Use Owner-Financing To Buy This Business?

Summary

Podcast Summary: "Use Owner-Financing To Buy This Business?"

Episode Details:

• Title: Use Owner-Financing To Buy This Business?
• Host: Ramsey Network
• Release Date: December 14, 2024

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Introduction to Kane’s Business Offer

In this episode of The Ramsey Show Highlights, a listener named Kane seeks advice on a business acquisition opportunity. Kane was approached with an offer to take over an HVAC and plumbing business from an older gentleman looking to retire. However, Kane lacks the necessary funds to make the initial investment. He reaches out to the Ramsey Network seeking guidance on navigating this potential purchase.

[00:05]
Kane: “Today I got proposed a business offer to take over a business from an older gentleman who has no kids and wants to retire. I wouldn't have enough to put it all down, but I was just wondering what some pause would be of that.”

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Assessing Kane’s Background and the Business Opportunity

John begins by understanding Kane's connection to the business and his professional background.

[00:19]
John: “Were you working in the business before? How did you come across this offer?”

[00:26]
Kane: “I actually reached out to do some private work through Facebook. The guy also has some rentals and he needed some employees. And yes, I have got my EPA certifications for refrigeration. And I was a plumber for three years for a construction company.”

Mama Jade further inquires about the specifics of the business.

[00:40]
Mama Jade: “So what's the business?”

[00:43]
Kane: “It's an HVAC and plumbing business. Kind of a smaller town, but there's three of them collected together and there's quite a bit of work for that company.”

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Evaluating Financials and Profitability

John probes into the financial health of the business, questioning its profitability and overall performance.

[00:54]
John: “Okay. How's it doing? I mean, have you looked at the numbers and is it profitable? And if so, how well are they doing?”

Kane admits he hasn’t fully assessed the financials but has conducted preliminary research on valuation.

[01:02]
Kane: “No, that's kind of what I was wondering. I hadn't went across that bridge completely. I'm going to shadow them tomorrow and see how it's going. If it is profitable, I did all this research. Maybe you can tell me if I researched it right. But roughly two to three times the business yearly profits is usually what a business like that would go for.”

Mama Jade introduces the concept of net present value in evaluating the business.

[01:26]
Mama Jade: “It's a net present value, is what they call it.”

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Owner-Financing vs. Traditional Loans

The discussion shifts to structuring the purchase, with Mama Jade advising against traditional financing methods.

[01:30]
Mama Jade: “What I would not do is go down to a local bank and get a loan and buy this guy out, or I wouldn't go call the SBA and take out an SBA loan and try to buy negative.”

Kane shares details of the seller’s original private financing arrangement.

[01:39]
Kane: “Yeah, this guy said that the guy that originally started from, they did it as a private deal. He put, I think he said $20K down and skimmed the profits off to him as payment until the business was paid for and then it was essentially his.”

John acknowledges the viability of owner-financing.

[01:53]
John: “That's not a bad idea. If you just say, hey, I want to receive a salary from the business, but you're paying all the profits back to the seller until he receives the full amount. You could structure something like that because…”

Mama Jade elaborates on the advantages, emphasizing financial security and flexibility.

[02:09]
Mama Jade: “That way you're not in debt to him. You can and you will have made a salary for your work over X number of years. And let's say you have to walk away or the economy implodes or whatever happens, you won't be stuck with a worthless business. And yet the bank is still calling the note on your loan.”

Kane responds positively to the explanation, feeling more confident about his approach.

[02:50]
Kane: “Yeah, that makes perfect sense. And I just kind of wanted to make sure that I didn't go down the wrong rabbit hole of looking into this.”

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Illustrative Example of Owner-Financing

Mama Jade presents a hypothetical scenario to demonstrate the benefits of owner-financing over traditional loans.

[03:23]
Mama Jade: “Let’s say after all expenses were paid, this business is sitting on $350,000 cash at the end of every year. You've already done your depreciating, you put money aside, you've got all that stuff taken care of, you paid all your bills, and you decide I’m going to take him $100K a year as a salary as the owner of this company. I'm going to pay him $250K over four years. And at year four, this will have been signed over to me. I'll own the whole thing.”

She contrasts this with obtaining a traditional bank loan, highlighting the reduced financial risk.

[03:53]
Mama Jade: “And that’s different than going to a bank and saying I need a million-dollar loan, 100%, and I'm going to write him a million-dollar check. And then I'm going to hope that I make that back over the next four years.”

She discusses worst-case scenarios to underscore the safety net owner-financing provides.

[04:08]
Mama Jade: “In two years, you will have made $100K a year as the president of your company. He will have made $250K a year. So he would have received $500K. And that's under the made-up numbers I'm just using. Then it all falls apart. All goes away. And you come to him and you say, hey, I'm tearing this contract up. I'm walking away. And he says, I'm going to sue you. But he still has half a million dollars that he has earned over two years. You have been paid for your wages and there's not a bank saying, hey, I want my money back.”

[04:57]
Mama Jade: “Do you get the difference? And now he may look at you and say, go jump in a lake. I'm not doing this. We're going to structure a dollar amount and you're going to owe me this dollar amount, Jade. And I would just tell you four years, five years, six years. Who knows what the world's going to look like? That's another presidential election away. Who knows what the world's going to look like? So I would not invest. I would not put myself on the hook like that downstream.”

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Further Considerations and Expert Opinions

Kane reflects on Mama Jade’s advice, recognizing its merit and contemplating his next steps.

[05:21]
Kane: “Right, right. And I. That's. That kind of really solidifies my answer. I was leaning towards it, but I just, you know, I am doing the baby steps. I haven't particularly went through it, but I do have enough for six months' wages and I am investing 11%. What is retirement?”

John probes about the business’s valuation and sale price.

[05:37]
John: “What is the amount of the business? What is he selling it for?”

[05:41]
Kane: “Like I said, I hadn't quite gotten into that. Maybe I should have had that information before I called you guys. I'm going to job shadow him tomorrow and kind of after the day, you know, make sure that he is really profitable.”

[05:55]
John: “I wouldn't. Not after the day. I would do this for a little while.”

Mama Jade advises Kane to delve deeper into the business’s financials before proceeding.

[06:06]
Mama Jade: “You're wandering into what I'd call adult land. Big boy, big girl land. Okay. And that's when you say things like, I need to see the last four years of your books or the last five years of your books. I need to see all the outstanding debts. I need to see any notes you have called and I'm going to have an accountant look over it all.”

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Encouraging Gaining Business Experience First

Both John and Mama Jade express concerns regarding Kane’s readiness to take on such a significant business responsibility at his age.

[06:24]
John: “Everything that John said and everything that I've said about structuring this deal is accurate. I don't like this for you. I'm just going to come out and say that because I want to go on record as saying for you, at your age, I'd like you to get your feet wet starting your own business first before you just up and take on something that there's so many learning curves I think, um, in business and I would love for you to learn those with lower stakes before you come in and learn them with high stakes where there's really a lot of money on the line and there's a time frames. Yeah. And there's a time frame where you're having to kind of. Yeah. Like if this is the salary that I'm paying back, I'm getting my salary, I'm paying him back. There is going to be a term to that and you are going to have to make good on that depending on how you structure it. So Mama Jade doesn't like this for you yet. I'm just going to say that.”

Mama Jade reiterates the importance of gaining practical business management experience before making such a leap.

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Understanding the Business Operations and Clientele

Kane describes the unique selling point of the current business—its responsiveness to customer needs, even at inconvenient times.

[07:31]
Kane: “The clientele market is pretty stiff. The reason why they're loyal to him, so to speak, is because he takes service calls. So if the furnace goes down at midnight, he will be there at midnight. And he's a one man show. So that's kind of how this business proposition came about.”

John and Mama Jade highlight that technical expertise alone doesn’t equate to effective business management.

[07:48]
John: “But the thing about it is at midnight, here's the thing, you can be amazing at your job. You can know HVAC very well, you can be good with customers. It doesn't mean you're good at running a business.”

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Advice on Building an Independent Business

Mama Jade advises Kane to consider building his own clientele rather than purchasing an existing one, especially in a one-man operation.

[08:41]
Mama Jade: “Okay, so, but it's a one employee shop. So what you're buying is his book of business. You do not need to do that. You need to open up a local Facebook Marketplace ad and say, I will be there 24/7, 365 midnight, 2am I will be there. And you're going to get a few calls, you're going to show up at midnight and you're going to start your own business. You don't buy somebody's clients from them in this one man shop kind of way. I mean, you can do that. I wouldn't do it if it was a big company. Maybe. But yes, I'm recounting on my offer.”

John concurs with Mama Jade's recommendation, urging Kane to gain experience by starting his own venture first.

[09:15]
John: “I am too.”

Kane wraps up by reaffirming his cautious approach, emphasizing his current financial stability and investment habits.

[09:15]
Kane: “Create your free every dollar budget today. The simplest way to budget for your life.” (Note: This appears to be an advertisement and is likely skipped in the summary.)

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Conclusion and Takeaways

Throughout the episode, the Ramsey Network experts John and Mama Jade provide Kane with prudent advice, emphasizing the importance of thorough financial assessment, understanding business operations beyond technical skills, and gaining foundational business experience before undertaking significant investments like purchasing an existing business. Mama Jade’s insights into owner-financing offer a safer alternative to traditional loans, mitigating financial risks and offering flexibility. However, both experts advise caution, especially considering Kane’s young age and limited experience in business management.

Notable Quotes:

• Kane [00:05]: “I wouldn't have enough to put it all down, but I was just wondering what some pause would be of that.”

• Mama Jade [01:26]: “It's a net present value, is what they call it.”

• Mama Jade [02:09]: “That way you're not in debt to him. You can and you will have made a salary for your work over X number of years…you won't be stuck with a worthless business.”

• Mama Jade [04:57]: “Do you get the difference? … So I would not invest. I would not put myself on the hook like that downstream.”

• John [06:24]: “I would like you to get your feet wet starting your own business first before you just up and take on something…”

• Mama Jade [08:41]: “You do not need to do that. You need to open up a local Facebook Marketplace ad…”

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Final Thoughts

Kane’s inquiry serves as a valuable case study for aspiring entrepreneurs contemplating business acquisitions. The episode underscores the necessity of comprehensive due diligence, the benefits of owner-financing, and the critical importance of foundational business experience. By heeding the advice of seasoned experts, listeners can better navigate the complexities of business ownership and make informed, strategic decisions that align with their financial and professional goals.

Transcript

[Kane]

Brought to you by the EveryDollar app.

[John]

Start budgeting for free.

[Kane]

Today I got proposed a business offer to take over a business from an older gentleman who has no kids and wants to retire. I wouldn't have enough to put it all down, but I was just wondering what some pause would be of that.

[John]

Okay. Were you working in the business before? How did you come across this offer?

[Kane]

I actually reached out to do some private work through Facebook. The guy also has some rentals and he needed some employees. And yes, I have got my EPA certifications for refrigeration. And I was a plumber for three years for a construction company.

[Mama Jade]

So what's the business?

[Kane]

It's a H VAC and plumbing business. Kind of a smaller town, but there's three of them collected together and there's quite a bit of work for that company.

[Mama Jade]

Okay.

[John]

Okay. How's it doing? I mean, have you looked at the numbers and is it profitable? And if so, how well are they doing?

[Kane]

No, that's. That's kind of what I was. Another thing I wanted to get into. I hadn't went across that bridge completely. I'm going to shadow them tomorrow and see how it's going. I just. If it is profitable, I did all this research. Maybe you can tell me if I researched it right. But roughly two to three times the business. Yearly profits is usually what a business like that would go for.

[John]

Okay.

[Kane]

Being a smaller business.

[John]

Yeah, you're right about that.

[Mama Jade]

It's a net present value is what they call it.

[Kane]

Okay.

[Mama Jade]

What I would not do is go down to a local bank and get a loan and buy this guy out, or I wouldn't go call the SBA and take out SBA loan and try to buy negative.

[Kane]

Yeah, this guy said that the guy that he originally started from, they did it as a private deal. He put, I think he said 20 grand down and skimmed the profits off to him.

[John]

Yeah.

[Kane]

As payment until the business was paid for and then it was essentially his.

[John]

That's. That's not a bad idea. If you just say, hey, I want to receive a salary from the business, but you're paying all the profits back to the seller until he receives the full amount. You could structure something like that because.

[Mama Jade]

That way you're not in debt to him. You can and you will have made a salary for your work over X number of years. And let's say you have to walk away or the economy implodes or whatever happens, you won't be stuck with a worthless business. And yet the bank is still calling the note on your loan.

[Kane]

Okay.

[Mama Jade]

Do you get what I'm saying?

[John]

This is also better for the seller because this is better for the seller because anybody who's going to come in with maybe cash or credit or some sort of investor is probably going to lowball them because they have debt on it as opposed to you who's saying, hey, I value the business that you're in. Let's work together, keep the valuation that you have. Does that make sense?

[Kane]

Yeah, that makes perfect sense. And I just kind of wanted to make sure that I didn't go down the wrong rabbit hole of looking into this.

[Mama Jade]

I'm going to make up completely, I'm going to completely fabricate numbers here. Okay. So don't use my math. Just kind of get the spirit of what I'm saying. Let's say after all expenses were paid, this business pay is sitting on $350,000 cash. End of every year. You've already done your depreciating, you put money aside, you've got all that stuff taken care of, you paid all your bills and you decide. I'm going to take him 100k a year as a salary as the owner, as the president of this company. I'm going to pay him and let's say we decided on a million dollar sale price. I'm going to give him $250,000 over four years. And at the year four, this will have, this will be signed over to me. I'll own the whole thing.

[Kane]

Okay?

[Mama Jade]

That's different than going to a bank and saying I need a million dollar loan, 100% and I'm going to write him a million dollar check. And then I'm going to hope that I make that back over the next four years.

[Kane]

Okay. And as well as hope the market doesn't crash in that particular business, let's.

[Mama Jade]

Say, let's, here's the worst case scenario for you and for him. Worst case scenario is the market crashes in two years. Nobody wants a plumber anymore.

[John]

Yeah. Business, which by the way, if we're.

[Mama Jade]

In that world, I don't want to be in that world. Right. I think we're always getting plumbers. Right. But let's pretend that happens and that happens. In two years you will have made 100 grand a year. As the president or CEO, whatever you want to call yourself of your, of this company. He will have made 250 grand a year. So he would have received $500,000.

[Kane]

Okay.

[Mama Jade]

And that's under the made up numbers I'm just using. Then it all falls apart. All Goes away. And you, you come to him and you say, hey, I'm tearing this contract up. I'm walking away. And he says, I'm going to sue you. But he still has a half a million dollars that he has earned over two years. You have been paid for your wages and there's not a bank saying, hey, I want my money back.

[Kane]

Right?

[Mama Jade]

Do you get the difference? And now he may look at you and say, go jump in a lake. I'm not doing this. We're going to structure a dollar amount and you're going to owe me this dollar amount, Jade. And I would just tell you four years, five years, six years. Who knows what the world's going to look like? That's another presidential election away. Let me put it that way. Who knows what the world's going to look like? So I would not invest. I would not put myself on the hook like that downstream.

[Kane]

Right, right. And I. That's. That kind of really solidifies my answer. I was leaning towards it, but I just, you know, I am doing the baby steps. I haven't particularly went through it, but I do have enough for six months wages and I am investing 11%. What is retirement?

[John]

What is the amount of the business? What is he selling it for?

[Kane]

Like I said, I hadn't quite gotten into that. Maybe I should have had that information before I called you guys. I'm going to job shadow him tomorrow and kind of after the day, you know, make sure that he is really a profitable.

[John]

I wouldn't. Not after the day. I would do this for a little while.

[Mama Jade]

Yeah. How old are you, Kane?

[Kane]

I'm 22.

[Mama Jade]

Okay, I'm gonna say something and not at you. I'm gonna say it with you. Okay?

[Kane]

Okay.

[Mama Jade]

You're wandering into what I'd call adult land. Big boy, big girl land. Okay.

[Kane]

Okay.

[Mama Jade]

And that's when you say things like, I need to see the last four years of your books or the last five years of your books. I need to see all the outstanding debts. I need to see any notes you have called and I'm gonna have an accountant look over it all.

[John]

And can I? Can I? Can I? I'm rowing the canoe back for a minute. Everything that John said and everything that I've said about structuring this deal is accurate. I don't like this for you. I'm just going to come out and say that because I want to go on record as saying for you, at your age, I'd like you to get your feet wet starting your own business first before you just up and take on something that there's so many learning curves I think, um, in business and I would love for you to learn those with lower stakes before you come in and learn them with high stakes where there's really a lot of money on the line and there's a time frames. Yeah. And there's a time frame where you're having to kind of. Yeah. Like if this is the salary that I'm paying back, I'm getting my salary, I'm paying him back. There is going to be a term to that and you are going to have to make good on that depending on how you structure it. So Mama Jade doesn't like this for you yet. I'm just going to say that.

[Mama Jade]

So let me ask you, what do you think? What's the difference going to be between you running out and getting your own business?

[Kane]

The clientele market is pretty stiff. The reason why they're loyal to him, so to speak, is because he takes service calls. So if the furnace goes down at midnight, he will be there at midnight. And he's a one man show. So that's kind of how this business proposition came about.

[John]

But the thing about it is at midnight, here's the thing, you can be amazing at your job. You can know H Vac very well, you can be good with customers. It doesn't mean you're good at running a business.

[Mama Jade]

Yeah.

[John]

And that's the part that I want you to learn on your own. First. Are you, are you an organized person? Are you good with operations? Are you good with logistics? Are you good with handling, you know, all of those ins and out payroll? Like, are you good with that stuff? Because if it's a one man show, it is requiring you to wear all those hats. And the truth is no one gets it all right the first time. Like there's quite a learning curve there. And I, like I said before, I love for you to learn that with lower stakes.

[Mama Jade]

And dude, I'm going to recant on my support too. Here's why this is a, you just said this is a one man shop.

[Kane]

His wife actually writes down the payroll and they take it to an accountant.

[Mama Jade]

Okay, so, but it's a one employee shop. So what you're buying is his book of business. His book of business. You do not need to do that. You need to open up a local Facebook marketplace ad and say, I will be there 24 7, 365 midnight 2am I will be there. And you're going to get a few calls, you're going to show up at midnight and you're going to start your own business. You don't buy somebody's clients from them in this one man shop kind of way. I mean, you can do that. I wouldn't do it if it was a big company. Maybe. But yes, I'm recounting on my offer.

[John]

I am too.

[Kane]

Create your free every dollar budget today. The simplest way to budget for your life.