New Venture Lab: Equipping Christian Entrepreneurs

Question

I am negotiating to buy a retail business and would like your advice.  I’ve listened to your “Before You Launch Your Business” presentation -- which was very good -- but I’d like some help thinking through buying this business.   The business is a boutique in an upscale part of town that has a very loyal customer base.  The owner has relocated out of state and is desperate to sell the business, which is currently being run temporarily by his aged father.  I actually know the business fairly well because I sold to the business for years as a manufacturer’s sales rep.  It was one of my best retailers and every time I visited their store, I could see their focus on customer service.  (I am no longer with the manufacturer and I have been looking for what to do next.) The price the buyer is asking sounds like a fair price and I think I could really ramp up the store volume and earnings, but I am not sure what to do next to really make sure this is a good deal.  I am a hands-on learner and one of my friends suggested that I work in the store for a while to check it out.  Also, the store has a lease that is way over-priced in my opinion that will reach the end of its term in December, so I would most likely want to wait until then to buy the business.  The store is not very profitable and I think part of the problem is the absentee owner and the other problem is a lease that is way too expensive.  Any thoughts on how I should proceed?

Answer

First of all I really like the fact that you know the business as well as you do, but given the situation, I do have a couple of creative suggestions:

1. Due diligence: The best way to perform your due diligence to see if the business and pricing are attractive is to work inside the business, so I agree with your friend on that front.  Since your time is currently freed up, you could easily jump in and run the store to test your ability to ramp things up and to test even whether or not you really want to own a retail establishment.
2. The deal:  I see a short-term deal opportunity for the next several months until the lease expires and a longer-term potential acquisition.  There is a typical arrangement called a “lease management” agreement where a person runs a business for an owner (more on that type of arrangement here).  The typical deal is 50% of the earnings to each party.  Since the business is simply being watched by the owner’s aged father, there is real potential that you could dramatically ramp up the store revenue during the next several months.  Therefore, I would recommend that you negotiate a Letter of Intent (LOI) to buy the business with the Seller along the following fronts (download a LOI template here):
   • Negotiate the main deal points with the seller and then find a good Mergers and Acquisitions (M&A) attorney that can help write up the LOI.  This will not be a typical LOI in that you will want to include the lease management language and you will want some parts, like price, to be binding on the seller.  Read more here and here about how to manage an attorney and their fees.
   • Nail down a binding purchase price if you think it is fair (and after a thorough review of the financials - download a detailed due diligence checklist here).  The purchase price would only change if there were material changes to the business that you were not aware of at the time of the execution of the LOI.  The reason you want to nail down the purchase price now is so that you do not end up paying the owner more for the value you’ve created by growing the store’s volume and earnings.  The value of the store prior to your involvement is the fair price for you to pay, barring any other material matters.
   • Nail down a binding lease management compensation whereby you take over management of the store, the owner’s father reports to you and you have fairly free to rain to apply your skills and energy to ramp it up.  I think it would be fair for you to negotiate for 50% of the earnings (paid monthly) up to the 24-month average and 75% of any earnings over the 24-month average.  That way you are getting a disproportionate value for the growth that you brought to the operation, but the owner benefits as well.
   • Nail down a closing date – think of this as the “go-no go date” that you decide whether or not to pursue the deal.  A typical LOI will have exclusivity language in it that ensures that the owner is not free to negotiate with any other buyer, so you have the exclusive right to buy or walk away from the deal.  The LOI should not bind you to buy the business, only give you the opportunity to run it, check it out, etc.
3. The lease: Negotiate a new lease ASAP.  Do not wait until the lease nears expiration, because by doing that you will have ceded all of the negotiating power to the building owner.  (At that point you might be in love with the business, but your back is against the wall and you can’t plan a move for the business, etc. and the temptation would be to simply cave and over pay for the lease).  As soon as the LOI/Lease Management agreement is signed, you should go to the landlord and tell them what you are going to potentially buy the store and that the lease is a major part of your decision-making process.  Tell the landlord that you may not purchase the business or that you may relocate, depending on the favorability of the lease.  This way time and negotiating leverage are on your side.  What you want to sign with the landlord is a binding LOI with them that binds them to lease to you for specific lease terms that you’ve negotiated, but that doesn’t bind you in the event that you do not buy the business.  Having that deal done and tucked away will then allow you to focus your full attention on running the store and kicking the tires on the entire deal.

Let us know if you need additional advice during the process as we would be happy to advise you on the deal.