Are you interested in purchasing a business? In this series you will learn the steps to evaluating a business and acquiring that business.Sign Up to Watch
-Daniel McKenna here and today we are with Clay Clark and Thriver of the Month winner David Grossman. In this mentoring session, Clay is going over Evaluate a Business for Purchase. Four Primary Ways to Determine the Value of a Business. Are you looking to buy a business but have no clue what to look for? In this lesson, Clay is going to teach you the specific ways you should go about finding the value for business so you can find out if it's worth your investment. So, let's not waste any more time and dive on in.
-David, how are you, my friend?
-Hey, this is your second trip to Oklahoma? Or in your lifetime, how many times have you been here, my friend? Twice? OK. So you won. You are Thriver of the Month. Give the Thrivers across the world-- we have people in 36 countries, I believe, right now. What was your tip for winning?
-My tip for winning was study hard.
CLAY CLARK: So you are a massive viewer of content?
CLAY CLARK: And so--
-And I love the tests. The tests are the best part.
-Kind of got you to think a little bit?
-Well, here's the deal. I'm excited to talk to you today because it looks like you are in the process of looking at acquiring a business potentially. And rumor has it, you're looking to buying a franchise maybe, and now you're looking at buying maybe a non-franchise? Can you share with us kind of where you're at and what you're looking to do?
DAVID GROSSMAN: Sure. I'm looking at franchises, and I'm looking at other businesses. And I wanted to do that thing we talked last time about with senior care, but there's some incredible government regulations with that. And to get into that would take quite a bit of time. It's not the end of the world to do, but-- so I started looking at Chick Fil A and some other places, and whatever I do I want to be able to have an equity position when I'm done doing it.
DAVID GROSSMAN: Yeah.
-Chick Fil A-- they don't let you have an equity position. So that's kind of sad. So I looked at a gym-- several gyms where they--
CLAY CLARK: Like a fitness place?
CLAY CLARK: OK. Cool.
-They literally wanted to give me the place, and there was something wrong with it, and I figured out that the dynamics of membership are changing now an other things. And I should really know how to look at a business-- evaluate it-- because I'm looking to grow the business. My end is business development. That's what I do. So most businesses don't have that particular expertise, and I'm sure I'm going to be able to find a business that's-- I want to purchase it at a fair value, or of course a lot less, and then grow the business and then sell the business.
CLAY CLARK: Well, my secret little goal today is-- I have helped several dozen entrepreneurs buy a business. Worked with them to kind of from the beginning, with the idea, to actually acquiring. Most of them were buying a second business or acquiring a third business. That kind of thing. And a lot of times, there are these consulting companies that charge thousands and thousands of dollars to teach you this stuff. And my goal is to teach you all this stuff so we can save you thousands and thousands of dollars.
DAVID GROSSMAN: Love it already.
-We're going to hop on into it here. There's basically four primary ways to determine the value of the business. But before we do that, I'm going to hop into some Warren Buffett knowledge, because of some great ideas and concepts I want to share with you there.
The first quote Warren Buffett has-- the first notable quotable Warren has is, he says, "To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools--" What!-- "whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses. How to Value a Business and How to Think About Market Prices. Warren Buffett. He's doing all right. Rumor has it he's worth $69.7 billion as of this morning, according to Forbes. And Warren is saying that we don't want to make it complicated, is basically the idea. So we're going to keep it simple. We're going to go into these four moves, but keep it simple."
The second tip he has, which I absolutely love, is he says, a cigar butt found on the street-- this is kind of gross, by the way-- a cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the bargain purchase will make the puff all profit. So the moral of the story there is that it's going to gross if you picked up a soggy cigar that's not yours and you took a puff from it, but you'll probably get it at a very inexpensive price.
So one is we don't want to make it complicated. Two, we want to get it at the cheapest price possible. Third, we simply attempt to be fearful when others are greedy, and to be greedy when others are fearful. So the idea is we want to get a good deal because somebody's maybe in a bad spot.
So we don't want to be buying anything unless we're buying something from somebody who absolutely needs to sell it for probably an emotional reason. And the fourth. If you are willing to own a stock for 10 years, don't even think about owning it for 10 minutes.
What he's talking about is-- my generation especially-- I'm 34-- you'll have a lot of folks who want to buy something and then quickly unload it. I'll buy a franchise, I'll run it for three years, hopefully I can sell it. But as history shows, a lot of times you're with the business for 10 years or 15 years. Or a lot of times, after you buy it you can't sell it. So we should plan on kind of a long-term approach to this.
The second concept says, you don't need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ. So I guess he's saying people like me who lack supernatural intelligence can buy a business. And then finally he says, I try to buy a stock in businesses that are so wonderful that an idiot can run them because sooner or later, one will.
So the point is if you buy a business, you want to buy a business that is dumb enough for a guy like me to operate it. Because if you bought a very complicated business that requires a rocket scientist, and some sort a laser technician, and a guy who can juggle while doing algebra, at a certain point he won't work there anymore and an idiot will be running it and then you're stuck.
So of these are kind of the ideas we want to frame this. But there's four major principles want to get into. One is future income. This is how we're going to evaluate the value. One is, we're going to look at the future income. Two, we're going to look at the asset valuations. Three, we're going to look at the liquidation value. And number four, batting cleanup comparisons. And so, let's go ahead and get started here on the first one. Principle number one-- future income. Warren Buffett says, "After all, you only find out who is swimming naked when the tide goes out. We talking about ", basically every business looks good right now. If I'm looking to sell you a business, I my be able to make it look good right now. But if the revenue goes down a little bit, the tide goes out all of a sudden, you see the naked business. You see the naked people. So the whole idea is, we want to make sure that we really understand the value the company. So I'm going to deep dive into this. One, we want to look at the future income based upon historical data. So do we know, in your case, how much revenue or how much income the business is generating right now? -The ones that we're looking at? Yes. INSTRUCTOR: OK. So let's go ahead and put this up on the Board of Awesome, here. OK. So how much income does, let's say, business number produce-- just gross revenue on an annual basis right now. Do we know? -I believe it was $178,000. -Of gross revenue, not profit. Just gross revenues revenue? -Gross revenue. -OK. And this is a gym, right? STUDENT: Yes. -OK, so $178,000. And then the profit-- do you know how much profit that is? STUDENT: $598. INSTRUCTOR: $598. Really? STUDENT: And that was stretching it. INSTRUCTOR: That's awesome. So $178,000 of income, for $598. The thing is, if you could live on $1 a day, this would be something you could live on So the next one, what's the second one you're looking at? -The second one I was looking at was the Chick-fil-A business. INSTRUCTOR: OK. But you don't do that, because of the equity deal. -The equity deal. I was doing the thing with health care. I was looking at a couple things with the health care. One was $195,000. INSTRUCTOR: Of gross revenue? -The gross revenue was about $145. INSTRUCTOR: OK. -And the profit was about $45. INSTRUCTOR: Thousand? -Yeah, which was a little better. INSTRUCTOR: Yeah. It's a lot better than this. This right here is kind of the business where they might be going to give you a nail gun with the purchase so you can use it on your head. STUDENT: That's where the negotiating part comes in. Because they have all these crazy franchise fees. I basically told them, if they give it to me, and I turn around, I'll work something out in the future. That's how bad this place is. -I want to share this with you, is the future income-- this is based on the expectations of future profits and return on investment. So you kind of have to take these four different principles, and apply it to evaluating the business. So under this model, if we're looking at future income, I would say this business is about worth what the cigar butt is worth. You know? I mean, it's that sort of deal. So the formula we have-- and I'm going to put this up on the screen of awesome here. The formula you have, is you want to take the owner's salary plus pre-tax profit, plus owner perks, you know, if the owner has a car, or the owner goes on vacation, or the other uses the business somehow. All of this it is going to equal the value of the biz. So in this model, if we took the owner's salary, which is $598 per year. STUDENT: Well that's after everything. -So do you know, in this case, how much is the owner's salary? -I believe $31,000. -OK. So now let's get a little better. I was about ready to get the nail gun out. OK, so this is $31,000. And pre-tax profit was $598 dollars, right? STUDENT: Yes. INSTRUCTOR: And then, the perks. Was homie driving like a Mercedes or a Maserati that was paid for the company? Was getting his hair cut? Was he living high on the hog? Did he have a pet lion that the company paid for. STUDENT: Well, he had a wonderful 401k. -OK, 401k. So he was contributing to that annually? INSTRUCTOR: Yes. -How much? INSTRUCTOR: Well, he had about a half a million dollars into it, over five years. So about maybe $100 a year. -Oh, OK. So now it's not getting so bad. Now we're starting to get off of the-- I was starting to just really get worried. STUDENT: Here is a third business. INSTRUCTOR: Well, OK. So here we go. So then, if you look at this, you take this formula. I'm not to worry about depreciation. But in this model, you can add in depreciation too. But since we're not here joined with an accountant today, I'm just going to put depreciation. You could add that in there as well.
[MUSIC PLAYING] CLAY CLARK: If you look at this and you just say, $31,000 plus $598 plus $100, I'm going to say that equals $131,000. This is the total. So you're staying the guy brings in $178,000 a year, but $131,598 is profit? STUDENT: Pretty much. CLAY CLARK: So under that model, you would take the value, that number. This is the number we're going to take. And what you're going to do is you're going to take this number, and you're going to do a multiplier. Again, this is typical in every industry. If you're watching this and you're thinking about buying a boat, maybe a boat business, and you go, well, this isn't true for the boat business. The thing is, you're going to talk to an accountant-- typically accountants are great at this-- or a business acquisition attorney, somebody who helps routinely sell those companies, and ask them what the typical comps are. If you're buying real estate, you say, a house in this neighborhood is worth $100,000, a house in this neighborhoods is worth $110,000. So you know the average, the comparative prices. But generally speaking, across the board, this is a very broad thing. You're going to take that total times 2.5. Take that times 2.5, and that's going to your total. So I'm going to get out my calculator. Do you have a calculator on you? STUDENT: I do? CLAY CLARK: OK. Here we go. So we're going to take $131,598 times 2.5. I would mentally guess, but I'd be off by about, I don't know, a lot. I bet you it's it's ish near what, $300,000? $131.598 times 2.5. STUDENT: What do you think it is? -Near 300? Come on baby. Here we go, anticipation, the excitement, the alacrity, the focus. STUDENT: What'd you say it was? -Near 300. STUDENT: 328. -328, OK. STUDENT: You're within the margin of error. -So under this model-- just want to make sure the folks at home, as you're taking notes. Feel free to watch it once, watch it twice, flip it, reverse it, [DJ SCRATCH]. The point is it's going to be $328,000 is the value of that business. Now, we don't have to pay that much, but that's about what it's valued at. Cool? That's using our first concept here, our first principle. This first idea right up here of future income, if you're going to evaluate that way. Now, the next is asset valuations. Asset valuations. Now, I'm going to read this notable quotable to you. From our main man Warren Buffett. He says, I have pledged to you, the rating, agencies and myself, to always run Berkshire with more than ample cash. We never want to count on the kindness of strangers in order to meet tomorrow's obligations. When forced to choose, I will not trade even a night's sleep for the chance of extra profits. What Warren is saying is you don't want to borrow money to buy a business, if at all possible. And if you do borrow money, you want to borrow it in a way that doesn't require a lot of cash out of pocket. You want have as much cash as you want. Cash is king. So example, if you did agree to buy that business for $328,000, see if you can buy it and only put in $598 of cash, and then have him owner finance it, or try to get a separate LLC and finance it through that. But you want to keep as much cash as you can. You don't want to be in a spot where you don't have the cash. So we're going to go ahead and get in the asset value now. This asset valuation, this is a different model. Again, we have four different ways that we can determine the value of a business. Now, why am I telling all four? Because if I'm trying to sell a business, as a general rule, I'm going to try to push whatever angle works best for me. So under this model, asset valuation, this calculates the value of the assets of a business and arrives at a price. SO how much crap is in this business? How much stuff, how much gizmos, how much fitness flyers and free weights? -About 65,000. CLAY CLARK: So we had $65,000 of stuff. That's the stuff he has. This is the tangible goods. So if I'm buying a dentistry, these are-- one dentist I worked with, he has a machine that makes molars in like three or four hours. It's an expensive machine Another dentist I work with has all these machines, where they kind of can analyze your face and determine what kind of dental work you need, and they're very expensive. I work with a cosmetic surgeon who has equipment that's half a million dollars. And then other people I work with have businesses where they only have about $65,000 of stuff, and they can use that to make a lot of money.
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