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Business Profit Question

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n_touch
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11:09p, 1/26/23
Someone posed a question about buying. a coffee shop. Husband and wife owner with no other employees. They had a net income of 40k for the year and are selling the business. They are wanting 85k for the business.

My question is in this scenario when looking at the business would you consider their 40k profit of the business or an employee expense?

My stance is that someone has to be there whether it is them or not. Unless you are going to be an owner operator with no other employees then you could call it profit, but in the end it is still really just a employee cost.
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Casey TableTennis
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11:35p, 1/26/23
AG
There could be a different capital structure for the old vs new owners. There could be different capital structures for different potential buyers.

Similarly, you could have differing levels of operational effectiveness of new vs old or among vs potential new owners.

New owner could have multiple locations, better vendor relationships, etc… that will allow for better cost control and higher profits.

All of these and more effect profitability and ability to have non-owner Mgmt. So, it could be an employee cost, but that is for the potential buyer to evaluate and it varies specific to the potential buyer.
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n_touch
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In reply to Casey TableTennis • 11:48p, 1/26/23
Just for pricing reasons do you say that they 40k that the owners paid themselves is profit?

The issue that came up was I said that I would not consider it profit since they were the only employees. I would consider it employee cost since no matter what someone has to run the shop on a daily basis and get paid. If I was the one buying I would look at it as based on the numbers given, my employee budget would be 40k for the year. Whether that came to me as the owner or not.

I guess technically if it goes only to the owner then it is profit.
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Casey TableTennis
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11:52p, 1/26/23
AG
I wouldn't care what they called it. I would build my own pro forma and determine expected profits and determine staffing needs, which may include owner being the operator.
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Troglodyte
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7:09a, 1/27/23
AG
Typically, when you buy a existing business, it is priced based on having a GM run the place with employees.
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ChoppinDs40
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In reply to Casey TableTennis • 7:51a, 1/27/23
AG
Casey TableTennis said:
I wouldn't care what they called it. I would build my own pro forma and determine expected profits and determine staffing needs, which may include owner being the operator.


This is the answer. Were they paying themselves BEFORE the 40k? If not, this business is worth nothing in its current state. You aren't going to find a person to run this shop (or 2 people) for $40k year.

OP- would you pay yourself 40k to run this thing?

There is no free cash flow if what I said above is true and hence worth nothing other than the OLV of the assets purchased less whatever debt you use to buy it.
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n_touch
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In reply to ChoppinDs40 • 8:00a, 1/27/23
This was the original posting

Quote:
We are looking into purchasing a shop that's not doing so well.
Their net income is around 40,000. ITs just the couple working there.
They don't serve much food. Just some bakery really.
He's asking 85,000 for it , ( from what I'm being told it's probably worth about half of that).
The landlord is asking 1865 for rent.
So with the rent and loan payment we would be cashed out.
My significant other is a chef so we would be adding sandwiches and soups and private dinners. So I think we would do better than what they are doing but goodness. With rent being so much how do you all do it??
There was a broker that responded that the business was at least worth that or more. My response.

Quote:
The problem is they are considering their pay "profit". That is not profit. It is nothing more than a lie to tell a perspective buyer that the business profited XXX dollars if you are using that said profit to pay your employees but not reporting it as such.
I got called out and told that my inexperience in business. Not sure why that came up, just wondering if I was really that far off in looking at it this way. I also got the "I have been a CPA for 27 years" line lol.
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ChoppinDs40
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In reply to n_touch • 8:10a, 1/27/23
AG
Hah. "Broker"

This thing has no value other than intrinsic "potential"

Can you value the "repeat customers" and the potential for them to buy more product?

Or can you value additional marketing spend to get more people in the door?

IMO, this thing is worth no more, and likely less, than the value of the equipment inside the building. Because as it stands today, it makes no money for an investor.

Why would someone pay 2x for what they can pay themselves? Literally putting your money/time into slavery.

Any valuation on this thing is pure speculation of potential growth that will be performed and funded by a new owner.

Is it in a great location where the lease appears to be super cheap and locked in long term? Ok there might be some value there but still requires capital to get going.
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BizBroker97
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In reply to n_touch • 8:19a, 1/27/23
AG
Here's the problem with business market valuation - it's incredibly subjective, and there is literally no wrong answer to the question of "what is a business worth." Of course, there are answers that are more reasonable, sound and market standard, but at the end of the day, the business is worth what the seller and buyer can agree on. Deals that don't get done are very rarely because of a difference in business valuation between the parties - it's because of a difference in methodology of determining value.

And your scenario above is a great example of that.

The thing you have to consider in this specific case is that you're dealing with a small, main street or "solo-preneur" business. In those cases, to determine value, we look at global cash flow, or seller's discretionary earnings. SDE takes into account all of net profit, plus owner's personal expenses/benefits the business is paying for, and any owner's wages. Small businesses like this are valued on a multiple of SDE, and in the case of a coffee shop, a 2x multiple of SDE is reasonable.

The other key thing to consider about small business valuation is that businesses are valued based on their current operational metrics and financial structure. Meaning, if the owners are running the business full-time and have no employees, they are going to value it like the next owner will do the same thing. They are not going to value it based on the way a new owner "might" run it.

Of course, buyers are going to evaluate a business based on how they will run it, which is what you're doing here - saying that you would likely not owner-operate the business, and using the net profit the previous owners generated to pay employees. That's certainly your prerogative as the new owner, but it doesn't change the value of the business from the seller's perspective.

This is what I mean by deals dying based on methodology rather than value - you and the seller may both be using the same multiple of SDE to determine value, but you are defining SDE differently.

if I was selling this business for the current owners, I would have weeded you out before you ever signed the NDA to look at it - you are not the right buyer. The right buyer for this business is someone that is going to operate it in the same manner, or maybe someone with big growth plans for the business and is willing to pay what the sellers want even though they are going to run it differently.
jeremy@northstar-mergers.com
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n_touch
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In reply to BizBroker97 • 8:27a, 1/27/23
Quote:
Of course, buyers are going to evaluate a business based on how they will run it, which is what you're doing here - saying that you would likely not owner-operate the business, and using the net profit the previous owners generated to pay employees. That's certainly your prerogative as the new owner, but it doesn't change the value of the business from the seller's perspective.

This is what I mean by deals dying based on methodology rather than value - you and the seller may both be using the same multiple of SDE to determine value, but you are defining SDE differently.
Thank you very much for the detailed response. Just making sure that I was not crazy out there in the way that I was looking at it.

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Agilaw
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In reply to BizBroker97 • 9:08a, 1/27/23
AG
A broker's job is basically to get the property sold to maximize the profit for the seller. Weeding out this potential buyer because they raise legitimate questions on valuation is simply the broker recognizing they won't get maximum value for the seller from this buyer. As the proposal stands, it is a pretty valueless proposition unless there are significant fixtures/business good will/great lease-location in place. Even then, the buyer is basically purchasing a job that they can expect to return $40,000.00 if two people work the business full time+. Those two people could work at Target full time and almost double that return. If the $40,000.00 was after paying two full time employees it would be a different matter.
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9:15a, 1/27/23
AG
IMO I would buy it for that price if the equipment, marketing to get same traffic and buildout would cost you more than the buy price. Of course you have to see a large upside. Another consideration as the other poster said, does the current sublease offer you a locked in lower rate or shorter term to not be locked in for 5 years?
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BizBroker97
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In reply to Agilaw • 9:40a, 1/27/23
AG
Agilaw said:
A broker's job is basically to get the property sold to maximize the profit for the seller. Weeding out this potential buyer because they raise legitimate questions on valuation is simply the broker recognizing they won't get maximum value for the seller from this buyer. As the proposal stands, it is a pretty valueless proposition unless there are significant fixtures/business good will/great lease-location in place. Even then, the buyer is basically purchasing a job that they can expect to return $40,000.00 if two people work the business full time+. Those two people could work at Target full time and almost double that return. If the $40,000.00 was after paying two full time employees it would be a different matter.
I generally agree with your statements, and at the same time you've confirmed my point.

My job as a representative of the seller is to maximize value - weeding out the "wrong" buyers is primary to that task. That doesn't mean I dismiss a "potential buyer because they raise legitimate questions," but rather it means that I know how to identify the right pool of buyers who see the value of the business the same way the sellers do, and I eliminate the buyers who see the value differently from consideration.

But like I said, you confirmed my point. I don't disagree with your assessment of this business in question - I would never buy it, but I'm not the right target. However, when it comes to business valuation, again, there's no right or wrong - there's just what's right for one seller and one buyer.

This obviously isn't the right type of business for you, and for thousands of other prospective buyers, including me. But millions of people in this country disagree, and do believe there is value here. That's why there are about 3.5 million businesses registered in Texas, and of those less than 1 million have employees - the other 2.5 million are those "solopreneurs" that don't employ anyone outside of the owners.

While you may think working at Target for the same compensation makes more sense, someone else may see owning a business like this as a way to have more personal freedom - even if they are working harder and more hours for the same net amount, the feeling of pride and of taking some semblance of control is invaluable for many small business owners.

All this to say, both perspectives can be right about the same business - it all boils down to finding what makes sense for you.
jeremy@northstar-mergers.com
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AgLA06
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In reply to BizBroker97 • 5:01p, 1/27/23
AG
At what point do you see something like this and wonder if it's ethical to pitch it that way.

I couldn't in good conscience recommend this opportunity to someone.
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Rexter
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6:14p, 1/27/23
Last time I checked, no expenses were included in net. They're just sunshine pumping to get it sold.
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Corps_Ag12
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7:15p, 1/27/23
AG
Simple formula

Owners compensation plus net income = cash flow

If that passes the test then you decide if it's worth your time

If this is how is sounds, I would run away. As in:

0 + 40k = 40k cash flow
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Ragoo
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8:15p, 1/27/23
AG
Let them go out of business
Buy their espresso machines distressed
Open new coffee shop in better location with more offerings
?????
Profit

Save 70k
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one safe place
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In reply to n_touch • 8:20p, 1/27/23
n_touch said:
This was the original posting

Quote:
We are looking into purchasing a shop that's not doing so well.
Their net income is around 40,000. ITs just the couple working there.
They don't serve much food. Just some bakery really.
He's asking 85,000 for it , ( from what I'm being told it's probably worth about half of that).
The landlord is asking 1865 for rent.
So with the rent and loan payment we would be cashed out.
My significant other is a chef so we would be adding sandwiches and soups and private dinners. So I think we would do better than what they are doing but goodness. With rent being so much how do you all do it??
There was a broker that responded that the business was at least worth that or more. My response.

Quote:
The problem is they are considering their pay "profit". That is not profit. It is nothing more than a lie to tell a perspective buyer that the business profited XXX dollars if you are using that said profit to pay your employees but not reporting it as such.
I got called out and told that my inexperience in business. Not sure why that came up, just wondering if I was really that far off in looking at it this way. I also got the "I have been a CPA for 27 years" line lol.
Where in anything that you posted is "pay" mentioned?
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one safe place
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In reply to Corps_Ag12 • 8:21p, 1/27/23
Corps_Ag12 said:
Simple formula

Owners compensation plus net income = cash flow

If that passes the test then you decide if it's worth your time

If this is how is sounds, I would run away. As in:

0 + 40k = 40k cash flow
There likely are other items that need to be added to your "compensation plus net income" to approximate cash flow.
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htxag09
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9:09p, 1/27/23
AG
Are we just assuming the $40k is all the "profit" from this business or was that explicitly said somewhere?
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n_touch
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In reply to one safe place • 9:36a, 1/28/23
An assumption based on it being worded that their net income and they are the only workers.

Also based on other coffee shop numbers I have seen in the past lines up with how owner/operators numbers looked.
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BizBroker97
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In reply to AgLA06 • 9:37a, 1/30/23
AG
AgLA06 said:
At what point do you see something like this and wonder if it's ethical to pitch it that way.

I couldn't in good conscience recommend this opportunity to someone.
Speaking for myself and my firm, if there's an ethical question about a business, financial or otherwise, we steer clear.

However, what's being discussed in this thread is not an ethical concern at all. If I was listing and marketing this business for sale, all of the facts would be on the table for potential buyers from the very outset, including how I calculated SDE provided in a detailed worksheet that ties to the financial statements. So if a buyer happens to have a fundamental objection to including owner's comp in SDE, for example, they know this is not a deal worth pursuing. Or they might choose to argue their point and try to negotiate a deal more in line with their evaluation.

Like I said above, there is no right or wrong way to value a business - some buyers will agree and some won't. All I can do is present the facts and let the buyers make their own determinations. At the end of the day, I'm really not "pitching" or "recommending" anything to buyers - I'm providing information and data for buyers to utilize for their own analyses.

You could even look at it like a restaurant ... you may think serving pulled pork is absolutely fine and you order it every chance you get. But at the same time, there are other diners who have a fundamental religious objection to eating pork, even so far as not eating anywhere it's served. Is the restaurant doing anything wrong here? They aren't hiding the fact they serve pork, so if someone wants to eat there they can, and if someone else doesn't want to eat there they can choose a different restaurant to go to or order something different off the menu.

This isn't a question of ethics. Now if the restaurant was selling a hamburger they claimed to be 100% beef but it actually contained pork byproducts, then we've entered a discussion of ethics.
jeremy@northstar-mergers.com
214.442.6706
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ChoppinDs40
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10:39a, 1/30/23
AG
yeah I don't know.

Saying a business is making money or "profit" without paying employees/layering in payroll costs is just a flat out lie.

I've worked on over 250 deals in my career and that item is viewed only 1 way... ever. You have to include costs for people that are operating the business. Period.
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Diggity
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In reply to ChoppinDs40 • 11:22a, 1/30/23
AG
If there are no employees, I really don't see why you need to include anything, as the numbers will be arbitrary.

As mentioned several times in this thread, it's up to the interested parties to conduct their own buy-side valuation and determine how they value the business and allocate staffing costs.
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1:07p, 1/30/23
AG
The cost of employee to legitimately run the place should be included in the costs and net profits. If the owner was taking out $100K but could run the place at the same level for $30K then I could see backing out $70K as they were owner distributions.

This company appears to be breaking even if paying an equivalent employee salary. So it seems they are better off selling their equipment, lease, starting customer base, and name recognition rather than focusing on profits.

If you start the business from scratch you inherit all of those expenses and take longer to build up name recognition and baseline of customers to break even.
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