Buy a Great Business at a Discount

The proven business buying strategies of Warren Buffett made simple for all entrepreneurs

Q.  We have an opportunity to buy a wine and coffee shop. We think this is a safe investment because commercial property values and public interest in wines are soaring. The total purchase price is $750,000 including the building, appliances, furniture and wine inventory. How can we raise the last $100,000 from investors in a hurry so we can swing this? Any suggestions welcome.

A.  When it comes to buying businesses there is no better guru than Warren Buffett. His investment and business management track record is impressive. In over 35 years as Chairman and CEO of Berkshire Hathaway, the company has steadily grown its market value by a compound growth rate of over 25% per year. No other company or buy-out fund approaches this extraordinary achievement.

What can we all learn from Warren Buffett? First and foremost, he doesn't buy on sentiment. Yes, it's easy to be passionate about wine and coffee, but when buying businesses it's more important to be a dispassionate, skeptical number-cruncher. Your brain must rule the buying decision, not your heart or in this case your taste buds.

Buffett is also known for his disciplined approach to measuring value. He favors businesses that are profitable and generate high cash flow that in turn can be used to buy even more super cash generating businesses. It's a remarkable cash-building cycle of success.

If your target wine and coffee business isn't profitable today and you do not previously have experience turning around a retail operation, it's probably best to wait for a better, less risky acquisition. Buffett would probably want me to emphasize this point further. You'll lose less money by waiting for a more lucrative opportunity.

Buffett also likes to invest in well-managed companies with broad-based consumer demand, (insurance, razor blades, candy, etc.). And as a final point of guidance, Buffett buys bargains. He doesn't like to open his wallet unless he is buying below a company's asset or market value. It's a cushion to offset unexpected financial needs or yet another way he delivers upside to Berkshire Hathaway investors.

I must admit, what you describe sounds a little speculative. Yes, there may be some long-term upside in owning a building and some cases of reserve wine. However, the more relevant test is if the retail business of buying and selling coffee and wine can generate considerable cash every single year you own the business. What you ultimately sell the building and company for should be an extra bonus, not the total reward. Buffett buys businesses that he is happy to own in up markets and down markets. You can too.

I am sympathetic to your entrepreneurial eagerness to just get going. But, at any price?

Many first time business buyers want to own a business so badly they skip the tire kicking process (called "due diligence" by professional investors), ignore warnings from knowledgeable advisors and never challenge the purchase price. They assume that they can fix nagging pre-sale issues after they own the business without ever really thinking through the kinds of problems they are prepared to handle. This is how successful business buyers become unsuccessful business owners.

If you want investors to help you buy this business, you first have to do some homework. Investors will ask tough questions about (i) the strength of the base business and (ii) if the purchase price is low enough to give all investors and owners room to make good money. If investors ask too many unanswered questions, they will assume new management (you) are not capable of buying a business successfully. Investors back management teams that "look at the numbers" just as much as they do.

Ok, let's get down to it. As a former investment banker and buyout fund investor, most companies are put up for sale at a price that exceeds its true value. To determine the right number, start by verifying the value of the building and inventory.

Pay considerable attention to inventory value and turnover rates because the information can provide meaningful clues to business health. Ask for an inventory report including original purchase prices, purchase dates and how the owner values the inventory today. Most goods should be valued at original cost, but the owner may seek to boost the company's purchase price by raising wine values to some loose estimate of "market" value.

Also investigate if the inventory is in good, salable condition. How was the wine stored over the years? Are any cartons or bottles damaged? Did you count all the bottles and cases to make sure all the stated inventory is really there? As you go through your investigation, consider every problem as an opportunity to lower the purchase price.

Accountants who audit financial statements typically discount inventory that has not been sold within 12 months of purchase. But wine can be tricky. Be wary if inventory has been sold at prices below original cost or if there is too much of any single type of product. Here you don't want to buy other peoples' mistakes. If there is no market for any of the wine or coffee, don't buy it. Let the owner keep all merchandize that you can't sell at a profit. No exceptions!

Your next area of investigation is the business itself. Look at the company's monthly and annual results during the last 3 years. Have revenues and profits grown every year? Ask what causes monthly revenue fluctuations. Ask to sit in the store for several days to monitor customer traffic. What and why do customers buy? Can customers buy the same merchandise in Publix, Kroger, Safeway or Costco? What will it take to improve the business? What will it cost to do it?

Now here's the acid test. Can you put together a similar retail shop for less than $750,000, preferably without a real estate purchase? Remember, if you finance a business purchase with variable interest debt, as interest rates rise (and they will), the cash cost of buying and operating the business also rises.

Take Command Action Step

Researching a business acquisition involves many more considerations than this column can reasonably cover. Visit http://www.takecommand.org/special_main.htm for a free list of due diligence considerations for ambitious business buying entrepreneurs. You can buy the business of your dreams without overpaying. You can do it!

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