Can someone help me determine whether this is a good buy or not?

We've just been presented what looks like a good cashflow business.
Its a Backpackers business right in the middle of the CBD.

We've got their profit/loss statements for the past 5-6yrs and each financial year the average Gross profit is $275K or Net profit of $120K. Agent tells me that these figures in their profit/loss statement are actually significantly less than what they actually get in because alot of their business runs on a 'cash' basis.

Asking price is $340-$360K and the deal is contract must be signed Jul 2010 next year for tax purposes (thats what they've requested). This is the price of the business, they don't own the building (leased).

From the looks of things, it seems like a really good buy but this is the first real commercial deal we've looked at and am not too sure whether its a reasonable buy or not?

Is there a rule of thumb for commercial buys? I'm guessing the thing thats thrown me a little is we're not buying the building + business....its just the business only.

Please help!
 
I don't know anything about buying businesses, but I would only go on the proven figures. Unless they can prove "undeclared cash" then ignore it in your calculations.
marg
 
Agent tells me that these figures in their profit/loss statement are actually significantly less than what they actually get in because alot of their business runs on a 'cash' basis.
If this is the ethics they demonstrate in their dealings with the ATO, what are their ethics going to be in relation to their dealings with you? The ATO has the power to fine them and put them in prison, but they still lie to them. Since you can't fine or imprison them, I assume they'll feel even less motivated to be truthful to you than to the ATO.
 
Thanks Marg. Yep thats our thoughts exactly. We're only looking at actual figures on profit/loss statement which still seems healthy....but still very unsure if this is the normal return for commercial?
 
What are the lease terms. It sounds like a good deal but how long is left on the lease? Whats the property like? Is it a prime redevelopment area? Is there a market review coming up that will wipe away profit? Is there a makegood clause or some other onerous provision that will cost you money that you haven't considered? Repair clause and tenant has let the property deteriorate? etc, etc.

If theres less than 5 years left on the lease in a redevelopment zone with a mid term market review coming up with landlord friendly drafting you may find its a terrible buy!

The business is intrinsically linked to the property so the lease is critical.
 
8.5yrs left on lease (new lease started in 2008). Rent is increased 5% each year....They started the lease 6yrs ago at $69/annum....it is currently $73K/annum.

its in the middle of the CBD (new developments going on all the time) however we wouldn't be buying the land/building...just the business so not sure if this makes a difference :confused:

There's a 90% occupancy during summer months and 75% occupancy during winter months.
 
Ignore the 'cash' component as it is not substantiated.

Has the $120k net provisions for management /employees or is the current owner slaving away and not accounting his wage costs.

Based on a $340k+ purchase with a return of $120k its just a standard 33% price. You will find that most business brokers will automatically try and value a business on this basis.

Only reason that a price may be good price is that there is unidentified/untapped potential that you don't pay for and gives you the substantial cost benefits rewards.

Think about a property which has been fully renovated and the rent is fully priced compared to a property where there is a twist and is currently under rented. which would you buy!!!

Cheers
 
yep that $120K net is with the hubby and wife running it....occasionally if they go away on holidays themselves and take 2-3mths off then they hire someone to manage it.

so based on its current net income, what would be a 'good' buy price?
 
Is there a rule of thumb for commercial buys? I'm guessing the thing thats thrown me a little is we're not buying the building + business....its just the business only.

Please help!

This is not a commercial property deal you are looking at at all.

You are looking to buy a business.

Commecial property investment is where you are the landlord, in this case you will be the tenant .. you will make noting out of any movement in the property market.

With this business you need to determine wether you are buying a business or buying yorself a job!

How well do you understand the backpacker market? Have you ever looked at the Thorn Tree or Trip Advisor? If not you may well be out of your depth.

Is the business listed in any guidebooks (this is important from a marketing perspective) - how do they reach their target market? Is it part of any association?

Valuers can value this buiness for you .. it is essentially the same as valuing a motel.

Personally I would want a return on my investment at a suitable rate plus a return for any time I spend running the business.

cheers

RightValue.

PS. Backpackers meet .. they talk .. one of the first questions they ask is .. where did you stay, what was it like?

Thorn Tree is the message board of Lonely Planet ..

Trip Advisor is where guests make comments, good and bad, about places they stayed at .. a bad review can hurt your business.
 
yep that $120K net is with the hubby and wife running it....occasionally if they go away on holidays themselves and take 2-3mths off then they hire someone to manage it.

so based on its current net income, what would be a 'good' buy price?

To me they would have to pay me several hundred thousand to take the placve over.

I would want a 20% return on my capital as an investment return.

Then you have to consider how hard you have to work and how long the hours are for two people.

$120k would be a pay cut for me so the wife would be working for free.

If you could each earn $60k working 40-50 hours a week without the risk then why would you buy this business?

Sounds like you would be buying a job, and a job at a pretty low hourly rate at that .. rather than making an investment.

Ask how many hours the owners work on the business .. or better still check into the place for a few days as see for yourself.

Still it may just be the lifestyle you are after.

cheers

RightValue
 
This place has good reviews in Lonely Planet.

We are only looking at buying a business because it would help us cashflow-wise. Our core business which is developments really doens't bring in any money until we sell which can be a challenge at times.

We ran several student accomodation places about 3 yrs ago and were very active in sourcing tenants with our local contacts. I'm guessing backpackers is a slightly different market but i would think keeping occupancy rates to a min. would be ok because we've dealt with a similar thing before. However as for everything else that comes with backpackers we'd be beginners. The owners are willing to spend a couple of months helping us out if we were to buy it..to show us the ropes.

I would say from the profit/loss statements that it has a fairly good rep as it gets about $30K/annum from commissions alone.

A mate of ours just told me that a good commercial buy is normally 1 x or 2 x the nett profit...ie. nett profit in this case is $120K (average) so for it to be a good deal i should only be paying between $120K-$240K for the business....does that sound about right as a rule of thumb?
 
thats definitley not a lifestyle we're seeking for ourselves. If we were to buy something like this we would employ someone to run it...we quit our day jobs a couple of years ago so not going to get back into a 'job' anytime soon :)

its beginning to sound like its not a very good deal....which is great that we learn this now!
 
I would venture to say that one of the reasons this place does so well is that the owners really care about the business.. you think you can get an employee that will treat your business as if it is their own in a similar way?

If you can find such a person or persons, then what would you have to pay them?

This needs to come off the $120k.

My guess is that the current owners work about 14 hours a day 7 days a week between them .. That is about 100 hours a week..for about $2,500 pw in income ..

Like I said before, this is a business not a commercial property deal.. many people are happy with this sort of income and lifestyle as they couldn't earn that much any other way ..

but for you??

cheers

RightValue
 
You're looking at buying a business that will be harder to sell all the time because the term of the lease is lessening each day. This is a job not a business. You need to be able to recover your capital over the 8.5 years.

So from the $120 you pay wages, you pay interest on your borrowings, you pay tax and then what's left over needs to be used to recover the purchase price you have paid out.
 
hi kimanand
for me you are buying a job yes
the property is owned by another so the lease is the main thing to look at and then the income
the question which seems to be missed is not is this a comm purchase or a business purchase but is it a good deal
and for me no
when you invest you need to be able to invest either your money or your time not both
if you do both you have just knackered yourself as you can't now expand.
is it a good buy if you don't invest the time
no because the labour is an expense so you need to look at a business as an ebit
earnings before interest and tax
you will see edit when buying a business
its the ebit thats most important
its this ebit and a multiplyer of the edit that gives a value
so yes its 3 times but not 3 times of net but 3 times of ebit
if you take out 70k of the cash flow for this business(if it could run on one person) leaves 50 makes it worth 150k
that is raw data because ebit is all other costs.
buying a business or valuing a business is very different to buying a comm as the way you do it is very different
so on ebit is it a good deal
no 150 k in to buy someting giving 150k over 3 years is not a good deal
for me its a very bad deal and not only would not touch it with a barge pole would not even pick up the barge pole to hit it with.
now lets look at time
they have 130k income
is your time worth 70k into this business
this is a question for you
if you do not know this industry ( and I will say you don't tell me I am wrong if you want) then you will struggle to make it work if they gave you the business
so time
its not worth it.
I can't see a good point
except one
for them not you
they get someone to buy something they have no idea about pay them an amount that they can't get from a business buyer.
and hope people like you buy it
its a wounder the real estate doesn't say that they are building some thing around the corner to make you feel happier.
if you or anyone else is looking at buying a business
the best way to look at these is to get a business broker to run the numbers and they will do it via ebit and then you will see the true colours.
hope this helps
 
Thanks so much for all the replies.
I certainly have a ginormous amount to learn in commercial.....i think i've just come to the realisation i know pretty well nothing!

Sending off email to agent to give her green light to show other propsective buyers this deal as we're definitley passing on it!

Thanks again for all your advice guys!
 
its the ebit thats most important
its this ebit and a multiplyer of the edit that gives a value
so yes its 3 times but not 3 times of net but 3 times of ebit
if you take out 70k of the cash flow for this business(if it could run on one person) leaves 50 makes it worth 150k

in a nutshell, in this case the ebit being the profit you would make if the business was fully managed (is this right grossreal?, are we on the same wavelength), so if you did need $60k salary x 2, then your net profit = $0, if you need $60k salary x1 then your netprofit = $60k.
 
Other factors are whether the lease includes a right of first refusal of sale of the building. Are the landlords likely to sell in the next few years. You say there is a lot of development going on nearby - any chance on getting the freehold down the track and selling on the lease?

A business can be a way to get your hands on the real estate down the track.
 
If this is the ethics they demonstrate in their dealings with the ATO, what are their ethics going to be in relation to their dealings with you? The ATO has the power to fine them and put them in prison, but they still lie to them. Since you can't fine or imprison them, I assume they'll feel even less motivated to be truthful to you than to the ATO.

This is the ethics of many small businesses... doesn't mean he's not ethical in his dealings with you.

You need a lawyer to draft your contract of sale very carefully as there's many get-outs you can put in there in relation to business profits, supervision period etc. Also all the usual things about stocktake etc (is he selling you the stock too?). It shoulds like you haven't really thought through the issues.
 
in a nutshell, in this case the ebit being the profit you would make if the business was fully managed (is this right grossreal?, are we on the same wavelength), so if you did need $60k salary x 2, then your net profit = $0, if you need $60k salary x1 then your netprofit = $60k.

The EBIT, is before you pay your interset and tax. So your NPAT is not your EBIT obviously.

However most retail businesses sell on PBT multiples. 3x is quite high for retail businesses. Small businesses cannot command premium multiples because the diversifiable risk in the business is too high. Generally we've bought and sold most of our family businesses (which have probably been over 30 over the last few decades) for around 2.0x to 2.5x PBT.

Also you're right. Your salary is never included in the EBIT/PBT/NPAT of your calcs. You always look at a business from the perspective of what's left after you draw a salary. Including your salary is just deluding yourself because that's your opportunity cost.
 
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