Buying a business

kdowling

I'm looking to buy a business which is averaging a net profit of €50,000 over the last few years for €250,000.
I would like to get out a loan for €200,000 and pay €50,000 deposit.

On the €200,000 at 6% interest over 20 years I calculate that I would be
repaying €21,500 a year.
If I use €40,000 of the net profit (leaving €10,000 for cash flow) to pay the loan after income tax is taken off leaves approx €20,000 (higher rate of tax)
which would cover most of the loan.

If I manage to increase the net profit to €60,000 yearly and sell the business
in 5 years time for 5 times the net profit (industry standard) I can sell it for €300,000 at which time I would have €100,000 paid off the loan leaving €150,000 owed. €300,000-€150,000=€150,000 profit
Minus capital gains tax @25% = €112,500 profit

Is all this feasible?
Do banks give out business loans over 20 years?
Am I working out the correct interest repayments?
Is there anything other than capital gains tax on the sale of a business?
Does the sale come under income tax?
Is there any way the loan can be a business loan where some of
the net profit can be used to make the repayments directly
without being subjected to income tax first?

Sorry for all the questions, but any help would be appreciated.

kennyb3

Sorry i dont mean to be critical but sounds like your way way over simplfying - its like a form of junior economics your using.

What if analysis!

1 - what if you makes a loss? how do you repay the loan then?

2 - what make you think you can run the business 50% better than the current owners? Is it not more likely that existing customers may leave with a change in management?

3 - what if taxes go up? Especially CGT which could be 40% in no time.

I wont go on and on but its not just a case of taking one years profit and multplying it by a multiple. what assets has the business got? What is its trading history and market sector?

Id suggest doing a lot of research and then engaging a professional.

SGKM

You’re kind of half way there…

Firstly, what industry is it in? Where are you getting the 5x valuation from? Generally in Mergers and Acquisitions, businesses are valued at a multiple of Earnings Before Interest, Taxation, Depreciation and Amortisation (EBITDA). Different businesses in different industries are valued on different multiples based on different factors, primarily growth potential, but also profit margins, cash conversion, brand, etc… For example, a tech company with high potential earnings (think year 2000 dot com and Facebook generation today) will trade at far high multiples of EBITDA than say a steady food distributor.

You say that the business is making a 20% net margin already which seems high but without knowing the industry, is hard to gauge. What capital expenditure is required in the business over then next X years? What potential synergies can you bring which will increase net profit by 20%?

You’re essentially trying to do a leveraged buy out, exactly what private equity firms did over the last few years with cheap debt – buy it, strip it and flog it. With regard to debt, I know that for bigger transactions banks are only agreeing to fund c. 3x EBITDA and that is with established multi million trade businesses. Will they fund you? I don’t really know enough about your situation to answer that but in theory you could potentially get c. €150k, maybe more of debt into the business if you know what you’re doing.

On length of time, banks will generally look to be repaid in c. 5 years for a loan of this type.

Banks will also charge you a lower margin if you have a lower Net Debt to EBITDA ratio as the less debt in the business, the less risk for them. So if you start at 3x and by next year things aren’t going as well as u you hoped, and your Net Debt to EBITDA increases to 3.3x, you’ll be charged a higher margin – its called banking covenants.

Interest is tax deductable – so you write if off against your tax bill, hence one of the reasons businesses are valued on EBITDA multiples and not Net Income.

I don’t work in tax so I wouldn’t be able to offer any proper guidance there but generally the sale of a business is taxed at a capital gain rate.

My advice would be firstly to build a proper model in excel to value the business based on various changeable assumptions which will give you different valuation outputs now and in 5 years. And secondly to get someone who knows what their doing to help you here as there are many places to slip up in an M&A transaction, especially if you don’t carry out sufficient due diligence.

EamonOSullivan

With all due respects to you, you cannot go out a buy a business like the one that you've constructed on an excel spreadsheet - it just doesnt work like that. SGKM has very sound advice for if and when you do find a business to buy.

kdowling

Thanks a million for your replys.
They were extremely helpful.
The business is a pharmacy. They used to be
valued at 8 times the adjusted net profits
but are now being sold for 5 times the adjusted net profits.