Guerrilla Billionaire™

How to Buy a Business: Creative Financing Using an Earnout

On So-called Creative Financing

There's two basic types of creative financing. The type that works and that type that doesn't. If you keep your eyes and ears open, you will continue to be astonished by new discoveries. I recently completed a 100 page lesson on creative financing that works in contrast to the kind that doesn't. The lesson consists of the proven financing techniques, I have seen used over 20 years.

Then last night I come across something quite audacious. There was a conversation about how earn-outs work. Several people tried to explain the tactic. Then one gentleman, Mark Makuta, stepped in and gave two personal examples of how he used earn-outs to buy two businesses.

Here is his account in full:

Ron: I structured a few "earn outs" in my prior business and all is subject to negotiation. All of my earn outs were 100%, meaning there was no cash down payment. I was taking over retiring peoples list of clients and business, which was just to risky to warrant any amount of cash upfront. Two examples:

Earn Out "A": Existing business was valued at $300,000.00. Earn out structured as 10% of GROSS paid monthly on a "Net 30", no caps and a 10 year term. So, if after 10 years, I only paid out $250,000.00 that was the end of the deal. Result: After 4 years, all of the persons clients whose business I took over ended up moving to other firms and were restricted as to who they can give business to. Therefore, all revenues dried up and I only ended up paying out I think around $75,000.00. Glad I did not put any cash up front.

Earn out "B" : Existing business was valued at $900,000.00 and I really wanted this business. I knew of the clients and their business I was going to possibly be assuming and I cut a deal with the seller where the base value was to be $1,000,000.00 ( So he was to receive another $100,000 as an incentive to do this deal with me ). Unlike "A", earn out was structured as 20% of NET Income paid monthly on a Net 30 basis with a yearly cap of $200,000.00. So if by October, we reached $200,000.00, no further payment was due until January of the following year. Bottom line: The gentleman received his million in a little over 7 years and I also thru in paying his health benefit premiums for the 1st five years of the deal which had a value of approximately $45,000.00 for him. This was a sweet heart deal. It worked very well for the retiree and it worked extremely well for me because my firm ended up continuing relationships with this guys clients list for quite a few years after the deal ended.

Again, everything is negotiable from monthly caps to yearly caps to final terms, etc.

Hope this helps,

Mark

~end

Earn-outs are typically used to postpone, possibly forever, 5 to maybe 30% of the selling price. Seeing them used to pushback 100% is something new even to myself.

Hats off to Mr. Makuta. 

Find out more ways to buy businesses using creative tactics.

How to Buy a Business: Business Acquisition Financing - SBA Policy Changes Effective Oct 1, 2009

By way of KeyBank.

SBA Business Acquisition Financing - SBA Policy Changes
Effective Oct 1, 2009

Intangibles Policy: - Change of ownership loans that include purchase of intangible assets are allowed.

Intangible Asset Definition: - SBA Now defines “Intangible Assets” as including, but not limited to, goodwill, client/customer lists, patents, copyrights, trademarks and agreements not to compete.

Purchase Price of Intangibles over $500,000: - If purchase price includes intangible assets in excess of $500,000 then, Borrower and/or seller must provide an equity injection of at least 25% of the purchase price of the business.

Purchase Price of Intangible less than $500,000: - If purchase price of business includes less than $500,000 for intangibles, the 25% equity requirement does not apply.

Seller Equity: - Seller Equity = Seller-take back financing that is on full stand-by (no payments of principal or interest) for at least 2 years. Borrower and seller will agree how much equity each will provide Ex: borrower may provide 10%; seller may provide 15% total must equal at least 25%.

Buyer’s Down Payment: - Cash that is borrowed; SBA considers funds borrowed through the use of personal credit for injection (Ex: Home Equity Loans) into the business as additional debt, not equity, with one exception. If the Small Business Applicant can demonstrate repayment of this personal loan from sources other than the cash flow of the business, the cash injection may be considered equity.

Business Valuations: - If the amount being financed (including any 7(a), 504, seller, or other financing minus the appraised value of real estate and/or equipment being financed is $250,000 or less, the lender may perform its own valuation of the business being sold. If the amount being financed minus the appraised value of real estate and/or equipment is greater than $250,000 or if there is a close relationship between the buyer and seller, the lender must obtain an independent business valuation from a qualified source.

Loan Terms: Business acquisitions with no real estate remain at a 10 year term. Real estate acquisitions remain at a 25 year term. Historically, loans that included both business and real estate were blended. Lender’s now have the option of providing a blended maturity or a maturity based on the maximum maturity allowed for the asset comprising the largest portion of the use of loan proceeds. For example, if the majority of loan proceeds are financing real estate, a maximum term of 25 years is allowed. Verify with the lender what method will be used to determine the maturity.

Collateral: SBA no longer allows lenders to provide a value to accounts receivable and inventory when determining collateral coverage, even if those assets are required as collateral on term loans.

How to Buy a Business: James Ling "The Merger King"

James Ling "The Merger King"

"James J. Ling collected companies the way boys do baseball cards."

When I was about 9 or 10, I read this article in Newsweek or Businessweek about the great conglomerate builders of the 50s and 60s. This was probably around '69 or '70. Chief among them was James Ling, "The Merger King." Words fail me when it comes to describing just how excited I got over this way of making money. Yes, I was an odd sort of child. To this day, I still recall that article and the editorial cartoon that went with it.

Unfortunately, within a very short time, I became distracted by the members of the opposite sex and all the troubles that go with adolescence. However, my interest in business never waned. I even became a business broker eventually and got a chance to see some real wheeler-dealers in action.

Anyways, I just want to pay tribute to a financial genius who started with nothing and built a great empire.

http://www.nytimes.com/2004/12/26/business/26ling.html?_r=1

http://en.wikipedia.org/wiki/James_Ling

James Ling is partly the inspiration for this blog and course on how to buy businesses.

Learn how he and others did it by joining our list for free.

How to Buy a Business: SBA's Latest Modifications to Small Business Loan Guaranty Program

SBA's Latest Modifications to the Small Business Loan Guaranty Program

SBA issued the long awaited changes to its rules regulating business acquisition loans (referred to as 7(a) loans). When buying a business, the SBA will finance goodwill. However, if the goodwill portion of the loan exceeds $500,000, the SBA requires the buyer and/or seller to contribute 25% of the loan amount in "equity" to the deal. The seller can contribute "equity" to the deal by taking back a seller finance note.

Appraisal requirements have not changed. If the loan amount less land and equipment exceed $250,000. The bank making the loan will require an appraisal by an outside qualified appraiser. Qualified appraisers are those holding the CVA, ABV, ASA or CBA credentials. www.sba.gov

How to Buy a Business: Broker Versus Intermediary

From searching through the listings of businesses for sale, I have noticed that there are both brokers and intermediaries. What is the difference between the two and who should a first time buyer talk to?

This is a great question and one that almost everyone wonders about. The best way to answer this is to explain that brokers and intermediaries sell different sizes of business. The broker typically sells the small or what is commonly known as the "Main Street" business. This include restaurants, coffee shops, retail shops, gas stations, bowling alleys, etc. In contrast the intermediary will typically represent larger companies with ten million dollars in sales or more.

They also work differently. A business broker will usually work like a real estate broker. That is to say, they will try to acquire as many listings as possible in the hopes that some buyer will come along for each one eventually.Business brokers often belong to a franchise operation and have store front offices you can walk into and inquire about the opportunities they have for sale.

In contrast, you see intermediaries by appointment only. They are very selective about the clients they take on because finding buyers for larger companies takes a lot of time and effort. As a result, intermediaries will limit themselves to about half a dozen or so clients at a time that they can effectively market.

How to Buy a Business: The Coming Boom in M&A

I've already made mention of this emerging trend in my post on the next Gold Rush. While this NYT piece focuses on middle-market M&A, rest assured that there's also going to be activity at the lower end of the markets--which is where we focus.

Mr. Roberts predicts that the resurgence of deal-making will begin within the next six months to a year as the economy improves and the middle-market mergers-and-acquisitions cycle pulls out of its current contraction.

This time, though, in his view, the recovery will get extra thrust from the convergence of four other trends: burnout in the ranks of baby-boomer business owners, rapid technology advances that are driving market consolidation, long-term growth in the appetite of foreigners for United States companies and a buildup of cash at the nation’s 4,000 to 8,000 private equity groups.

“There is tremendous, pent-up demand on both the buy and sell side,” he said. “These middle-market firms account for two-thirds of gross national product. And they aren’t going anywhere.”

 ...

Mr. Roberts, the investment banker, says baby boomer burnout will be a driving force in the M.& A. boom that he sees on the horizon. Of the 1.2 million middle-market businesses, more than 800,000, with a total market value of $3 trillion, are owned by people born in the years 1946 through 1964, he calculates. He estimates they will sell or leave to heirs 560,000 companies with a value of $2.5 trillion, and shut down or otherwise dispose of the others.

The process has already begun, as some of the owners retire, become sick or disabled or find a sudden need for cash. “Those entrepreneurial fires can die more quickly than you’d think,” Mr. Roberts said. “One day you’re suddenly tired.” (source)

The Next Gold Rush.

How to Buy Up Companies: Tom Murphy of Capital Cities/ABC Shares His Story

Tom Murphy has bought a lot of companies over the years. He began from humble roots and shares his story with Charlie Rose. He talks about the Disney/ABC merger, the highly competitive worlds of entertainment and television, his business strategies, and his long career as an executive and entrepreneur.

How to Buy a Business: How Profitable Are Different Types of Businesses?

New York Magazine has an article on the profitability of various types of businesses in New York.

A Yellow-Cab Driver: Samuel Pekoh     
A Four-Star Restaurant: Nobu
A Drug Dealer: 'Nick'    
A Private School: Horace Mann School
A Private Investigator: Michael McKeever    
A Department Store: Macy's Herald Square
A Diner: Silver Star    
A Drug Company: Pfizer
A Soup Kitchen: Yorkville Common Pantry    
A Financial Firm: Goldman Sachs
A Yoga Studio: Joschi Body Bodega    
A Midtown Building: 666 Fifth Avenue
A Sex Shop: Babeland    
A Baseball Team: New York Yankees    
A Discount Store: Jack’s 99¢ Stores    
A Museum: Museum of Modern Art
A Pizza Place: Nina’s Argentinian Pizzeria    
A Clothing Store: H&M Flagship
A Copy Shop: Copyland    
A Publishing Company: Random House
City Government: The City of New York

Go read The Profit Calculator.

How to Buy a Business: Having Trouble Choosing a Business?

If you are interested in starting or buying a business but at the same time having a problem deciding which kind to get involved with, demographics can provide beneficial data. Nielsen offers some chilling predictions for the next four decades.

           Below The Topline: The United States in 2020 A Very Different Place

The recession of 2007–2009 has placed a great deal of strain on marketers and retailers of consumer products. Price and value have become more and more important, challenging marketers to rethink product and distribution. Everyone just wants things to get back to normal, but will they? While discretionary spending will return to moderate levels as markets rebound, the economy of the United States—as well as the rest of the more developed World—is well on the road to longer-term difficult times. The economic hard times to come do not stem from the misuse of arcane investment instruments that can take a degree in calculus to understand, but rather from simple demographics. The emerging marketplace will be very different than today, and filled with wide-ranging challenges.    (source)

How to Buy a Business: Price Reductions

We're looking at buying a business in our town which be a nice complement to
our three old business. This one is listed with a broker and is over priced a great
deal. We told them this but they won't budge. Are prices ever reduced on listings?

Businesses, like almost anything else, will come down if they're not attracting offers at their opening price. Often a broker will exaggerate the business's value and potential selling price to the seller in order to get the listing. His plan is to then wait a month or two before putting pressure on the seller to reduce the asking price to a reasonable level. This happens in areas where there are a lot of brokers competing for listings.

Think about it this way. Who is more likely to win the listing?

Broker A tells the owner that her can probably get 3X ODFC.

Broker B tells the owner that her can probably get 4X ODFC.

The answer is Broker B almost every time. The exception is the sophisticated multi-business owner with an objective approach to valuing his businesses. Owners of single businesses tend to over-value their "baby."

If you want to wait, expect a price reduction after the first 30 days. If it doesn't happen then it will definitely happen within 60 days.

The risk you take in waiting for the price reduction is someone else snapping it up.