After reading this article, you are ready to begin applying your knowledge and achieving your American Dream of owning a business. This comes with a lot of effort on your part; However, reading this article, I assume that you have decided to take this long journey and start making a change in your life. I’m going to introduce you to some simple 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 pay for itself without having to reach for 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. Such techniques only seem to be reserved for financial experts because [the techniques] they appear more frequently in strategic financial markets. You hear about many major acquisitions worth trillions of dollars. However, you will never know 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.
Actually, these are 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 more information about the company you want to acquire. Remember, the most powerful tool you have while dealing with the salesperson is showing him your knowledge of the industry 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 out of the box.
Question: What is the simplest way to explain how to use a company’s cash flow for financing purposes?
Answer: Let me start by giving you perspective on how much money we are really talking about. An expert explains it this way:
“The amount of cash an average business puts into their cash register in just two to three weeks is usually enough to cover the down payment to buy that business.”
Think about it. The cash that is collected in just a few days is usually enough so that, with a little creativity, you can use it to meet the seller’s down payment. That can work no matter what type of business you are doing. 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 collected cash to pay for the business once you’ve purchased it. It’s that 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 should determine the net cash flow generated during the first few weeks of activity by determining the difference between your cash receipt totals and operating expenses.
Question: What are the proper procedures to evaluate a company and what should I prioritize to make my decision?
Answer: There are several methods that are used to evaluate companies. Generally, replacement cash flow, assets or values, or a combination of these, are considered when determining the value of a business. Here are several valuation methodologies commonly used by valuation companies.
Replacement cost analysis:
o Generally, the value of a company is not related to the value of replacing the assets of the company. 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, is much higher than the replacement value of PP&E.
Often times, you can choose a particular industry by expanding the facilities you already own, investing in entirely new facilities, or buying all or part of a new company operating in the industry. The decision about 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, to determine 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 appraisal analysis:
o Generally, it is possible to liquidate the PP&E assets of a company and after liquidating the liabilities of the company, the net income would increase to the equity of the company. It is necessary to determine whether such a liquidation analysis should be carried out assuming a quick or orderly liquidation of the assets. However, even when an orderly liquidation of a business is assumed, it is generally the case that an operating business will have substantially greater value. It is not appropriate to use the asset appraisal approach in this case because the business 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 assets on a liquidated basis. The sum is more valuable than the parts. It is appropriate to appraise 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 determinant in the value of a company is the anticipated cash flow. Discounted cash flow analysis is a valuation method that isolates the company’s projected cash flow that is available to pay off debt and provides a return on equity; The net present value of this free cash flow to equity is calculated over a projected period based on the perceived risk of achieving said cash flow. To account for the time value of equity, it is normally appropriate to value the company’s cash flows 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 capital invested. These various values are compared to reach a definitive fair market value. It is often appropriate to weight the various implicit values of the total capital invested based on the relative effectiveness of each valuation method used for the analysis. When the value of the total capital invested has been determined, any claim to that value that has a claim greater than that of the common shares will be subtracted to determine the fair market value of the common shares. These other claims include the fair market value of all debt, preference shares outstanding, options on shares outstanding, and stock appreciation rights. Non-operating assets that have not been previously valued should 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 flow that can reasonably be expected to extend beyond the horizon of the projections. This value, known as the terminal value, is often calculated by multiplying the fifth year cash flow by a multiple. The selected multiples commonly use the median multiple of the total capital invested for selected comparable companies in the comparable public company analysis. The multiple selected may be discounted to reflect company performance or size characteristics relative to comparable companies. This is quite similar to dividing the cash flow by the weighted average cost of equity and including a growth factor.
Question: Well that’s great. However, how will that help me in buying the business?
Answer: Negotiate a deal that allows the seller to receive the initial payment directly from the cash flow after he has taken over the business. If this sounds too good to be true, here is an example of its feasibility:
Sandy and Kevin, a young couple of aspiring entrepreneurs, wanted to buy a thriving restaurant and bakery in Northern Virginia. Although they were bright and energetic, with some experience in the food industry, they largely lacked the ability to pay the $ 100,000 the seller wanted below the $ 500,000 full price. (The restaurant’s annual sales equaled $ 1 million, some of which came from a thriving commercial business that sells its freshly roasted coffee to local gourmet supermarkets and coffee shops.)
Fortunately, the seller agreed to collaborate and finance the difference of $ 400,000 for five years at 10% interest. This happens often, especially with a lot of persuasion. The couple’s problem, however, was raising the remaining $ 100,000. Kevin’s parents firmly believed in the abilities and determination of their son and daughter-in-law and decided to loan them $ 20,000 to be repaid when it was convenient for them. That certainly helped, but they still needed $ 80,000. To achieve this goal, the couple’s certified public accountant developed a cash flow statement for the first month of their clients’ new ownership. Their providers 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 financial analysis figures, 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 check for $ 100,000 at closing) to wait three to four weeks for their money?
This is where creativity, persuasion and seriousness were required. By 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 did not make a payment, the seller would have the right to default on the deal. The seller accepted this proposal and gave Sandy and Kevin their American Dream without cash.
This example represents more than 80% of all acquisitions and acquisitions. In the worst case, the seller may not cooperate; In this case, you should understand that you were probably never seriously interested in selling your business. It is possible that the seller was waiting to see how far you would go during the negotiation process, which brings us to the next question.