An old saying in business:
Growth is Vanity | Profit is Sanity | Cash is King
We reiterated this saying many times over the years. However, that concept of ‘cash’ does not relate to the folding stuff under the counter.
We have come across a couple of cases lately where we have been asked about small retail businesses that clients were looking to buy. Typically, an impulse to run a café or a restaurant … often for the kids, retirement hobby, or as a change of career.
The real estate agent/business broker for the vendor has told the prospective purchasers that the business is doing a lot better than the losses the vendor’s accounts show. The losses have arisen because the business pays the owners expenses, plus a small salary and you guessed it … they take a lot of ‘cash’ out of the business.
Must be a good opportunity… yes?
What do we think?
- When valuing a business, it is normal to adjust for a commercial remuneration for the owners who work in the business. That would mean adding back expenses that were private in nature (of some unknown amount), adding back cash taken from the till (also an unknown amount), and then adding back the (small) salaries actually paid. A commercial estimate of ‘replacement’ owner salaries (for the huge hours worked) is then deducted. All up, any adjustment to profit may be positive or negative.
- That may leave the profit much the same as it is in the accounts. That is, not much.As you probably already know, this profit is then multiplied by a multiple to get a theoretical value. That multiple is based around the future certainty of profit continuing. In this situation, that might (or might not even) be a multiple of 2. Zero times 2 is still zero. To be fair, plus the value of used equipment. In our view, even the best of these types of businesses are not worth much.
- These businesses can also be very hard to sell. Especially for the typical asking price. Our local coffee shop/cafe owners tell me that they can’t sell their business for much… if at all. Yet their shop has big queues for coffee and food all day long. They are burnt out and are considering just closing the door. No buyers.
- The current owners are paying their own private expenses through the business and taking cash. Whilst that may be a common practice, they are still defrauding the Commonwealth. It’s a crime. Disgruntled staff can dob you in to the ATO.
- Make no mistake, running a business like these can also be a huge undertaking that is hard to get out of. It can consume your life and you can become ‘bone’ tired.
- When staff let you down, you will have to work extra hours and it is very basic work. Staff will steal your cash when you are not there. You could end up hating it. And you are stuck.
We had a case a few years ago where a former client bought a restaurant after selling their main business. They paid a lot for it too (and didn’t ask for our advice). Turned out that the restaurant was losing $5,000 per week. Massive losses that could not be stopped. Poor patronage, long lease, and big guarantees. Turned out that the ‘cash’ was never there.
Desperate… they finally asked for our advice.
Tough advice followed. They would be better off paying someone to take it off their hands than taking years to sell it for a few hundred thousand dollars. If they ever could. Even to give it away would also be a great outcome.
What did they do? They understood their circumstances. It took a couple of months but by dropping the price to just $50,000, a prospective buyer was found, and they did the deal. It was an expensive lesson. They lost significant capital plus they funded many months of heart-breaking losses and lost a lot of sleep.
As we said last month… not all that glitters is gold.
Chris Alp & Andrea McNamara