Even though the future is uncertain, this might be a good time for business owners to expand by purchasing another business, or for employees who have been laid off or downsized to think about becoming entrepreneurs.
“There is a natural selection process going on,” said Ron Chernak, president of business brokerage The FBB Group. “A lot of businesses have been fully vetted by the economy, while the weak businesses are probably gone or will be gone shortly.”
That means potential buyers are likely to find well-managed, profitable businesses on the market.
In addition, Chernak said, capital is available for qualified borrowers.
“There is a lot of money available from lenders and private equity money, and interest rates are historically low,” he said.
With favorable conditions in place, Chernak and other local experts said it’s important for potential buyers to make sure the business is the right one by doing due diligence, finding the right sources of financing and accessing available resources to maximize a successful transaction.
FINDING THE RIGHT MATCH
With the economy uncertain and the election looming, some potential buyers are sitting on the sidelines unless they have a strong reason to buy.
“It is a different market now,” Chernak said. “There is still good demand for businesses, and there are somewhat fewer businesses on the market. But it is still a robust market.”
Chernak said his firm currently has a transaction under contract with a buyer who had bought a business from The FBB Group several years ago.
“He owns a couple other businesses, and he is looking to expand his ownership into other companies,” Chernak said. “So he is buying a well-managed, very profitable construction-related business.”
The buyer is picking up the business at a fair price with “extremely good financing,” Chernak said. He is probably going to obtain a 10-year Small Business Administration 7(a) loan at 4.5 percent. The transaction also involves real estate, which is being financed conventionally with a low interest rate. Rates currently are sitting at about 3.8 percent, he said.
Another buyer with whom Chernak has dealt had worked for a large
“His position was downsized, but he received a significant separation package,” Chernak said. He bought an 80-year-old business whose owner was retiring.
“The buyer really knew the business, and the lender was comfortable that this business would continue forward and do well,” Chernak said.
This buyer benefited from CARES Act incentives that provided for six months of forgiveness of principal and interest payments.
“That program has expired, but there is discussion about a revamping of that type of incentive if we can get agreement with Congress on the next incentive package, if there is one,” Chernak said. (President Trump broke off negotiations with Congress on a new stimulus package earlier this week.)
In valuing businesses for sale, Chernak said, lenders are looking at long-term track records.
In some cases, he said, “there might be a gap where revenue declined for a couple months before the economy opened up again and people understood how to do business in the current environment. … Some lenders are saying, ‘OK, if you can show to me that your future revenue stream is not going to be negatively impacted by the COVID environment, we’re going to value your business the same way we would have valued it previously.’”
“It’s always a good time to start a business, as long as you’re solving a problem that needs to be solved,” said Robin Roberts, president and CEO of Pikes Peak National Bank.
From a lender’s point of view, “it is still a good time to buy a business, but the type of business being purchased may require a bit more scrutiny,” she said.
“Banks are still providing financing for acquisition and/or expansion but they are certainly looking at the impact of the pandemic on the business itself, or industry, and the business owners personally,” Roberts said.
For businesses and industries that have fared well, funding opportunities have not changed, she said. But for industries such as restaurants, retail and office properties severely impacted by the pandemic, “we can expect tightening credit standards as banks work through their existing portfolios and customers.”
Banks already have many of these types of businesses in their portfolios, Roberts said.
“Some borrowers are not going to make it through, and bankers have to work through those situations before they’re going to want to make loans in those industries.”
Banks are looking closely at the management teams of businesses that want to expand through acquisition. Those already in business have an advantage because of their experience.
First-time entrepreneurs need to show that they have knowledge of the industry they’re looking to buy into and that the management team brings appropriate knowledge and experience.
“People who want to start a restaurant because they love to cook — well, that’s not running a business,” Roberts said.
“There’s a section of every business plan that covers the management team,” she said. “People kind of brush over that, thinking that it’s not that important. It’s a really important part of the business plan, and banks look at it.”
Lenders look closely at two other things: the ability of a purchased business to generate enough cash flow to cover the loan payments, and the ability of the business owner to support the business if it can’t.
“The lender will ask for tax returns and financial statements from the business owner as well as financial records for the business being purchased,” Roberts said. Banks will want to see historical financial records on the business for at least the past three years.
“If significant changes will be made in the operation of the purchased business, the borrower should provide a short business plan that details the changes and their effect on the ongoing revenues,” she said. “In theory, those changes should improve cash flow and make the business more efficient.”
CONSIDERATIONS FOR BUYERS
Besides satisfying the requirements of a lender and accurately assessing their financial capabilities, individual buyers — and their family members if they will be involved — need to be committed to the buying process.
“There’s some work involved in finding the right business that is going to work for them,” Chernak said. “It doesn’t happen overnight.”
It’s also crucial for buyers to do their homework — “talking to people in the industry, getting on the internet, doing some research as far as types of businesses that may be available, and what fits the buyer’s personality and geographic location,” he said.
There are other, nonfinancial considerations as well, especially for owners who are acquiring another business, said George Russo, Colorado Springs regional director at Employers Council.
“Is it going to be separate from your current business, or is it going to be merged with your current business?” Russo said. “Depending on that question, there’s a lot of questions that would follow.”
For example, the new owner must determine how to reconcile different cultures if the two companies are going to be merged.
“Whose culture is going to win out, and how are you going to make sure that whoever’s culture doesn’t win out, they still feel welcome in that new company?” he said. “That’s one thing that companies should be thinking about, pretty early on in the process.”
Buyers also need to be aware that the new company’s increased size may subject it to employment laws that weren’t applicable before, such as the federal Family and Medical Leave Act. The act, which became law in 1993, entitles eligible employees of covered companies (those with 50 or more employees) to take unpaid leave for specific family and medical reasons, including the birth of a child or caring for a relative with a serious health condition, while retaining group health insurance coverage.
A company with a base of 30 employees that adds 30 more employees through an acquisition would find itself subject to the FMLA and other laws such as the Americans with Disabilities Act.
Potential buyers also should consider potential liabilities that could be acquired along with the new company.
“For example, if the company being acquired wasn’t paying overtime, the acquiring company could be on the hook for that overtime,” Russo said. “Another example of that is, are they defending an [Equal Employment Opportunity Commission] charge of discrimination? If so, is the acquiring company going to have to take over that defect?”
The U.S. Department of Labor does not want employers to avoid liability by starting a new corporation or renaming a company, he said.
“The DOL has a test to figure out whether or not someone should be liable for those wage and hour or overtime violations,” Russo said.
Purchasers also need to be aware of state labor laws, including two new acts that will take effect Jan. 1.
The Healthy Families and Workplaces Act, Colorado’s paid sick leave law, will require employers with 16 or more employees to provide one hour of sick leave for every 30 hours of work.
The Equal Pay for Equal Work Act will prohibit wage discrimination on the basis of sex, including gender identity.
Employers Council provides its members with classes on leadership, diversity and inclusion, and trust in the workplace, as well as coaching services and organizational development programs customized to support leadership teams.
RESOURCES FOR BUYERS
Buyers need to have strong financial and marketing plans in place for their new businesses, a valuation that shows there is a good customer base and a solid plan to continue the new business’ growth, said Aikta Marcoulier, executive director of the Pikes Peak Small Business Development Center.
“Business model changes to respond to the changing needs of delivery and service during a pandemic are also important,” Marcoulier said.
Owners also should not neglect a cybersecurity plan “to ensure the business stays resilient in an environment that has increased cyber attacks, scams and threats,” she said.
The SBDC offers information and resources to help businesses develop their business plans.
“We provide free business valuation through our consultant and partners at The FBB Group,” Marcoulier said.
The SBDC also helps potential buyers with financial and business planning based on market research and industry benchmarking, as well as disaster preparedness and recovery and success after a disaster.
Other resources include SizeUp COS, a tool offered by the Colorado Springs Chamber & EDC.
“SizeUp is a great market research tool that can help a business in its startup phase and growth phase,” Marcoulier said. “Coupled with our IBISWorld data reports, the business will have the market research and industry benchmarks it needs to produce a solid financial and business plan.”
For a brick-and-mortar startup, “COSOpenforBiz.com is a great resource,” she said. COSOpenforBiz walks entrepreneurs step by step from idea to opening.
Additional resources include the Pikes Peak Library District’s extensive collection of databases and information.