Today’s question is from Charlie in West Cobb. Charlie is thinking about buying a business where the tax returns do not agree with what the owner says he really makes from the business. Charlie wants my counsel on what to do.

Listen to the following podcast for the answer…

Unreported Income [ 6:33 ] Play Now | Play in Popup | Download

Or, read the answer here:

First and foremost, I am not an attorney and cannot give legal advice. Second, I am not affiliated with the IRS or any law enforcement agency. Third, I am going to recite “stories” I have heard from “other” brokers during the last 23 years.

Let’s go case by case. An owner of a trophy shop said he was earning $145,000 from his business, but the tax return said $98,000. To prove the missing $47,000, he walked over to a desk drawer and pulled out a stack of customer invoices that all said “cash sale.” The buyer ran an adding machine tape on the 14 inch high stack, and the total came within $700 of the correct difference. The buyer then went through an entire year’s deposit slips and bank statements and discovered that never once was any cash or checks deposited. Only credit card sales were shown. The buyer concluded that it was very probable that the invoices were legitimate and that the owner kept all cash and checks from the business as unreported income.

The next situation was where the owners of a pizza parlor claimed they were making more than $100,000 a year but their tax return showed $49,000. The buyer asked the owners to prove the missing sales figures. The husband went to his Point of Sale cash register and printed out a very, very long report. The report showed sales by day, by week, by month and for the year. Then he printed out a second report that showed “voided transactions.” The total of the voided transactions report was $56,000. So the tax return plus the voided transactions report totaled $105,000, and the buyer bought the business.

The next situation is absolutely the most unbelievable story I have ever heard in 23 years of being a business broker. Two men who owned a liquor store said they would not sell for less than $300,000 all cash. They guaranteed a minimum inventory of $50,000. Their tax return showed that they earned $55,000, but they claimed they were making $159,000. When asked to explain the difference of $104,000, they said that each of them withdrew $1,000 cash a week for a combined total of $104,000. But the broker and the buyer wanted “proof” of this. The owners then pulled out 16 years of over-sized multi-column accounting spreadsheets. The older years were clearly very, very old, and the more recent years looked cleaner.

But the next part of the story is the 8th wonder of the world. They had kept track of sales for the past 16 years, not by year, not by month, not by week, not by day but actually by “hour.” As unbelievable as this may sound, they could tell you how much product they sold between the hours of 2:00 p.m. and 3:00 p.m. March 26, 1987 or between the hours of 9:00 p.m. and 10:00 p.m. on a Friday night in 1991. When the buyer saw the extraordinary “accounting records” they had been maintaining, he wrote them a check for $300,000 without any further due diligence.

The next situation is not outrageous like the last one. A buyer wanted to buy a light manufacturing company. When he compared the tax return to what the owners claimed they had made from the business, the difference was $22,000. The buyer asked the owners to prove where the missing $22,000 could be found. They went to a file marked “confidential” and produced photocopies of checks that had been written to them personally during the year. These checks totaled the exact amount that was missing, and it was obvious that they were never deposited into the company checking account.

I could go on and on with other stories, but the old adage “buyer beware” certainly applies in all cases. There is a reason for “professional due diligence” using a CPA firm. You want to avoid making the mistake of your lifetime by believing something too good to be true. You need to obtain “unassailable proof” before taking the plunge, and when in doubt, run, don’t walk from any situation where the owner has to work too hard to “convince” you of what he is making that cannot be supported by tax records validated with the IRS.

Author’s note. After helping sellers and buyers for more than 20 years, I have found that honesty, integrity, full disclosure, patience and a willingness to consider various alternatives makes the probability of success for all parties very high.

Today’s question is from Wilson in Decatur. Wilson wants to know how I feel about his buying a food and beverage business at this time.

Listen to the following podcast for the answer…

Time to Buy a Restaurant? [ 5:05 ] Play Now | Play in Popup | Download

Or, read the answer here…

Have you ever thought about buying a restaurant? If so, you may want to give it a second thought. Or maybe a third and fourth thought. Restaurant ownership is a major commitment of time, energy and staying power.

It is true that everybody needs to eat. But eating at a restaurant is a discretionary expenditure. And if it’s your restaurant, you don’t know whether or not the customer will choose to stop by and partake of what you have to offer.

By far and away, the most popular type of restaurant is the office building sandwich shop. The pros are that it is a 5 day operation with only breakfast and lunch being served. Normally it closes at 3:30 p.m., and you are free to beat the traffic going home. Also, the limited menu does not require the skill set of a cook or chef.

The cons are that your market is the tenant population of the office building and possibly some people from other buildings in a complex that has more than one building. If a major tenant moves or goes out of business, you could also be put out of business.

In today’s economy with all the chains offering $5.00 combination meals, you will have to lower your prices which will shrink your gross margin and make the business less profitable. It’s also unlikely that you will get rich from owning and operating just one sandwich shop. Unless you are located in a AAA office building and other options are inconvenient for the tenants, you will always be competing against the fast food chains.

Another popular restaurant is the sports bar. It is a bar first that serves food second and provides multiple televisions showing many different types of sports events. It can also have pool tables, darts, video games and other distractions. The pros are that it can be very profitable if run properly. The cons are that it is normally a 7 day operation, and you must have good and honest help. It will normally have a more extensive menu than the sandwich shop.

The full service restaurant requires different skills than sandwich shops and sports bars. You need to have very talented cooks or a competent chef to prepare all the items on the menu which is more extensive than the sports bar. There will be appetizers, soups, salads, entrees, desserts, beers, wines, liquors, etc.

What is critical in a full service restaurant is keeping food cost down while not compromising food quality. Additionally, you need to make sure you order correctly to avoid wasting food. Most restaurant owners are held prisoner by their business. They must show up on short notice if a key employee does not report for work.

I am constantly amazed at how many people want to own restaurants who have no knowledge of what’s involved. The failure rate with inexperienced people is more than 90%. You are more likely to go out of business within 6 months owning this type of business than any other. So as I said in the beginning, you better give it plenty of thought before committing to taking a bite out of this apple.

After helping sellers and buyers for more than 20 years, I have found that honesty, integrity, full disclosure, patience and a willingness to consider various alternatives makes the probability of success for all parties very high.

Read the owner’s own words that explain what sets this firm apart from the competition:

“Our company was established in August 1983. Our business objective is to provide totally independent telecommunications consulting services in the rapidly changing and expanding Information Age. We have provided unbiased, client-oriented consulting services to a wide range of business, government, and healthcare clients during our many years in business.

We have been privileged to have many clients who have used our services on an as needed basis throughout the years. For example, we have completed numerous projects for one large client since 1985. Our staff has ranged from two to six members, depending upon the number of in-house client projects.

We have several subcontracting arrangements that we use on an “as needed” basis. We have completed many projects for the Federal Court System, Service Organizations, Manufacturers, E911 Centers, Healthcare, as well as others across a wide variety of business segments.

Our business has remained stable, and has progressed to the extent that I desire as the owner and founder. We have changed and evolved to meet the ever-changing technologies that have developed over the years.

We have an outstanding, ethical reputation in the business, and have become extremely well established in the Healthcare industry – this has been our main focus over the past several years.

We have the respect and experience necessary in the marketplace to continue to be successful under new ownership.”

Financial Information

Asking: $265,000
Gross: $229,214
Cash Flow: $93,977 (ODCF)
FF&E: $20,000 (included in the asking price)

General Information

Year Established: 1983

Employees: (1) full-time

Relocatable: Yes

Facilities: Lease is month to month with special provision to give 2 month’s notice and pay 1 month’s penalty for early termination.

Competition: This business has its own niche.

Growth and Expansion: A new owner can hire a salesman or do the selling himself. Additional marketing and asking for referrals will go a long way towards building the business. With the owner staying on in a part-time basis, there will be a “seamless” transition.

Management Training and Support: Owner will assist a new owner for 4 weeks, but is also willing to work part-time on an hourly basis for actual hours billed.

Reason For Selling: Owner wants to slow down and semi-retire.

Seller Financing: $150,000 down with $115,000 @ 6% amortized over 10 years with a 5 year balloon.

Contact Information

Contact: Loren Marc Schmerler
Phone: 404-550-1417
Email: lms@botline.com

Today’s question is from Lynn in Fayetteville. Lynn wants to know how I feel about distribution and manufacturing businesses.

Listen to the following podcast for the answer…

The Advantages of a Distribution Business [ 5:31 ] Play Now | Play in Popup | Download

Or, read the answer here:

If you ask me what my favorite companies are to sell, I would have to say distribution and light manufacturing. The reasons are quite simple. A distribution company is typically not complicated. You order merchandise from the manufacturer. You receive the merchandise. You repackage the merchandise and ship it out to the end user.

Or better yet, you order from the manufacturer and have the manufacturer drop ship the merchandise directly to the customer. The goods never enter your premises. Now what could be easier than that? Your priority is to ensure delivery, invoice the customer and await payment!

Now with light manufacturing, the story is a little different. You must first understand the difference between light manufacturing and heavy manufacturing. Heavy manufacturing companies are very capital intensive with very large pieces of machinery and equipment. They can be antiquated like 40-year old printing presses or leading edge like laser cutting devices, but in either event, there is a great deal of repair and maintenance involved.

Some of the maintenance is routine. Some of the maintenance is preventative. Preventative maintenance is where a schedule is established to inspect equipment and machinery “before” it breaks down or fails to operate. A company can have its own internal personnel perform the maintenance, or they can outsource the service.

My preference is to outsource the service so that another company can be held responsible if there is a preventable problem that arises. Another reason for outsourcing is that you eliminate the risk of an employee sabotaging the equipment or machinery.

Now, let us discuss employees. With a distribution company, you typically need fewer employees to handle operations because most of their time is spent receiving, shipping and billing. There will be times when physical inventories must be taken, but even if they are performed as infrequently as annually or as routinely as monthly, either internal personnel can handle the task or part-time staff can be used to supplement their efforts.

With manufacturing companies, you are dealing with different issues altogether. Typically, you need more employees in a light manufacturing environment to generate the same level of sales as a distribution company. This means more hiring, more supervision, more potential personnel conflicts, more possible injuries, more downtime, etc. But the upside is that light manufacturing is normally much more manageable than heavy manufacturing when things go wrong.

You may ask what I mean when I say “when things go wrong.” If equipment or machinery fails to operate, it normally can be replaced or repaired in a short period of time with little impact on production. If employees are ill or you sustain unexpected turnover, the learning curve for full or part-time replacements is much quicker. If you run out of inventory, you might be able to obtain a shipment the same day or even pick it up yourself.

I think you will agree that distribution and light manufacturing businesses are highly desirable to all parties. Buyers like them due to their lack of complexity and short learning curve. Sellers like them due to their ease of ownership and ease in selling. Buyers and Sellers both like them because they are able to take raw materials and labor and create finished products. There is a great deal of satisfaction in creating “stuff” that is tangible. And brokers like them because they are in high demand under normal circumstances.

Author’s note. After helping sellers and buyers for more than 20 years, I have found that honesty, integrity, full disclosure, patience and a willingness to consider various alternatives makes the probability of success for all parties very high.

Today’s question is from Michael in Woodstock. Michael wants my opinion about his buying a publishing business.

Listen to the following podcast for the answer…

The Upside of a Publishing Business [ 5:15 ] Play Now | Play in Popup | Download

Or, read the answer here:

In my 38 years of being a business consultant and 23 years of being a business broker, the publishing industry has been my favorite for many reasons. Whether it’s a newspaper, magazine, newsletter, coupon book, Internet website, etc., the benefits during ownership and when you sell are immeasurable.

Let’s start with ego. Can you imagine what it’s like to see your name in print with every issue or on an Internet website visited by thousands of “hits?” It’s like winning an award each and every month with your name engraved on it. Now, how does that make you feel each day that you get up and go to work?

Speaking of going to work, how does a commute down your hallway from your bedroom to your home office sound? I’m sure that not having to fight traffic anymore makes sense on multiple levels. No more wear and tear on the car. No more crawling along in traffic. No more monthly parking expense. No more dealing with nasty days of rain, snow, oppressive heat, high humidity, etc. I’m sure you get the picture.

How about the learning curve when you buy a publishing business? Well, you can either be a writer or a non-writer. If you are a writer, you can contribute to each issue. If you are not a writer, there are many freelance writers continually seeking a venue for their talents. If you are not a proofreader, you can always hire an editor to perform this task.

You may be wondering what on earth you will be doing if all these other tasks are being handled by specialists. Well, one thing is to continually contact printers to be certain you are obtaining competitive prices. Particularly during today’s economy, you should be able to negotiate substantial savings.

Another thing you need to aggressively pursue is the sale of advertising. If your publication is subscription based, advertising is less important. But, if you rely upon advertising to cover fixed and variable costs, the amount of advertising sold will dictate the size and quality content of each issue.

One added bonus that is not readily apparent is the ability to “give away space” for public service, community affairs and most important of all – barter. With regard to public service and community affairs, there are some obvious cases like The American Cancer Society, The American Heart Association, a local youth center, announcements of public meetings, etc. But there are also less obvious ways to donate your unsold space such as fundraising for victims of a neighborhood fire, soliciting donations for half way houses, homeless shelters, etc. This is called “giving back to the community.”

Now for the fun part. I have been bartering my business consulting services for 30 years. During this time, I have received tens of thousands of dollars in goods and services over 3 decades. As a publisher, you wield great power to exchange space in your publication for tangible goods and services. This allows you to lower your overhead or variable costs (as in the case of printing) or increase your standard of living (as in free meals, hotels, trips, theater and sports tickets, furniture, jewelry, etc.)

Are you beginning to get the picture yet? There is also one additional benefit. When you are ready to sell your business, all the benefits I mentioned above will be easy to explain to a prospective buyer. After all, he or she will want to see their name in print. And who knows, they may want to see a picture of themselves as well!

Service companies are high on the list of businesses I like to sell. Some can be capital intensive, like a limousine company with many vehicles. Others may have very little hard assets, like a business coaching service. They can have recurring revenue like alarm monitoring services, exterminating services, landscaping services, home cleaning services, etc. And, some may use independent contractors or employees.

If you are looking to buy a service business, here is some useful information to consider when determining which type of service business would best suit you.

With a limousine service, you normally have 3 ways to acquire vehicles. You can pay all cash, which is highly unlikely. You can finance. Or you can lease. A limousine service can specialize or be a general provider. If it specializes, it might just provide airport service from hotels, businesses, residences or pickup/drop off points to the airport and back. If it is full service, it may handle weddings, proms, bachelor and bachelorette parties, executive service, etc.

The important thing to remember is that the use of a limousine service is very discretionary. People do not need limousines. They want limousines for special situations or occasions. If the economy changes to the downside, the revenues of limousine companies can decrease. With an exterminating company, the service is also discretionary because a consumer or business can provide the service for themselves. But typically, an outside service is used for convenience.

With an alarm monitoring service, the service is typically not discretionary because the consumer or business owner wants to be protected. But, because the industry is very competitive with many choices and plans, the business is very price sensitive. And, there are many kinds of service offerings within this one category. You can have passive monitoring using telephone lines, or you can have cellular, cable, voip or interactive monitoring.

With a landscaping business, there is a more equal combination of equipment and labor necessary to handle customer needs. The normal equipment would include lawnmowers, edgers, trimmers and one or more vehicles and carriers for the mowers. Manual labor is a very large component of this type of business and therefore, supervision is of great importance.

With a home cleaning service, you have cleaning supplies, vacuum cleaners, etc. and one or more vehicles. This business is also very labor intensive and requires a high level of quality control to retain customers. A painting company can either use employees or independent contractors or a combination of both. Here also, quality control is critical for customer referrals and repeat business.

With a business coaching service, it is critical that the owner is not the business. Since buyers want to feel confident and comfortable that customers will not leave when the business changes hands, the owner must create a full organization and not have the business dependent on just him or her. There are other things that must be done, but that will be the subject of another blog!

Author’s note: After helping sellers and buyers for more than 20 years, I have found that honesty, integrity, full disclosure, patience and a willingness to consider various alternatives makes the probability of success for all parties very high.