Hi,

Two friends and I are considering a firearms-related business venture. One friend is clueless about firearms and the other worked for his grandfather's gunstore while he was in college. We sat down and discussed the idea of the business and have some very great ideas about it and figured we would need somewhere in the neighborhood of $750K to get started. This would include all the start-up expenses to include heavy advertising and build out. Now, we found a business for sale and the cost is in the neighborhood of $1.5 million.

Here is my question. For those of you that have negotiated such deals or been involved in them, what formula do you folks use to figure out percentages? Is there some text book answer that I am looking for or just common sense negotiations amongst ourselves?

If we put in equal amounts of money but I an in charge of everything then of course I should be awarded a larger percentage. Should I expect to put in very little money and accept a equal percentage because I am running things?

I know these questions are pretty vague at best but if some of you have been down this road before please post some advice.

thanks,
Ron

I hope this doesn't come across badly, it's not meant to, so try and take it that way.

So, you want to borrow 1.5 million from the bank and you don't know how to structure a partnership?  

Or, are you just asking for ideas on how other people have done it?


rules of thumb.
1.  all partnerships end badly.  All of them.  They usually kill the friendship too.
2.  Everything in a partnership requires a lawyer, all of it, in writing with a lawyer. (which is another expense).  Do not EVER just "oh, we'll just do this agreement" and as to why, see rule #1
3.  it's called capitalism.  The person who puts the money in makes most of the money on the way out.  "running" the business isn't worth boo.  If you run the business, you should figure on a salary for that person.  Because sooner or later that's how it works, you hire someone (not a partner) for that wage.   If the "manager" is a partner, then the other partners need to watch and audit the money because only that person can truly steal from the partnership.  (and it happens a lot because that person figures he's doing "all" the work and not getting rewarded).  So, if you want to run the business, your return should only be based on your capital investment, plus you should get a salary.  Expect a lot of pushback on this, because when the business is hurting in the begining, you'll still be getting money (in the form of a salary) and the other partners will be upset.  (despite the fact that if you hired someone to be the manager, they would still have to pay that person).  see rule #1

4.  If you buy a business, expect to take ZERO money out of the business for the first 3 years.  (business are usually priced at 3 times Net, thus you have to pay it off first).

a few more thoughts.
Buying an existing business is easier than getting a loan for starting a new one (since it already has books and a proven record)

as a general rule of thumb (and it's actually pretty complex), you need 10 to 20% down (or more, sometimes as much as 1/3rd) and it's basically Prime rate plus 1 to 2 percentage points.  Expect to have to personally gaurantee it also
Prime is currently running 7.25%, I would expect to pay higher on the scale right now (credit market is closing up), so figure 9% for now

1.5 million minus 20% is 1.2 million (300,000 down)

1.2 million at 9% (guesstimate) over 3 years (typical term, parts will be longer, parts will be shorter).  
That's $38,000 .
Can the business generate that kind of free cash flow?  (it should BTW to be priced at 1.5 million).  Now, of course, after the loan is paid off, all that free cash flow flows to the owners.  But, it's getting there that's tough.

For new business's it's much worse.  The rates are much higher and the amount you must put down is much more (because it's much riskier)

Quoted: 4. Thanks for the advice on the partner/manager/percentage. My concern is that we all put in a equal amount and my wife and I end up being the only ones handling all operations.

How come you have two different names/entries on here?
Anyway.
If you all put in a equal amount, then you should split the profits 1/3, 1/3, 1/3
BUT
if you are running it, then you should take a salary.  How much would you pay Joe Blow to do it?  Then that's what you should take.  That's much simpler than a return on X or someone getting more or less because they "do more or less"
Just pay the manager a salary.  It will be a LOT less bitter in the end.

I would never go into business with an attorney.  

Here is another question that I have that maybe you can help me with. Is there some financial formula that you use to decided if a person should go forward with the purchase of an existing business as compared to a opening a new one? In the eight years of college I took maybe 4-5 business classes at most and remember there were always some financial formulas to weigh your options.

If this business sold for $1.5 million but my first years expenses (including build out costs and other one-time-only expenses) for a NEW business only equaled $750K, would it better to start fresh? The pros to purchasing the existing business are instant cash flow, established name and all city, state, EPA, OSHA licenses are already in order. The biggest con for the purchase is that it will be $750K more than I need for my years expenses? There are others but that is my biggest concern.

thanks,
Ron

Here is another question that I have that maybe you can help me with. Is there some financial formula that you use to decided if a person should go forward with the purchase of an existing business as compared to a opening a new one? In the eight years of college I took maybe 4-5 business classes at most and remember there were always some financial formulas to weigh your options. If this business sold for $1.5 million but my first years expenses (including build out costs and other one-time-only expenses) for a NEW business only equaled $750K, would it better to start fresh? The pros to purchasing the existing business are instant cash flow, established name and all city, state, EPA, OSHA licenses are already in order. The biggest con for the purchase is that it will be $750K more than I need for my years expenses? There are others but that is my biggest concern

Business valuation is a whore.  You'll want a competent finance person (probably not your CPA) to review their justification for asking 1.5MM.   You don't need a full-on study (the last private company valuation I paid for cost $17,000), but at least make a cursory analysis.  1.5MM ain't pocket change.

Also, one other thing a new business won't have is hidden liability.  Have you looked at all possible risks?

What effect will the current owner's departure have on the business?  For many small businesses, the owner IS the business.  No owner, no goodwill, so to speak.

What's the book value of the established business?  Presumably you have financials already.  I'd start there.  Since comparables are hard to come by on private companies, especially in the likely sector you're looking at, you can model discounted cash flows for an idea.

I am always hesitant to give the green light to clients to buy into a small business selling for significantly more than book value, because 9 times out of 10 the current owner vastly overvakues "goodwill" - as in an order of magnitude in some cases.  

My favorite was a guy who had a porcelain repair business. He'd fix chipped sinks, bathtubs, etc.  He had been doing this on the side for 3 years.  Very little repeat business as you'd imagine, about a thousand bucks worth of inventory (which was specious anyway), and various junk sinks - maybe 10 of them.  No financials.  He wanted 50 grand for the business.    He just pulled the number out of his ass.  No yellow page ads, just a few thrifty nickel ads here and there, no established brand - you get the picture.  I advised the prospective buyer to spend a thousand bucks on porcelain repair paint, another thousand on advertising, and to go ahead and sacrifice the $48,000 junk collection and start his own repair business if he thought it was that good of an idea.  

Quoted: I am still waiting for his tax returns and other financials and until I receive them I just have the broker's business analysis/sale form (which could be just a big fairytale). The broker even stated that he is still waiting on the Assets/Inventory List. They list a net of $350K+ but some of the numbers just don't add up. They list eight part-time employees but COMBINED they only have an annual payroll of $30K (and $3K payroll tax). The husband and wife are full-time employees in the place but there are not payroll taxes listed for their income. I HIGHLY doubt their entire wage is in the form monthly/bi-weekly dividens. The broker relayed to us that only one employee is really paid by the hour and the others take ammo/supplies and guns at cost as wages. I am well aware that ammo/supplies cost money and that has to be figured into the bottom line somewhere. We are not going to push the issue and let the broker call us back. The SHOT Show is less than three weeks away and after talking to all the different companies there we may just decide to follow another avenue. There are way too many variables at this point and I am just looking for some sound advice. thanks, Ron

They could be set up as an LLC and taking owner's draws directly out of the equity account, which is normal.  As for the other stuff, I'd want each month's full financials (cash flow, balance sheet, and income statement).  Audited by a CPA is better.

The inventory that's taken as comp throws a red flag.  I have seen busineses like this before, and shit seems to disappear out of inventory at a faster and faster rate over time.  Not to mention potential tax issues such an arrangement presents.

Henderson Defense, et al, without disclosing the specifics of the proposed business, will your business just take over an existing business?  Is manufacturing of firearms-related parts involved?  The reason for my questions is that, seems-to-me, margins in the firearms industry are generally pretty low, due to competition.  

You guys are talking about investing a lot of your personal assets into this business.  Until the business shows a profit, as Bozeman indicated, you won't be able to get loans from banks.  If you find that you need to raise funds, in media res, privately, then you can expect to give up more equity than you'd probably like.  If you have to raise funds more than once privately, you can rest assured that the second deal will be worse for you and your partners than the first deal.

If manufacturing is involved, you should consider Asian sourcing.  

Quoted: Henderson Defense, et al, without disclosing the specifics of the proposed business, will your business just take over an existing business?  Is manufacturing of firearms-related parts involved?  The reason for my questions is that, seems-to-me, margins in the firearms industry are generally pretty low, due to competition.   You guys are talking about investing a lot of your personal assets into this business.  Until the business shows a profit, as Bozeman indicated, you won't be able to get loans from banks.  If you find that you need to raise funds, in media res, privately, then you can expect to give up more equity than you'd probably like.  If you have to raise funds more than once privately, you can rest assured that the second deal will be worse for you and your partners than the first deal. If manufacturing is involved, you should consider Asian sourcing.

This aspect of the business has no manufacturing involved but I can definitely incorporate my manufacturing business into it.

thanks,
Ron

Good luck!  Let us know how it goes.  

Quoted: Good luck!  Let us know how it goes.

I went to speak to one of the owners yesterday. I asked if they have a detailed list of inventory and how they arrived at $500K for inventory. The owner stated that the inventory is constantly changing and did't have a list. She did state that at the time of the sale a list would be provided. I explained that if the inventory was $50K I could accept that but at a half million dollars there is just no way that is possible. She continued to state that it would be very difficult to provide a detailed account of all items. One of my good friends was with me at the time and we both agreed that the inventory could be range anywhere from $350K-$500K but I could be off plus or minus $100K. That is NO way to sell a business and I couldn't sell my practices in if I just stated that my AR is $10 million, but I can't provide a list of the AR's, how many new patients we see a year, who we are contracted providers for, etc.. That would be nice but it's not going to happen.

I will keep you guys posted with anything I find out if I get to speak to the other owner. I have known the other owner for many years and he was the one that I wanted to speak to but was not in yesterday.

thanks,
Ron

Quoted: Quoted: Good luck!  Let us know how it goes.   I went to speak to one of the owners yesterday. I asked if they have a detailed list of inventory and how they arrived at $500K for inventory. The owner stated that the inventory is constantly changing and did't have a list. She did state that at the time of the sale a list would be provided. I explained that if the inventory was $50K I could accept that but at a half million dollars there is just no way that is possible. She continued to state that it would be very difficult to provide a detailed account of all items. One of my good friends was with me at the time and we both agreed that the inventory could be range anywhere from $350K-$500K but I could be off plus or minus $100K. That is NO way to sell a business and I couldn't sell my practices in if I just stated that my AR is $10 million, but I can't provide a list of the AR's, how many new patients we see a year, who we are contracted providers for, etc.. That would be nice but it's not going to happen. I will keep you guys posted with anything I find out if I get to speak to the other owner. I have known the other owner for many years and he was the one that I wanted to speak to but was not in yesterday. thanks, Ron

Anyone with half a brain who has half a million dollars worth of inventory should certainly be able to at a moment's notice print out a detailed listing of that inventory.

WALK AWAY!!!

Run, Forrest, run!

Quoted: 4.  If you buy a business, expect to take ZERO money out of the business for the first 3 years.  (business are usually priced at 3 times Net, thus you have to pay it off first).

I hope I am not coming off as having zero intelligence in this discussion but this is my first attempt at something like this. I have managed to open three practices with literally ZERO money with the first office but this is a different ball game. My practices are purely service and not a combination of service/product. My wife and I literally had to empty our kid's piggy banks at one point because credit cards were maxed and we needed to eat. Eight years later things are much different. It doesn't take much to deduce what three practices can generate but my wife and family are pretty secure. That period of our lives really changed our attitudes towards life and we have been very cautious to spend money since that time. I guess it's post-traumatic stress of being literally dollars away from losing everything and moving in with relatives but big purchases can give me anxiety. I have tried to relax about it but there is always that fear in the back of my mind that maybe someday we will be where we were at so we had better save.

So, enough about my history and on to the question. If the seller is trying to get three times net, is it general practice to ask for equipment and inventory costs in addition to the 3x net?

You guys have been VERY nice and I am sure some of you have held back comments and it's much appreciated

thanks,
Ron

Several times in my life I have looked into gun shops for sale, and I ALWAYS come away with the same answer:  No way in hell.  

To me the gun business looks to be one of those, "the quickest way to make a million is to start with two" sectors.  There are obviously exceptions, but I wouldn't go into it with two partners, one knowing nothing about the industry, and a seller who has no clue what they are selling.  When I worked at a hobby shop, we could print a full inventory at a moments notice.  THe camera shop was the same.  The restaurant was a little looser, but still pretty close (especially on pricy items like booze and steak).  The automated systems that do this are pretty impressive, and I can't imagine someone not using one, ESPECIALLY when there is a legal imperative to keep good records.

I can't imagine how good a gun shop (high volume, great reputation) it would have to be before I would plunk down $1.5m.  It would take a big shop, a nice inventory, and active range with established clients (and not just walk-ins, but maybe shooting sports affiliations and law enforcement contracts).  

good luck,

shooter

Quoted: So, enough about my history and on to the question. If the seller is trying to get three times net, is it general practice to ask for equipment and inventory costs in addition to the 3x net? Ron

Yep
Business's are worth (generally) their assets plus the business.  The business is worth more or less 3x net.  Some business's are worth more.  Manufacturing can get up to 10x net (bigger company, etc), some business's are worth less. Restaurants typically go for 1.5x net.  The more involved YOU have to be on a daily basis, the less it's a business and it's more of buying a job.  The assets are worth what the assets are worth.  They typically get different loans too.  For example, Building on a 10 year loan, equipment on a 5 year loan, office supplies on a 2 year loan.  Etc.  Less risk because the bank has real assets backing those up.  

some business's are worth precisely nothing.  An excellent example is a lawn mowing business.  It's worth teh assets, and maybe a few hundred or thousand for the customer list.  That's it.  There are TONS of books on how to buy a business, they all say basically the same thing (i.e. buy only one), but it's real helpful to look at.

Business with great books going back a long ways are worth a lot more than books that seem to be made up on the spot.  

No reflection on you Doc, but this deal is bad to epic proportions.
The smoke and mirrors exist because there is nothing there to begin with.