23:17):

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David Barnett (24:37):

Well, it’s a great question because the answer is hard to define because we don’t know what precisely will be the success rate of your startup, but we do know that the current business is successful right now. That isn’t to say it’s a guarantee that it’s going to be successful forever. All small businesses have this fragility that I explained before. Things can happen entirely outside the control of the owner.

David Barnett (25:04):

Business owners like to think that they are in control of their destiny because they make decisions all day long. But I’ve seen restaurants that have closed, unfortunately because city governments took longer than expected to replace sewer lines in front of their parking lot, things that are completely outside of their control, the big pandemic and all the rules that happened with respect to that, it hurt a tremendous number of businesses completely unforeseen. And so always when we’re looking at a business purchase, I shouldn’t say always, I sometimes look at a deal and I’ll stop and I’ll think if there’s anything inside of me that gives me pause about whether the value is there, I’ll ask the question, what would it cost to start this? If you bought the equipment, you bought the material and then you took that extra amount of money, let’s say there’s another half a million there. Could you fund a two year startup towards breakeven with that money?

David Barnett (26:05):

And it can be a good benchmark to just measure the sanity of a deal that you might be getting into. The number one benchmark is to make sure it truly cash flows after all the expenses have been put back into a forecast. But to your point, Henry, sometimes it can be too expensive. And what is often lacking is empathy on the part of the seller, which is kind of funny to me because most business owners are keenly aware of the interests of their customers. So as a business owner, we about our customers all the time, what they want, what they’re willing to pay, what kind of service they demand. So that’s an exercise in empathy. We’re thinking about them, but for some reason when we come to sell our business, all we think about is ourselves,

Henry Lopez (26:55):

Right?

David Barnett (26:56):

So I’ll give you an example. There was a little coffee shop muffin shop that was for sale once back, this was over 10 years ago when I was a business broker, and I analyzed it for the woman that owned it. And I came back and I said, your business is probably worth between 60 and $75,000. And she said, no, no, no, I need a hundred thousand. I said, oh, in that case, all you have to do is institute a two coffee rule. Every customer that comes to the counter has to buy at least two cups of coffee. That should increase your sales substantially and your business will become worth a hundred thousand. And she looked at me and she said, but my customers don’t all want two cups of coffee. And then shortly after she drew the conclusion herself, the buyer of her business is also a customer and this person is being asked to pay money to acquire something. And what they’re acquiring is a cashflow. And so it’s got to be something that makes sense for that buyer or else they’re not going to do it. They’re going to weigh a way this opportunity versus something like starting their own or just maintaining their money in the bank account and going looking for a better deal.

Henry Lopez (28:06):

Yeah. Yeah, that’s my experience. It’s interesting because I just think it’s like having been a realtor, a residential realtor, such an emotionally charged transaction. But the same thing happens with our business. We likely, like you said, gave birth to this. We’ve nurtured it, it’s been a part of our lives, and by golly, it needs to pay off. Now, even though I might be completely unrealistic on what I think this might get, this is the number I have in my head. And sometimes that reality, it takes a while for them to process that. So speaking of valuing a business, the simple formula that I have typically used for most businesses is some multiple of an average of owner’s benefit. That bottom line, once we kind of take out all of the owner’s benefits that are added in there, is that the norm? Is that what you recommend or tell me about how you go about helping somebody value a business?

David Barnett (29:04):

So we use what are called notional cashflow levels, and notional simply means made up. So on your tax return, it comes down to a net income number because that’s what the government needs in order to calculate what taxes you owe. And so we know that there’s certain decisions that went into how your business operated that don’t necessarily have to be made by the person who buys it. So we back things out to get to this level of cashflow called seller’s discretionary earnings, which is the amount of money available to an owner operator that works full-time in the business. And we get there by adding back taxes, interest, depreciation and amortization. So basically all of the bills that needed to be paid for the business to function have been paid. The S d E is the leftover money. However, buyers should not be confused that this is somehow the money that goes in your pocket. And this is one of the big problems that people have is they’ll see a business advertise for sale with an s d E of a hundred thousand dollars and they think If I buy this business, I’ll get a hundred thousand dollars. It’s not true because the depreciation and amortization represent things wearing out capital equipment investment, and you’re going to have to buy stuff for your business

Henry Lopez (30:19):

Equipment retain of those earnings. There’s no doubt

David Barnett (30:22):

That’s going to cost money. You will have to pay interest on many money borrowed to buy the business that was added back. Now it’s going to come out of your pocket. You’re going to have to pay the principal portion of any loan payments, which is actually out of your profit, but it affects your cashflow and you’re certainly going to have taxes if you’re making money at this. And so the scenario that the buyer’s going to have is going to be very different. What their take home is not going to be that seller’s discretionary earnings, but we use these notional cashflow levels because it’s the best tool we have.

David Barnett (30:57):

And with that tool, because I work in this industry, I subscribed to some private databases of transactions that have already happened, I can go and look and see what the business sold for as a multiple of those of that seller’s discretionary earnings. I can also see what it’s sold for as a percentage of its annual sales. There are several different methodologies for arriving at a price, and they’re all very interesting to look at, but they’re all just guideposts because at the end of the day, you have to actually build a cashflow analysis to see what kind of money will be available for you, and you need to factor in the true expenses that you have. And one of the biggest ones that people forget, Henry, is the value of their own time. So they actually forget that that s d E involves them working 50 hours a week. Right?

Henry Lopez (31:47):

So let’s talk about that moment because one of the things that I usually do is I say to test that is, okay, add in then. If you were to hire a manager to run this day-to-day and what is the going rate for that manager and plug that in. Is that fair?

David Barnett (32:03):

Yeah. And what you’ve done when you do that is you’ve moved from SS d e to normalized ebitda. We have a different name for that notional cashflow. And basically the difference is is that if you’re going to be an owner operator, you’re typically looking at S D E. And if you’re doing a strategic acquisition, you typically look at normalized ebitda. But I’ve seen so many people, Henry will make this mistake. They’ll see a business that has a $200,000 s d e and it’s available for sale for $800,000 let’s say. And they’ll go, wow, it’s a 25% rate of return, but it isn’t a 25% rate of return. No,

Henry Lopez (32:39):

Just you’ve just completely discounted your labor to zero

David Barnett (32:44):

Precisely

Henry Lopez (32:45):

Or worse because the opportunity cost has gone as well. You can’t go do something else. You’re stuck running this business for nothing.

David Barnett (32:52):

Exactly. And that example I just gave would be four times s d e would actually be a incredibly overpriced small business. The overall average across all industries is about 2.3 times. So that $200,000 s d e business should really be worth about four 50. And those averages change by industry. So a highly competitive industry with few barriers to entry restaurants would have an even lower one. A business like septic tank cleaning with those pumper trucks would have a higher one because there’s greater barriers to entry in that industry. And also higher things like capital costs, like buying that equipment.

Henry Lopez (33:36):

Same thing. I was in the carwash business. And so in that kind of business where we own the land, we built the business, we have hundreds of thousand dollars’ worth of equipment, which depreciates nonetheless, that’s a different valuation because there’s that component plus an assets component that we bring into play as well. Right.

David Barnett (33:56):

And land brings in an interesting issue. So when we evaluate businesses, we only want to evaluate the operating business. And so companies that own their own real estate, they’re actually in two businesses at the same time. They’re in the commercial property business and in whatever business they happen to be in, let’s say dry cleaning, they just happen to be their own landlord.

David Barnett (34:20):

And so when you look at the financial statement of that dry cleaning business, part of that profit really belongs to the building. It’s what gives the building its value. If we asked a commercial property appraiser to look at the building, they’re going to look at what people are paying for rent in that area. They’re going to calculate what the costs for the building are, and they’re going to figure out using a cap rate based on the local market, what the building is worth. Well, if we want to isolate the business activity from the real estate, what we end up doing is putting in what we call imputed rent. And so we’re going to add an expense. And I’ve seen a lot of people, Henry, who thought they had very profitable businesses that when we normalize for real estate, they get surprised

Henry Lopez (35:01):

Their

David Barnett (35:01):

Business isn’t nearly as attractive as they thought. Once you take out the fact that the real estate holds certain value, there is a category of businesses like what you’re describing, like the mini storages, the motels, the special care homes, car washes, purpose-built facilities for industrial reasons where you’ve kind of got business and real estate mixed together. There’s just slightly different metrics that are available that we can look at in databases to tell us how to treat those.

Henry Lopez (35:32):

Yeah, well said. In a qualifying point that you’re making there in the carwash business is a perfect example. Those purpose-built businesses are not very valuable and the bank told us. So it’s just like, yeah, it’s collateral, that’s great, but what are we going to do with this piece of building not the land? The building is not worth anything other than another car wash, and if you couldn’t make a car wash work there, we’re assuming somebody else will. So we got to be careful with those purpose-built properties and what the real value is of that building from a buyer’s perspective. The rule of thumb that I’ve always used when I’m evaluating a business as I want my return after all these adjustments that we talked about, my return on my cash investment in particular to be somewhere into three to five years at most. What do you say to that and how similar is that to your guidelines? It’s a rule of thumb, obviously.

David Barnett (36:31):

Yeah. It depends on the industry. So the riskier the business, the faster you want your money back. And so that range you gave is in perfect alignment with what I think too.

Henry Lopez (36:43):

Yeah, I think that’s a great point. The risk of the business and the risk of that includes the risk of the market or the industry that the business is in. You mentioned some that are more volatile than others. Again, going back to the carwash industry, another example of what might happen, a municipality might have a knee jerk reaction in the case of a drought because they think we consume too much water. Whether that’s true or not, that could impact my business, and I have no control over that. Any other business that’s highly regulated or could be impacted by either local or federal government action falls into that category. But it goes beyond that, a business where the barrier to entry is low and my competition could increase wildly. Well, that’s another thing to look at as well when wanting to get that money back sooner than later, right?

David Barnett (37:31):

Absolutely. There’s a whole array of different risks. When you talk about government rules, we call that regulatory risk. The rules could simply change, and there’s no greater example of regulatory risk than what happened in 2020. All of a sudden there were all the issues related to the lockdown. Nobody foresaw that. People who bought a business at the end of 2019 probably didn’t have that in their business plan. I can tell you going forward though, if I was going to sign a 20 year lease in an expensive location, I’d probably want to get something in there.

Henry Lopez (38:08):

I’m going to have a clause in there about that.

David Barnett (38:11):

Yeah, some kind of relief built in, or at

Henry Lopez (38:14):

Least try to negotiate

David Barnett (38:15):

That.

Henry Lopez (38:15):

You may not get it, but you’re going to try to negotiate that and then see if you can get what you can get there. Alright. The big question I always get often, I’m sure you get it all the time, is where do I find a good business to buy?

David Barnett (38:26):

Yeah, it’s a great question. So let’s think about the world of business sales and the journey of a business owner when they decide to sell. So when someone says, I’ve decided I want to sell this business. I can no longer operate it anymore life conditions or my situation is such that I am now motivated to sell, the very first thing they’re going to ask themselves is, do I know anyone who would like to buy? And so this is why you see a Ford dealership being sold to the Ford dealer in the next county or some other industry auto group operator across town. So a lot of the times business owners know other business owners, they’ve met people through different associations. They have a network, so they try to exercise that network. It’s really hard to tell exactly, but we know that probably four out of five businesses sell without the help of any kind of intermediary find the buyer of the business.

David Barnett (39:25):

And so that one out of five, who can’t find a buyer for their business, they might end up going with someone like a business broker who might have a network of buyers. This is important. So a business broker earns a commission on the sale of the business, and they’re highly incentivized to sell the business as quickly as possible because then they get paid sooner. So a business broker that is established that has a list of buyers and people who’ve done business before, if they know someone they think is interested in that business, they’re going to go straight to that person. And so I talk with business brokers all the time, and I know that many of them have listings that never get to online websites. If the broker doesn’t know anyone who is a potential buyer, then they might put it onto one of these online marketplaces. And if it’s a good business priced well, a hundred people will inquire on it in the first week. And so there’s a big rush of competition between these buyers who want to get in there and get that business. And so I get the comment all the time, Dave, when I go on this website, it seems like everything’s junk.

David Barnett (40:32):

And what is happening is they’re looking at the picked over leftovers. And so if you’re serious, I run a group coaching program for people that are buying a business, and one of the first things we work on is what exactly do you want to buy? If you think about going to the mall, there’s two ways you can shop. You can look at what’s on display in the windows and try to figure out what you’d like to have. Or you can go in there with a list, you might go to the grocery store. And when you go in with a list that says, here are the items I need, you can get in and out quickly and get exactly what you need. And so if you figure out, I want a business, what kind of business? Let’s say I want a machine shop somewhere in upstate New York. Well, once you’ve made that decision, you just need Google or the Yellow Pages, you can find them all. And then it’s a matter of creating relationships, networking, finding out who owns these places, talking with those people so that when that personal event happens in the owner’s life and they think, who do I know that might like to buy my business? You’re actually on that list. And so you can actually get a chance to go in there and discuss and talk about a deal before you end up competing with all those other people. And so that’s kind of how the landscape or the ecosystem works.

Henry Lopez (41:55):

Brilliant, and I agree with that. That’s been my experience as well. But thanks for laying it out. If I’m following you correctly, and it’s what I’ve done as well is you start by defining your criteria. What is the type of business that I’m looking for? And you may have a very clear idea or you may be open, but that’s a challenge. You need to narrow that down. What types of businesses fit what I want my lifestyle? What types of businesses can I envision myself being in day in and day out, as you mentioned?

Henry Lopez (42:23):

And then narrow that down. You’re going to have to do some analysis of yourself and some research and visit businesses and then identify those businesses that fall into that, meet that criteria or that industry, and get to know those people. Be in the circles that they’re in, whether it’s a chamber of commerce or a networking group or whatever. You start to connect, buy the owner a cup of coffee and ask them just to learn. I know your business is not for sale, but I’d love to learn more about the industry. You’re going to find that most business owners, if you approach ’em the right way and at the right time, are more than willing to share and talk, right? We love to talk about business, build those relationships over time, and then you’re in the right position when one of those does come available. So it requires patience here. David is part of this. You’ve got to be patient in this approach and not expect it. Today, I decide to buy a business tomorrow, I’m going to find the right best. I might get lucky, but that’s typically not how it works. Am I getting that right?

David Barnett (43:21):

Well, yeah. And to really highlight patience, this is a key thing that the owner of a profitable business, unless they’re being motivated by something like illness or something really cutting their timeline short, the longer they delay or hold that on selling the wealthier they become because they a profitable business. So time is on their side. The only point of leverage a buyer has in the negotiation is a willingness to not do a deal. And so you engage with the seller, you learn about the business, you talk about the business, you present the offer that is going to be workable for you, but if that’s never going to be accepted by the seller, you have to have the willingness to actually disengage and back off. And I’ve seen instances before where people have made offers and the seller says, no, I want more. And the buyer just has to say, well, I understand you want more, but it’s not going to work for me. Perhaps you can find someone else that will do what you wish, and then that seller might go talk to two or three other people and end up coming back to you. That’s right.

Henry Lopez (44:27):

You have to be willing and able to walk. You cannot, as it applies to any real estate, you cannot fall in love with the business. I mean, you want to fall in love with the business, then you got to put that aside, and then this is a business transaction. Then you got to be prepared to walk, because to your point, that’s your leverage. Alright. You’ve put together, as I mentioned at the outset, a great a hundred page, I think it is starter guide. Tell me about that because we’re going to make that available to all of my listeners to download for free. But tell me about what’s in that.

David Barnett (44:58):

So I’ve got these two short eBooks. One of them is a bestseller of mine on Amazon, 21 Stupid Things People Do when Trying to Buy a Business. Another one is called 12 Things to Do before You Consider Selling Your Business. And so I put these two together with a third book that has not been published widely on Amazon or anything like that, which is simply called Buying versus Starting a Business. And I put all three of these together and it ended up being a 100 page P D F. And so I call it a starter guide to buying and selling businesses, and it’s going to give everyone an initiation into this world. Some of the ideas, some of the frameworks, some of the things to think about, and if you’re curious about this stuff and just download it and take a read, and I’m sure you’ll learn something. And if you learn this isn’t for you, then that’s got a value in itself as well.

Henry Lopez (45:47):

Agreed. Thanks for making that available. So just go to the show notes page for this [email protected]. You’ll see the link right in the description wherever you’re listening to this episode. That’ll take you directly to the show notes page, and then you’ll see the link to download this guide. I encourage you, all the stuff that I’ve read from David is really full of actionable information, so you’re going to get value from it. Alright, so that’s one way to learn from you. How else should people engage with you? And I often get the question of when should I contact somebody like David if I’m in the process of thinking about buying or selling a business? So tell us about that.

David Barnett (46:25):

Sure. So if you decide this is something you want to do, then I’ve got some education products that take a while to consume. And so time is on your side if you engage as early as possible. I also do direct consulting services with people who’ve found a business that they want to buy and they want help to analyze it, make up an offer, et cetera. So for the education components as soon as possible for the direct consulting engagements, you have to have that target identified first. And the best thing I can say to anyone is sign up for the podcast or the YouTube channel or come over to my blog and sign up for my email list because there’s a wealth of information there that’s just publicly available. I think I’ve got over 600 videos on my YouTube channel now,

Henry Lopez (47:12):

And

David Barnett (47:13):

Those are largely generated by questions in the comments from people, just like the people in your audience.

Henry Lopez (47:20):

Yeah, I love in particular, that just rang a bell episode you released recently about the survey that you did of your listening audience, and there was so many nuggets there of what people are asking because you know what I find David is when we hear that others are asking the same questions, it makes us feel, oh, it’s not just me that doesn’t know this. Right? So don’t be afraid to learn. Don’t be afraid to leverage David’s resources. So the podcast and all this information, David C as in Charlie Barnett with two t’s at the end.com, right? The YouTube channel. Do I just search for David C. Barnett, or what’s the YouTube channel? How do I best find that?

David Barnett (47:57):

Yeah, if you look for David c Barnett’s small business on YouTube or on any of the podcast hosting apps, I’ll come right up. I guess I’ve got, if you put small business, there’s a strong link in the algorithm between me and that topic.

Henry Lopez (48:15):

Agreed. Agreed. Alright, let’s wrap it up with this last question. What’s one thing you want us to take away from this conversation that we had about the evaluating this decision between building my own business from scratch or buying an existing business? What’s a key takeaway?

David Barnett (48:31):

Yeah. I would say evaluate your motivations. So why is it that you want to do this? And the reason why I say this is I meet a lot of people who think that business ownership or small business ownership is sort of a certain or quick path to wealth and riches. And when you read all the studies and look at the actual data, small business owners work really hard, and many of them don’t earn any more money. And so really understand what are your motivations? What are you looking for? And what’s interesting to me is I have a lot of conversations with C-suite level executives and big companies that want my help because they want to leave their $300,000 job to buy the fishing village and the fishing lodge in Colorado or whatever. And because they’re looking for some kind of lifestyle change, even if it comes with a decrease in their income.

David Barnett (49:29):

And so those guys have certainly considered what they want in life, and they’re looking for a whole overhaul of what their day-to-day looks like. And so think about what the future looks like, think about what success looks like, and think about what you would like to be doing day in and day out. And buying a business should really be part of a leveling up move if you’re driven by a desire for freedom, for liberty, for wanting to have control, more control over things. And with that comes greater responsibility. Responsibility for your life, your own income, and the responsibility of the people who are going to be working for you. If that’s something appealing to you, then this is probably a path that you want to look at. And then it really is a question of, do I want to try and build something regardless of the risks, or do I want a more certain path? Even though it could still take just as long to find the right thing, but maybe it’s going to be less risky. Maybe I can stay in my job while I look for the opportunity and then execute and move straight into something that makes money.

Henry Lopez (50:32):

Yeah. Great advice. Well said. Thanks for sharing that. Tell us again where you want us to go online to learn more.

David Barnett (50:39):

David c barnett.com is my blog site. From there, you can find all the different places I am and links to books and courses and my email list and everything.

Henry Lopez (50:49):

Wonderful. David, as always, thanks for the conversation for your insights, for sharing your knowledge. Thanks for this 100 page plus guide that you’re going to share with my audience. Again, go to the how of business.com to show notes page for this episode, to get that consume all of the content that David offers for free to help you learn about this, and then engage him at the right point in time so he can help you with this. Thanks for coming back on the show and spending time with me again.

David Barnett (51:17):

No problem, Henry. Great to see you. Until next time.

Henry Lopez (51:20):

Absolutely. This is Henry Lopez. My guest again was David Barnett. I release new episodes every Monday morning. You can find a show everywhere you listen to podcasts, including my YouTube channel, as well as at my website, the how of business.com. Thanks for listening.