Buying A Small Business

Introduction

This case focuses on entrepreneurship and more precisely delves into various aspects related to buying an existing small business. Like many people, David always wanted to be an entrepreneur. With this aim he pursued studies in entrepreneurship at Thompson Rivers University. His studies provided him with insights into the intricacies of starting a new venture. His work experience in different sales jobs gave him some practical skills that are needed to run a business. He has also learnt from his own experience that to be a successful entrepreneur one needs to be reasonably financially stable and must have a thorough knowledge of the industry he is entering. With this realization, David started working immediately after his graduation. After working at a couple of jobs in different industries, he finally landed a position as an assistant store manager in a reputable national retail store chain.

He worked there for a decade, gained substantial experience in running a retail businesses and saved a decent amount of money.  Though he was quite successful in his job, he never gave up on his dream of owning his own business. When he decided it was time to become an entrepreneur, he found himself facing the decision every new entrepreneur faces: should he start a new business himself or should he buy an existing business?

Analysis

Many people have entrepreneurial ambitions.  Many jump into their ‘dream’ venture without having a clear plan of how to go about their businesses. In many cases, entrepreneurs base their decision to start a business more on their emotional attachment to their business idea than the cold realities of the market place. Many also suffer from selective perception – they will listen and register all the good points about the business they want to start but will not hear or pay attention to the weaknesses of the business or business idea.  This is the reason why many first time entrepreneurs fail to realize their dream.

When people have entrepreneurial ambitions, it helps if they discuss their ideas with someone who is in a position to give unbiased advice. Many entrepreneurs discuss such ideas with family members which has some advantages but also many disadvantages.  The advantage is that an entrepreneur can get moral and sometimes financial support from a family member.  The disadvantage is that in many cases family members try to argue against such an idea, especially when an entrepreneur wants to leave a comfortable and secure job to start a business.

A better option is to find a mentor. In this case, luckily for David, John, his supervisor, fit the bill well. Initially, John felt that David had an excellent future in the company and advised him to continue in the job. However, after careful consideration of all factors and seeing David’s strong resolve, he became his mentor. Any new entrepreneur needs his mentor to be experienced and, more importantly, willing to act as a ‘Devil’s advocate.’ A mentor who can think outside the box can be of an immense value to an entrepreneur.

The more research an entrepreneur conducts into his business idea and the more information the entrepreneur gathers from different sources, the better the decision he will make. David did well to collect as much information as possible from different sources. Now, his is facing his first decision: should he start a new business from scratch or buy an existing business? The answer to this question is not simple and depends on many factors, such as the industry, market, customers, and products.

The Search

The most important issue is searching for a suitable company to buy. When a business is for sale, the first thing the buyer has to find out is why is the business being sold? This process is known as ‘due diligence.’ Many a time, sellers say that the business is a profitable one but there can be many hidden issues. For example, there may be pending litigation against the business. Although the seller may be confident that the litigation will be decided in the businesses’ favor, the decision  may go the other way with disastrous consequences for the business. An honest seller will tell you up front, but not everyone is honest. Remember the caveat ‘Buyer, Beware.’  The search for a business is a full time job in itself.

A Potential Business

David has found a business for sale that might be a good candidate. The details of the business are discussed thoroughly below. You will need this background information to answer the case study questions which will help you gain a greater understanding of the complexity of buying a business.

Background

It was a chilly winter night with temperatures reaching – 20 at 9:00pm on January 10, 2015. Robert was standing in front of his store Grimaldi Grocers. After closing the store for the day, he looked up at the glowing store sign with satisfaction and pride, just as any parent looks at their well settled children. This was a ritual Robert had followed every day for the past two decades, 21 years to be more precise. Whenever he looked at the store, a pleasant feeling passed over him as he recalled the store’s humble beginnings, its growth, and the ups and downs in the initial years. However, during the past two months he had something pressing on his mind – Grimaldi’s future. His emotional attachment with the store was so great that Robert wanted the store to be part of his family forever, but he knew that it may not be possible. Being a pragmatic person, Robert wondered about the future management of the store.

The Entrepreneur

Robert’s parents immigrated to Canada from Italy in the 1950s. Robert’s father was a farmer who chose to settle down in Kamloops. Robert was born and raised in Kamloops, a small yet beautiful community located along the banks of the majestic and beautiful twin Thompson rivers. His family consisted of his father, mother, and a brother. After graduating from North Kamloops High School in 1989, Robert enrolled himself in the BBA Program at Thompson Rivers University. Robert knew that in order to support his education he needed to take up a part-time job. After working a couple of odd jobs, Robert landed a position at the Canadian retail chain, Safeway. Working at Safeway suited him in many ways. Firstly, the hours were flexible and he could easily arrange his work based on his university routine. Secondly, it helped him to develop many skills, the most important one being people skills. Thirdly, the pay was sufficient for his current needs. Robert was making $12.65 per hour initially and by the time he left the job a few years later, he was earning $21.00 per hour. During summer vacation, he could work full time.

While at Safeway, Robert learned the intricacies of running a retail store, which Robert believes has influenced his success as a business owner. The job at Safeway not only helped Robert to pay for his tuition at university but also provided him with adequate savings for future business endeavors. Robert, being the elder son of immigrants from a humble financial background, was very frugal in his lifestyle and made saving a habit right from an early age. By 1994, Robert had not only graduated from TRU with a BBA, but also had savings upwards of $150,000.

It was during this period that Robert considered opening his own retail business and began looking for opportunities. From his research, he soon discovered that there are two types of retail stores in Kamloops: 1) large stores (e.g. the Real Canadian Super Store, Safeway, Save on Foods) and, 2) small street corner convenience stores. He was not sure if he wanted to open a conventional convenience store or an already established franchise. Around this time, Robert attended a social gathering of Europeans where he came across an interesting discussion. A group of women were discussing the difficulties in finding authentic European cheeses and olive oils in Kamloops. This was when Robert got the idea for his business: a specialty store for European grocery and food items.

The Strategy

Right from the beginning, Robert was clear about the growth strategies he wanted to pursue. The growth strategy of a firm is all about deciding the level to which the entrepreneur wants to grow his business. All firms adopt one of the following four generic strategies:

  1. Life style firms: These are normally part-time businesses with sales less than $25,000 and are started by the entrepreneur to supplement his other income. Nearly 50% of small businesses fall into this category.
  2. Traditional small businesses: These are full-time businesses that account for 22% of small businesses and have sales in the range of $25,000 to $100, 000. These kinds of businesses provide livelihood for the owners.
  3. High performing small businesses: These businesses have sales ranging from $100,000 to $1,000,000 and growth rates between 5 to 10% a year.
  4. High Growth Ventures: By far these types of firms are very few, normally around 5% of all small businesses (Katz & Green, 2012).

While Robert aimed at creating a traditional small business, it eventually developed into a high-performing small business.

The Business

Once Robert realized his business idea, he developed a business plan as the capstone project for his BBA. He tried to visualize the investment involved and make some projections about sales. Looking back now, after all these years, Robert recognizes that this effort to create a business plan certainly helped structure his approach. Another important step that helped Robert was his market research. He met owners of other specialty stores like the Indian stores on the North Shore and received valuable information from such meetings. There were many similarities between these stores and the one he planned to open, including the size of the customer population; both these communities have nearly 2,000 households in Kamloops. The Indian community is concentrated in the northern part of Kamloops; where as the European community is concentrated downtown. Robert also learned that both communities, especially immigrants and first generation Canadians, crave their respective ethnic foods. The larger stores offered a few items, but customers were not satisfied with them. The normal practice, at least for Indian families, was to buy foods in bulk from Surrey or Vancouver. Robert expected similar feedback from European Canadians too and his interviews with some Italians and other Europeans proved him to be right. From this data, he could forecast the expected sales in his business’ initial years. Robert began interacting with the European community extensively and, from these conversations, he developed a list of items that Europeans prefer.

The next piece of the puzzle was to determine the best suppliers for these foods. Robert had two options: 1) to import the items directly from Europe or, 2) buy them from suppliers in Vancouver. He could import high quality products from Europe but it would be prohibitively expensive to import the small quantities he needed. Hence, he decided to procure these items from suppliers in Vancouver and then attain those items that were not available in B.C. from Europe.

Next, Robert had to make two important decisions: 1) the location and, 2) financing for the new venture.

The Location

From his research, Robert learned that for businesses such as retail stores and restaurants the single most important factor for success is location. He recalled his new venture creation instructor who never got tired of saying “Location, Location and Location.” His market research revealed that a majority of the European population lived in and around downtown Kamloops so he decided to open a store in downtown Kamloops. The only hitch was that the downtown commercial space was very expensive. He needed a small place initially, but with a possibility to expand later, if business picked up. Also he needed sufficient parking space on the road or pay parking close by. This requirement proved to be a difficult one to meet. Many places that were available were not suitable for a store or if suitable they were very expensive. Fortunately, he came across a space available on Victoria Street. The property was owned by a group of 8 people jointly who were willing to lease the space on a long term basis. Further, the neighboring property was leased to another firm and was likely to be available in couple of years once their lease period was over. This seemed to be the closest Robert could get in terms of a desired location. Robert signed a lease agreement with the owners in January 1994.

The Financing

When it came to financing the new venture, the estimates Robert made in his informal business plan came in handy. He needed capital of $170,000 to make the store operational while keeping a reserve of 3 months working capital. Over a period of 12 years, he had saved $150,000 and thus needed only another $20,000. Family and friends promised help, as and when needed.

The Life Cycle – Introduction and Growth

That is how ‘Grimaldi Grocers” was born and opened its doors for business in 1994. Robert registered the store as a limited liability company. The store started with one employee and Robert’s father promised to help whenever needed as an additional hand. The items offered for sale were mainly of European flavor, like the olive oil, specialty cheeses, and pasta.

In the initial introductory years 1994 – 1997, the going was quite tough. Though Robert was very realistic in his projection of sales, he soon realized it was becoming difficult to reach those numbers. The first three years did not see much profit. Fortunately, Robert was able to break even and thus survive the initial growing pains. Conservatively, Robert made the decision to continue working at Safeway. This was hard work, but the strategy paid off in later years. Robert realized that in order for the store to succeed it must have a European flavor but must also cater to the needs of other communities in Kamloops. He started expanding the range of items that were offered to include products like meat and milk. Towards the end of the third year Robert started seeing the proverbial light at the end of the tunnel in the form of some decent profit.

In the initial years, Robert’s marketing and promotion campaign was mainly based on print media and radio. Though the advertising helped in creating awareness about the store and developing its branding, it did not contribute in a big way to the store’s bottom line. Robert realized that it was actually word-of-mouth that was bringing in new customers. Consequently, he started concentrating on customer relations activities aimed at retaining the existing customers and attracting new customers. Robert understood that promotional material like cotton bags with the store’s name and logo helped as well. By providing better personal service to his customers he was creating a positive image of the store in the public’s mind.

As it stands today Robert has 15 bulk suppliers from Vancouver, 15 Canadian suppliers and five suppliers of specialty items from Europe. Most of the cheese is imported directly from European suppliers; meat and milk is imported from Canadian suppliers; fruits, vegetables and other produce are from the US; and dry items like olive oil and pasta are imported from Italy.

The store entered a growth phase in 2007 and continued to grow until 2008. The growth during this period was phenomenal and the store started attracting domestic customers as well. During this period Robert concentrated on reducing waste with the eventual aim of achieving zero wastage. This is the same time that Robert introduced value added products like ready to eat European soups, meals and salads. This new addition was a success from the start and contributed 10% in the first year, growing to 25 to 30% of sales in just a few years. The location of the store, which was surrounded by many offices, also contributed positively towards the store’s growth. In the winter, soups and lasagna became very popular items and in the summer soups and salads were the meal of choice.

Robert, after having worked at Safeway for more than a decade, understood the needs and aspirations of employees well and practiced what he had learned. The store started with one employee in 1994 and by 2000 had 10 employees. The very fact that the first employee, who is 72 years old now, is still working for the store is a testimony to Robert’s human resource practices. Robert attributes the store’s success to the highly motivated employees. However, in 2000 technology started affecting small business practices and efficiency and, as a result of Robert’s adoption of automation, the number of employees fell to 6, though this number varies from year to year.

Another important development that occurred was a change in property ownership. Some of the property owners wanted to sell their shares. Robert bought the shares of 6 of the owners between 2008 and 2012. Currently, Robert owns the property along with two of the original owners.

Hungry for more knowledge, Robert enrolled in the MBA program offered at Thompson Rivers University. While attending school, Robert’s brother and father helped maintain the store. Robert performed well in the MBA program. After graduating, Robert started teaching as a sessional lecturer at the university which included instructing TRU’s program offered in Chandigarh, India. Robert shared his experiences with students and became a popular teacher at TRU. He enjoyed teaching in the classroom and appreciated the opportunity it provided to motivate young, aspiring entrepreneurs.

Last but not least, Robert believed the civic responsibilities he undertook had played a major role in developing his brand image and contributed to the success of Grimaldi Grocers. The store supported local fundraisers for charities, cancer runs, diabetes camps, Boogie the Bridge, and TRUSU clubs. His participation in Italian cultural committees and sport teams also helped to create a positive brand over the years.

In 2010, the store entered into a mature phase. The sales were still growing but at a much lower rate. The profits were still growing but less than 10% on a year to year basis. The financial performance of the store during the last 5 years is provided below:

GG Performance Data

 

 

The Choices

Buying an Existing Business

Advantages

  • Benefit from the existing brand
  • Captive customers and relationships
  • Processes in place
  • Can count on sales and profits from day one
  • Much easier to convince potential investors
  • Risk is much less when you buy a successful business
  • You are also buying relationships with suppliers, customers
  • You can take off from day one
  • Cost of setting up can be very low, as most often you are likely to get existing infrastructure at a deeply discounted rate
  • Easier to get new business through cold calls
  • You have a readymade team, with trained employees
  • Easier to convince banks for line of credit arrangements
  • Buyer may be able to negotiate an attractive price for stock
  • Non-Competition from seller

Disadvantages

  • Sometimes, if the image is poor, the brand can be a burden instead of being an advantage
  • Business model may not fit into your ideas
  • Larger initial investment
  • Inherit ‘not so good’ things also
  • Suppliers may not be good
  • You may like to have a new set of suppliers
  • This partially can be offset by outdated technology and equipment
  • Some of them may not be people you want
  • Getting rid of employees can be difficult
  • But banks normally wants the credit terms renegotiated
  • Liabilities, debts, litigation at the time of buying can be tricky and in most cases expensive
  • A few employees can become competitors

Starting Your Own Business

Advantages

  • Start with a clean slate
  • Much cheaper to start a new business than acquiring an existing business
  • No burden from past reputation and history
  • Can develop a new niche in the market
  • Can develop a team of your choice
  • If you wish to trade under a different name it is better to start your own new venture
  • Can develop a detailed business plan (blueprint)
  • Can have state of the art equipment and technology that can reduce operating costs

Disadvantages

  • May have a long gestation period to become profitable
  • Startups are normally not expected to make money for the first three years
  • High rate of failure for new businesses
  • Getting investors (financing) can be very difficult
  • Business risks of starting a new business are very high
  • You need to develop relationships from scratch; relationships are not built in day

This issue requires very serious consideration. Outright purchase gives David full control of the business. On the other hand, this also results in a large financial outflow and places the entire risk on David.

Joining as partner might not give David full freedom to plan and grow the business the way he wants.  Partnership comes with some legal obligations too. Each partner is bound by the other partner’s actions.  The role each partner would play, unless made explicit with a contract, could lead to other problems.

Robert is known as a very honest man in the community and has a great standing and hence David may not worry in this case. In fact Robert can be a valuable asset, because of his long and time-tested relationships with suppliers and customers.  Their expertise and knowledge can complement each other. David can supervise the business growth while Robert can take care of the logistics.

However, buyers must know here that this is a very complicated decision that only the buyer can make. There are many examples of failed partnerships. The buyer must be very careful.

Every buyer will face this situation. Buyers want to buy the business as cheaply as possible while the sellers want to maximize their gains. This is the place where the negotiation skills of the buyer are put to the test. Offering too low a price will not elicit any response from the seller. If the sale is a distress sale, the seller may agree to an unusually low price, but not in normal circumstances.  The buyer and seller must be able to meet each other halfway. If the seller is not willing to compromise on his sale price, and if the buyer feels that it is too high, the buyer must withdraw after making his final bid.

No prudent buyer should get emotional and increase their offer, solely with the aim of getting the business they want. The offer must be based on numbers not emotions.

In this case, David might offer up to $400,000 and no more.

The buyer has to crunch the numbers and see if the business is profitable at this price.

Use Microsoft Excel and find the answer for this question.

Question four

The buyer can work out the profit for the other years, first assessing the sales.

The buyer can also change the amounts of the down payment ($100,000 or $200,000 for example) and the loan ($400,000 or $300,000 for example) and see the implications of his choice of financing and his decision to pay $500,000. Working out the various permutations and combinations will provide different perspectives to the buyer.

The buyer must use Microsoft Excel and find the answer to this question. We advise the buyer should also adjust these percentages to 5%, 15%, and 20% and compare the results.

Question 5

The buyer must use Microsoft Excel to find the answer for this question. We advise the buyer should also adjust these percentages to 5%, 15%, and 20% and compare the results.

Question six

The buyer must use Microsoft Excel to find the answer to this question. In this case, David will only be investing $250,000. He could use $125,000 of his own savings and borrow $125,000 from bank. The profit he is likely to receive will also be 50%.

Question 7

The buyer must use Microsoft Excel to find the answer to this question.

Question 9

The buyer must use Microsoft Excel to find the answer to this question.

Question 10

Profit reduced by 20% is  = $22,284

Net Profit is reduced to $89,136

David in that case will only be making $39,136 for the year 2015.

 

References:

  1. Katz, J. & Green, R. ( 2012), Entrepreneurial Small Business, 3rd ed. McGraw-Hill Irvin, pp 641.
  2. www.canadone.com, (2014), Valuation Formulas, The Income method, Retrieved on 30 March 2015 from http://www.canadaone.com/tools/buy_a_biz/section2f.html
  3. Interviews with Robert
  4. Interviews with Krishna.
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