Well, you are in good company around here. We get a lot of visitors that are turning these ideas over and they come to pick the brains of the folks on the Think Tank. We are a collection of pizza store owners mostly in USA, Canada and Australia (common language for one thing!) but we have others from other places as well.
One of the most common topics new arrivals are interested in relates to the pizza store they are looking to buy. I am assuming that you are already interested so I will not go into the motivations and dreams that you may have or into the operations that are so thoroughly covered in a myriad of posts. I am just going to talk about the things you should be looking out for and why.
Business results reporting: In today’s world everyone has a computer. We have reached the point that a business that operates without one is suspect for more than one reason.
First of all, the myth that a hands-on operator can keep all the important stuff in their head is just nonsense.
Second, I want data! I want to know exactly what sales are. I want to know how many hours were worked and by who. I want to see what days of the week are best and what time the business is busy. I want to see what menu items are the best sellers and which coupons get used the most. I want to see that the declared sales to the taxing authority match the sales reporting that I am being sold and that all wages are declared and above board with work-comp and overtime paid!
If the business can not show you things proceed with extreme caution.
Costs are a huge factor. You will find most of the discussion around here is in percentage terms. The percentage is of sales. Sales is the money your customer pays and does not include sales tax or discounts and coupons. The big three are:
Food cost. You will find a lot of variation on how this is done so you need to looking carefully to be sure you are comparing apples to apples. For example, I roll all food, beverages, paper and supplies into the measure that I use. Others separate those things and refer to a “food cost” that excludes those things. When a seller quotes their food cost or COGS (cost of good sold) to you, be sure to find out what is included before you congratulate them! You will find a lot of us have a total COGS in the range between 27%-33%
Labor cost. Again, there is some variation here. Does it include employers share of taxes? Manager/owner salary? Bonuses and profit sharing? Make sure you understand what is included.
Occupancy Expense: RENT, common area expense or association dues. Key terms are NNN or “triple net” rent (base rent excluding property tax, common area costs and insurance which are added). Again, find out what is included. In my building common area expenses include snow removal, landscaping, water and trash. In another location I had utilities were included! These things are not included in other places. Excluding trash, water utilities etc most operators would tell you that occupancy expense under 10% is acceptable but lower is always better. Keep in mind that a poor location (cheaper maybe) will need to be offset by higher marketing costs… if one location is $4,000 per month and another is $3,000 there might be a good reason!
Do some homework on valuation. People will throw numbers out about 2X this and 3X that. My experience is that 4 out 5 people quoting those things have no clue at all about what they are talking about. Before you go shopping get informed. Don’t be afraid to offer what you think it’s worth. Some sellers start at 2X what is realistic but others are pretty much right on the money. You can’t just assume that 10% off the asking price is probably fair.
That lease! The lease is a binding contract. Usually for a quite a number of years. You will almost certainly be required to personally guarantee it. I could write another 10 pages on this subject alone (It is what I did for the last few years I worked for Patagonia doing leases around the US). In a business purchase you will likely be taking over the lease of the existing tenant so you don’t get to change the document but you should still understand what it says and be good with it. Approval and acceptance of the lease both by YOU and by the landlord must be a contingency of any offer you make. If you are looking at a new lease here are a few more points:
Work with a commercial broker who represents YOU. NOT the listing broker. A commercial broker is NOT a residential broker. In fact, if they do residential work find someone else. I have yet to meet the residential broker who was any good at commercial leases. You should not have to pay the broker. The landlord should take care of that. You need to have the broker BEFORE you look at property.
If you are pretty comfortable with legal documents you can get a lot done before you start paying an attorney but you should still have one look things over before you sign. Attorneys and brokers do not do the same thing. Brokers help you get the best deal on the best property. Attorneys make sure the deal says what you think it does.
Watch the money buckets. Rent is only one of them. Others include rent holiday, tenant improvement allowance, rent escalation, penalties, going dark clause, personal guarantee expiration.
The way sellers hide things:
Shifting expenses is something any small business owner can do in his sleep. Putting off paying expenses at the end of the year into the January following can make the current year look better. Pre-paying expenses can reduce the current tax burden. Looking at multiple years takes care of this. If you see $8,000 in utilities one year and $5,000 the next ask why. Last year marketing was 30K and this year it is 15K? It might be true. Ask. If you don’t like the answers get copies of the invoices during due diligence. Same goes for any category of expense.
A seller can fiddle the bottom line by under or over reporting inventory at the end of the year. Ask to see the count. Since it is rare that a sale closes on January 1, you can avoid a lot of these issues by simply doing a year to date P&L for this year and last year and doing a 365 day analysis. For example, if it is June you look at books through May 31 for both the current year and the prior year. You take the prior year tax return and subtract all the sales and expenses for the first five months of that year and add the values for the current year. You now have a 365 day P&L as of May 31 and you have washed out any year-end shenanigans. (Just be sure to count pay periods if they use a two week period and make any needed adjustment if there is one more period in one year or the other.)
Pay an appliance guy to come look at the equipment and report on the condition and age to you. This is not to say that you should avoid old equipment. A lot of it lasts for years and years but you want to know what you are looking at. 15 year old conveyor ovens are going to run you $1,000 or $2,000 per year in parts and maintenance. New ovens are not.
Make sure that the sales tax reports and the quarterly 941s match the info you are being provided. Check bank deposits against sales records. You don’t need to drag this through every month for the last 3 years but spot check at least one period for each year.
What to expect when you contact a seller/broker:
When I get contacted by a potential buyer the first thing I want to know is who they are and whether they are seriously looking. I require a non-disclosure agreement and I want to know how much actual cash they have to invest. If they will not answer these things I am done with them. You should not expect to be coy about who you are or your finances and get taken seriously.
Once you satisfy the broker or seller that you are real and that you have enough cash to do the deal they should be willing to identify the business and provide summary information about it to you. Don’t expect to see tax returns or even monthly reports at this point but you should have gross sales and discretionary earnings info for the last few years. You should know about the lease and have an overview of the equipment included. They get to ask YOU about your financing options, net worth, experience etc. Both sides have a reasonable interest in knowing about the other to determine if the deal is likely to go through.
Next step is visiting the business and meeting the seller. A broker should stay in the middle and be a clearing house for all the info but you should also have direct access to the seller to ask questions. If you are still interested it is time to make an offer. If you are going to ask for seller financing you should expect that they will want you to sign a release for a credit report on YOU since you are asking for credit.
You make an offer and reach a deal. Now comes due diligence. Essentially you are confirming the presentation that got you interested in the first place. You should be able to see [U]anything[/U] you want to see. [U]Be very cautious of any deal where they are not showing you anything and everything at this point.[/U] They said sales were 800K and earnings were 170K? Great. Show me the tax returns for the business. Explain the discretionary items.
The broker should help cover deal points like a training agreement, non-compete, review of key employees etc.
More later as I think of things.