So you're in do you get out?

So you’re in do you get out?

I was meeting with a business owner the other day and he said to me “When I started this business I never gave any thought to how I would get out of it, never crossed my mind.”

His business now does over $3 million in sales and has significant value….but no where near the value he thinks it has…….for one reason.

He’s never looked at his business the way a buyer for the business would look at it.
In my line of work, I see this nearly everyday. Business owners don’t understand, or at least they don’t have an appreciation for, the difference between a good business for them and a business that would be valuable to someone else. Understand how to value a business from the eyes of a buyer is an important part of the business owners job.
A perfect example was the business owners (let’s call him John) strategy as it relates to the real estate the business utilizes.
John started the business 10 years ago, it grew quickly and started generating good profits. About 6 years ago John decided he needed a new, bigger, building for his growing business. John also decided he wanted exposure on a major freeway so everyone would be able to see his business.
John located a great building with an excellent location. He went to his bank who was willing to give him a commercial real estate loan to buy the building because the business had the cash flow to pay the note. Everything was great. He moved into his new, bigger business and life was good.
However, John was only focused on making the note payments on the building. As he said to me “the business paying down the debt on the building is my retirement fund.”
Now fast forward to today.
John’s business is generating a profit for himself of $10,000 per month or $120,000 per year. Pretty good, wouldn’t you say?  Maybe……maybe not.
The area around John’s business has grown and property values have increased while Johns note has stayed the same. Good right? Not necessarily.
John’s note is $8,000 per month which the biz can afford…BUT  the real estate is now worth much more than he paid for it. If John were to lease the property out at today’s fair market value he could lease the building for $15,000 per month.
But remember John’s biz profit is $10,000 per month. If John was getting fair value for the property he would get $15,000 per month which is $7,000 per month more than the $8,000 monthly note payment.
If we adjust John’s monthly expenses to reflect fair value for the building then John’s monthly profit drops from $10,000 per month down to $3,000 per month ($10k – $7k).
John is now stuck.  His business can’t afford a fair rent but he needs the building to run his business. John’s real estate value makes his business value very low. A buyer who pays fair value for the real estate won’t have enough cash flow from the business to pay the note and a reasonable salary for himself.
John came to me thinking he was in a great situation and left thinking his situation was not nearly as good as he thought.
Do you have a business that one day will need to be sold? What concerns do you have as you look ahead to that day?


Using Credit Cards for your Small Business Financing

I see many, many small businesses that use the business owners’ personal credit cards to finance their business. Although this is often an easy source of cash it can be a terrible way to manage and grow your small business.

Often the biggest issue we see is that the business owner doesn’t understand the relationship between the interest expense on the credit card debt as it relates to the net profits the business generates. We regularly see businesses where they are guaranteed to lose money on the sale of an item which the business owner set the price. Meaning the business owner thought he had priced the product to make a profit but in fact the price guaranteed a loss.

Here are some problems you might want to try to avoid. Here’s an example of what we see.

John owns a small sign business let’s call it SignCo. John started the business in his garage a few years ago and now he’s opened a shop in a small retail center. When John started the business he was a sole proprietor but last year he formed an LLC when he moved into his retail space. To get the retail space looking good John needed to buy some shelving, signs, cash register, chairs, etc. SignCo is too new and a bank won’t give the business a loan but John has personal credit cards and he puts his purchases on those cards. John has total of $20,000 on his credit cards and his interest rate is 18%.

John put together a budget for SignCo and he wants a 10% profit after operating expenses.

SignCo’s average sale is $100. How much does SignCo need to sell each month just to pay the interest on John’s credit card debts?

The answer $3,000 per month or 30 signs per month just to pay the interest on John’s credit cards. That’s $36,000 per year or 360 signs to pay the interest. It will take the sale of another $200,000 to pay the principal!

The math: $20,000 x 18% = $3,600/yer interest divided by 12 months = $300 per month @$10 profit per sign that’s 30 signs per month just to pay the interest.

The point is you need to understand the relationship between your profits and your debt costs before you make a decision to borrow money from anyone, including yourself.

Here are associated articles “How to Start a Business like you’ve Done it Before”  and Business Owners and the Personal Guarantee

Finally, too many small business owners also fail to realize that personal credit card interest may not be tax deductible without some tricky accounting and documentation. If a business owner is running up his personal credit cards and then paying them off from his income from the business he is likely losing a substantial tax deduction, assuming he’s actually making a profit.

A very helpful book on managing small business finances:

Another article you may find useful:
Understanding the Inventory to Cash Cycle in Your Small Business

Build a Business that Can be Sold –  What makes a business valuable to a buyer?

Article Library – Buying , Selling and Running a Business

Can Owning a Small Business Make You Wealthy?

What’s the Value of This Business? Here’s a little game, takes 2 minutes