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Small Business Guide

JULY 18, 2000

SMART ANSWERS

Making Sure a Pet Shop Isn't a Real Dog
You'll have to do lots of research. Look closely at financials, fixed assets, and potential competition


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Q: My wife and daughter want to purchase a pet store that sells supplies and offers a grooming service. There is a very proficient young person who clerks in the front and they recently added a fourth groomer to the back, where business is growing. Should we venture down this avenue or pass up the opportunity?

-- T.B., Dallas
A: An element of risk is involved any time you buy a business. But that doesn't mean that you have to just take a cursory glance at an opportunity and then throw the dice. You can take several crucial steps that will help you weigh the profit potential of this business and decide whether it's a good bet for you and your family.

First, investigate the store's finances relentlessly. Ask the seller to provide tax records and financial statements for the last five years along with documents showing how the company has fared for the first six months of this year. If you don't have the expertise to evaluate these records yourself, take them to an accountant or business appraiser.

No matter how fantastic the employees seem or how glowingly the current owners describe sales volume, you need to adopt a somewhat skeptical attitude. Why is the current owner selling this little gold mine? Has he or she been taking a salary, perquisites, and generating a profit from the business? Before you put your savings on the line or go into debt, make sure that this pet store is going to be a moneymaker.

You can do that by figuring the discretionary cash flow of the business, says Brad Cashion, managing director of Mentor Group, a corporate valuation and financial advisory firm based in San Diego. "The discretionary cash flow is the total revenue of the business, plus the value of the inventory, minus expenses -- except the owner's salary," Cashion says. What income does the business generate for the owner before taxes? Is the cash flow enough for your family to live on, pay back any debt you incur buying the business, and generate a return on your investment?

A basic rule for purchase price is not to pay more than three times the discretionary cash flow, Cashion says. So if the pet store's discretionary cash flow is $50,000 a year, you should be wary about paying more than $150,000 for it, unless it's located in a growth area and business is likely to increase. Even in the best-case scenario, Cashion recommends not paying more than four times the annual discretionary cash figure.

Before you take the plunge, get a list of the fixed assets that will be included in the sale: inventory racks, displays, grooming benches, and any other capitalized equipment that you can borrow against in the future, says Jack Bakken, president of Business Appraisal Associates Inc. in Granby, Colo. "Banks won't loan money against a business, only against its hard assets, so you need to know what they are worth," he says.

You should also get a run-down on what inventory is going to cost you each month, and ask about the relationships the owner has with suppliers, vendors, and other professionals. Are there veterinarians on call, for instance?

Think about how you will pay for the pet store. Few people have enough cash to buy a business outright, Bakken says, but the seller may be willing to write a note to finance the purchase. What kind of terms is he or she asking? Will the payback period on the note be reasonable, given the discretionary income the business is generating? You should also investigate the terms of the lease and find out whether or not it is transferrable. Talk to the employees and see whether you can get them to agree to stay on after take over.

Look at the competition in your area and how other stores affect your sales volume, Bakken recommends. Try to find out through the grapevine or from your city's business development department if there is a large retail pet chain interested in building a location nearby. If a PetSmart were to open its doors six months after you purchase this shop, will it put you out of business?

Finally, sit down with your wife and daughter and talk about quality-of-life issues. Are you all at places in your lives where you want to take on a large and time-consuming challenge? Business ownership means long hours, and it loads you up with responsibilities. "Owning a business is a lot different than working at one," Cashion reminds. "Suddenly, you're on the hook for payroll, for rent, for everything. You can't leave at 5 p.m. and go home and not worry about anything until the next day."

Have a question about running your business? Ask our small-business experts. Send us an E-mail at smartanswers@businessweek.com, or write to Smart Answers, BW Online, 46th Floor, 1221 Avenue of the Americas, New York, NY 10020. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally.


By Karen E. Klein

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