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Buying a Business With Its Own Cash – And Not a Penny of Your Own
After reading this article, you will be ready to apply your knowledge and reach your American dream of business ownership. It comes with serious effort on your part; However, by reading this article, I assume that you have decided to take this long journey and make a change in your life. I’m going to introduce you to some easy ways to get the money you need through the miracle of modern-day leverage. We’ll start with a method that enables you to pay for yourself without ever having to reach for your wallet.
Question: Is it true that the method of withdrawing money from a company’s cash flow is reserved only 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 seem to be reserved only for financial experts because they [the techniques] Strategic financial markets appear more frequently. You hear about a lot of big multi-billion dollar acquisitions. Yet, we will never hear how it happened or what it involved. This information is never made public. As mentioned in Strategy 4, by developing a strong network with corporate leaders, you will certainly have access to that valuable information even if you do not work in that field.
These are actually 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 out more about the company you want to acquire. Remember, the most powerful tool you have when dealing with a seller is showing him your knowledge of the industry and how selling the business to you can benefit him (and of course yourself). And, trust me, you too can put these powerful, yet simple, tools to use right away.
Question: What is the simplest way to explain how to use a business’s cash flow for financing purposes?
A: Let me start by giving you some perspective on how much money we’re really talking about. One expert explains it this way:
“The average business keeps in its cash register in just two or three weeks the amount usually sufficient to pay the down payment to purchase that business”.
Think about it. Cash accumulation in just a few days is usually enough so that, with some creativity, you can use it to satisfy the seller’s down payment. It doesn’t matter what type of business you are running. Since there’s no law that says you can’t “borrow” that money, it’s up to you to figure out how to use the cash you’ve raised to pay for the business once you’ve got it. It’s easier if you have a CPA to calculate your cash flow to know how to approach a seller with your proposal.
Q: How does the process work?
Answer: A few steps are required. You, or your CPA, must determine the net cash flow generated in the first few weeks of business by determining the difference between the sum of cash receipts and operating expenses.
Q: What are the proper procedures for evaluating a business and what should I prioritize in making my decision?
Answer: There are many methods used to evaluate companies. Valuing a company typically takes into account cash flow, asset or replacement values, or a combination thereof. Below are listed the various valuation methods commonly used by valuation organizations.
Replacement Cost Analysis:
o Generally, the value of a company is not related to the replacement value of the company’s assets. 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 logos, and technical expertise far exceeds the replacement value of PP&E.
You can often choose a particular industry by expanding existing facilities, investing in entirely new facilities, or purchasing all or part of a new company operating in the industry. The decision about which investment to make depends partly on the relative costs of each. Of course, investors consider capacity utilization, location, environmental, political and legal issues when deciding where and how to invest. These issues may outweigh the importance of switching cost analysis; In such cases, this valuation method is not used to determine the fair market value of the company.
Property Valuation Analysis:
o It is possible to liquidate a company’s PP&E assets and after paying off the company’s liabilities, the net proceeds will accrue to the company’s equity. It is necessary to determine whether such a liquidation analysis should be performed assuming a quick or orderly liquidation of the assets. However, even assuming an orderly liquidation of a company, it is usually the case that the operating company will have a substantially higher value. In this case it is not appropriate to use the asset valuation approach because the company is successfully operating; In such cases, the fair market value of the company will almost certainly exceed the value of its assets, in the industry in which the company operates. The sum is more valuable than the parts. It is appropriate to value non-operating assets using the asset valuation approach to determine their value as part of the company’s fair market value.
Discounted Cash Flow Analysis.
o Another determinant of company value is expected cash flow. Discounted cash flow analysis is a valuation method that separates a company’s projected cash flows that are available to service debt and provide a return on equity; The net present value of these free cash flows of capital is calculated over the forecast period based on the perceived risk of achieving such cash flows. Therefore, considering the time value of capital, it is appropriate to determine the value of the company’s cash flows using the discounted cash flow method.
Total invested capital.
o Each method of valuing a company or its business units places a value on total invested capital. These various values are compared to arrive at a fixed fair market value. It is often appropriate to weight the various implied values for the total invested capital based on the relative effectiveness of each valuation method used for the analysis. When the value of the total invested capital is determined, any claims to that value that are senior to the common stock are deducted to determine the fair market value of the common stock. These other claims include the fair market value of all debt, outstanding preferred stock, outstanding stock options and share appreciation rights. Non-operating assets that have not been previously valued must be accounted for and added to the total invested capital. This usually includes cash and the fair market value of any non-operating assets.
o The owner can expect cash flows to capital over an indefinite period of time. While valuation models often use projections of future cash flows, it may be necessary to represent the value of cash flows that can 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’s cash flows. Selected Multiples Commonly used in comparative public company analysis is the average multiple of total invested capital for the selected comparable companies. A number selected may be discounted to reflect the company’s performance or size characteristics relative to comparable companies. This is equivalent to dividing cash flow by the weighted average cost of capital and a growth factor.
Q: Well, that’s all great. However, how will it help me in purchasing a business?
Answer: You negotiate a deal that allows the seller to receive a down payment directly from the cash flow after you take over the company. If it sounds too good to be true, here’s an example of its feasibility:
An ambitious young entrepreneurial couple, Sandy and Kevin wanted to buy a thriving restaurant and pastry shop in Northern Virginia. Although they were bright and energetic, and had some experience in the food industry, they lacked the ability – by a long shot – to pay a vendor $100,000 on a total cost of $500,000. (The restaurant had annual sales of $1 million, some of which came from a thriving commercial business selling freshly roasted coffee to local gourmet supermarkets and coffee shops.)
Fortunately, the seller agreed to pitch and finance the $400,000 difference over five years at 10% interest. This happens often, especially with a good deal of persuasion. The couple’s problem, however, was raising the remaining $100,000. Kevin’s parents had strong faith in their son and daughter-in-law’s skills and determination and decided to lend them $20,000 to repay at their convenience. This certainly helped, but they still needed $80,000. To reach this goal, the couple’s CPA developed a cash flow statement for his client’s first month of new ownership. Their suppliers do not require any payments for one month so Sandy and Kevin do not incur that expense. However operating costs such as rent, wages and utilities should be considered.
Looking at the numbers from the financial analysis, Sandy and Kevin are convinced that they can easily pull $80,000 from their business within four weeks. But the big question was: How could they make the seller (who expected a $100,000 check upon closing) wait three to four weeks for his money?
This is where creativity, persuasion and earnestness were needed. The attorneys and their CPAs, Sandy and Kevin, came up with a plan that allowed the seller to hold off on the final sale papers for four weeks. During that period, they will pay the seller approximately $20,000 per week. If they miss payment, the seller has the right to cancel the contract. The salesman agrees to give Sandy and Kevin their American dream without any money of their own.
This example represents more than 80% of all take-overs and acquisitions. In the worst case scenario, the seller may not cooperate; In this case you have to understand that he was probably never seriously interested in selling his business. It’s possible that the seller was waiting to see how far you would go during the negotiation process, which brings us to the next question.
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