Wednesday, July 11, 2012

Buying a Salon (Pt 1)

Part 1 in a Series on Buying a Salon

Interested in Buying and Existing Salon?

Here's What to Expect

Buying an existing salon instead of starting one up from scratch has definite advantages. There is already a base of clients and hopefully, profit. But if you don't understand the process, you could easily pay too much, or not understand what you are actually buying.

If the business is being offered by a business broker he or she will manage the transaction and explain the process. Remember, however, the broker works for the seller. You need experts on your side to protect your interests. Here are the basic steps, simplified.

Step 1 - Confidentiality Agreement

The first step in evaluating a business is the Non-disclosure Agreement. It customary to require an NDA prior to sharing confidential information about the business, including the name of the business. This is to protect the seller, whose business could be jeopardized if news of the sale got out. A business broker may also prequalify you financially prior to releasing information.

Step 2 - Basic Financial Information

The broker will share basic financial information with you, usually based on the tax returns of the business for the past two or three years. You will want to see a minimum of three years of tax returns.
An important number in buying or selling a business is Owner's Discretionary Income. The asking price is probably based on this number (for example, a multiplier applied to Owner's Discretionary Income). This number will be discussed in detail in a later post.

Step 3 - Due Diligence

This is your chance to get all your questions answered. You can review the lease, payroll records, sale figures etc. Remember that only you and your experts have your best interest in mind. Don't accept information at face value. You may meet the seller or everything may be coordinated through the broker. Sometimes before getting too far into due diligence, they will want a written offer.

Step 4 - Make Your Offer

You may need to do this before significant due diligence, but you can back out of the deal if your research uncovers something that makes you change your mind. Make sure your offer is contingent on financing and verification of earnings figures.

Step 5 - Negotiate

If your due diligence indicates your previously accepted offer is too high (the business is worth less than you thought at the time of the offer) now is your chance to renegotiate. What could affect the value of the business? Has there been turnover that will negatively impact the business's ability to generate cash flows? Was Owner's Discretionary Earnings not calculated accurately (see Part 2 coming soon)? Have you learned something else about the business that makes you doubt the profits are sustainable? Will you be taking on gift card liability by agreeing to redeem gift cards sold by the seller? The seller got the cash so you need an adjustment to the selling price to take on the liability.

Step 6 - Inventory

The selling price of the business usually does not include inventory (retail or professional) so just prior to closing on the sale, a complete inventory count needs to be done. You should be there for the inventory - don't let the seller just count and report to you. Watch for signs of obsolete inventory. Do they have 2 color lines in stock (the one they switched to 6 months ago and the old line they couldn't return)? If so, do not buy the old color. You only want to buy inventory that is relevant to the business today. Old color is their problem, not yours. Generally you will pay cost for the inventory. All pricing should be supported with an actual invoice showing it's purchase date. If retail products are more than six months old I would argue that they are obsolete and not included in the sale. You don't want to buy a bunch of stale inventory that the staff can't or won't sell.

Step 7 - The Closing

Congratulations, you're a business owner!

Have you purchased or sold a salon? What are some of the pitfalls you would warn others against? What do you wish you knew then?








12 comments:

  1. There is a nail salon for sale in my market. The owner stated she has invested more than $ 50,000 in the business and really wants to cut her losses move on to other ventures. The owner wants $20,000 if she offers financing or$ 10,000 if I pay cash and will consider a partnership as well. The leased space is $1,200.00 per month (one year remaining in the lease) .

    The nail salon has custom pedicure bowls / benches. The nail salon is fully equipped. (Gorgeous) The business has been open for about a year but she recently closed it due to the inability to manage staff. She stated she really wanted to just invest in the business however the managing partner left before the salon opened.

    As the business has no cash flow it is difficult for me to value the business. She reports the business has no debt or loans. The owner stated she will consider bringing on a partner who can manage/ grow the business and then buy her out at 10,000. The owner states she has no additional cash to put into the business, however will continue to pay the rent and salon maintenance (supplies, utilities, etc.) . Staff currently work on commission.

    I’ve always wanted to own a salon/spa. This business is definitely has issues (hiring staff, menu, staff training, no advertising , lack of spa software) But, I believe the issues can be corrected and the owner is willing to allow me to try. I have over 5 years of spa management/ marketing experience. I’ve worked for major chains like Massage Envy and a boutique high end day spa. However I have always been the employee and I know things are different as an owner. I also have a graduate degree and graduate certificate in hospitality management.

    Even if I lose 3,000 in this venture it still doesn’t compare to regular startup cost and it may be a good learning experience.

    Should I give this a try? How long should I work with the business before opting to buy or walk away? This is a much cheaper route than starting a salon/spa from scratch but are there risks I am not seeing.

    Should I get a business broker or attorney to draw up an official agreement? The seller does not have broker. I thought this was strange, but I honestly think it could be due to her lack of experience. I don’t want to organize and grow this business and then not have the opportunity to buy it as agreed.

    Thanks for your honest feedback.

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  2. What an exciting opportunity for you! Let me try to address all your questions...

    You don't need a business broker involved (they match up buyers and sellers and you two have already done that). An attorney should draft a purchase agreement. I am not an attorney so my advice in this area is not expert. When you buy a business you can buy the business itself (her legal entity) or you buy the assets of the business and start you own legal entity. You want to buy the assets. Any liabilities that are out there will not follow you, they stay with her. For example if a former employee sues for wrongful termination, if she signed a long-term contract for a service you don't think is necessary, if all the payroll taxes are not paid or if an audit shows back taxes are -- these are all things that go with the legal entity. So if her company is called Glamor Nails, LLC you will start your own business Awesome Nails, LLC dba (doing business as) Glamor Nails. An attorney can walk you through this but the key take-away is you want to start your own legal entity from scratch and that entity buys the assets from her legal entity.

    The assets will include all the equipment and supplies, web domain, facebook page, client lists, policy and procedure manuals, any trademarks, logos, etc. You will need to make sure you can either assume her lease, sublease from her (usually requires landlord approval) or get your own lease (hers gets terminated upon execution of yours). As your own legal entity, you will need to get all the utilities switched to your company. You will also need to set up a merchant services account so you can accept credit cards. (She may own her credit card equipment, in which case you buy it, or it may be leased in which case you may need equipment).

    I'm going to have to split my comment...too long for blogger.

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  3. Part 2 of my comment -
    Jumping back up to your opening paragraph, I think doubling the price for owner financing is pretty steep. Certainly $10k sounds like a good deal given your description. You should ask to see documentation on what she put in the business. Often when an owner says they put $50k in it, they really mean $30 to buy all the equipement, and another $20 to keep it running through losses. So while she may have spent $50k, she may only be selling the $30k portion. What are your financial resources? The business is going to run at a loss for a while so you don't want to go into this under capitalized. If you don't have sufficient capital to do the deal (even with owner financing you need some financial resources to make this work) then your best bet may be to look at running the business for her with an option to buy at a designated price at some stated time in the future. My concern here is that she is still the owner, so she may not give you the leeway to run the business as you see fit. She may tie your hands as far as additional expenses, pay rates, etc. and may even undermine your management authority. If you go this route you need a well-thought-out agreement in writing.
    The owner has no more money to put in the salon but can she pay a manager if you get it running again? Perhaps you could agree to manage the salon for 1/2 the profits for up to one year, but any time during that year you have the option of buying for $10k cash. Do you have an idea of what the business should be making? What were sales and profits/losses like when it was operating?

    You may want to dig deeper into the staffing issues that resulting in her closing the doors. Is it really a staff management issue, or was it an issue of not being able to find qualified staff? Can run a nail salon without technicians so make sure you'll be able to find some.

    Should you do this deal? Of course you know I can't answer that! Only you know your full living and financial situation. You clearly have an entrepreneurial streak, though, and this does seem like a relatively low-risk way to get the spa you've always wanted. Aside from the purchase price and any money you put into improvements or to feed it early on, the biggest risk seems to be the opportunity cost of you not having a regular job with a steady paycheck.

    I'd say your next steps are to:
    1) decide if you want to buy it or work in it with an option to buy it - this depends a lot on your financial situation and risk tolerance, plus whether you think you can work with the owner.
    2) have an attorney draw up an agreement

    Good luck and please post updates!

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  4. Thank you so much for your reply!! I printed out your reply and read it several times. Thanks for all of your insight.


    You are CORRECT in so many ways. Goodness this business kept no employee records. I have no idea how she is going to issue a 1099 or W-2 when the next tax season rolls around. The business is an LLC but has no liability insurance. There was no record of license numbers for nail techs. There are no profit and loss statements, no sales receipts, nothing. The owner stated the salon profits did pay the rent every month, but not much was left over after that. Again another verbal statement, nothing in writing. The owner paid for everything cash, the leasing site paid zero , towards the build out.


    In addition! The owner revealed she started the business with a well known artist who walked away from the partnership. I advised she may need to seek attorney advice because although the partner walked away they may have the right to come back and request a share of profits including from the sale of the business. Minimally they may be able to take her to court as she has no documents referring the partnership agreement. (No documents) . Although the LLC and salon license are in her name, unwritten partnerships can still be a headache.

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  5. Part 2

    You are absolutely correct in that the staffing issues are very complicated. It’s probably a good thing at this point the doors are closed and there is no chaos. I did speak to several former employees who stated the lack of organization concerning menu services, menu prices, and commission was very difficult to deal with. There was never a trained spa manager. For example nail tech/ makeup artist that brought in their own specialty equipment were paid the same commission amount as those who brought no supplies. There was no standard menu. Nail tech Sally uses hot towels and massage...Nail take Mary does not. There was always a fight for walk in clients as there was no order to assigning walk in clients. Lastly the nail spa has no management software. No way to keep up with employee commission, sales, etc.

    The owner has invested no funds in traditional marketing. All of the salon marketing is web based ( Instagram , Twiter, Facebook).


    After my review. The business isn’t even worth 10,000. The salon has less than 200 friends of Facebook and less than 200 followers on instagram. I can build social media from starch. Less than $1,000 in nail inventory/ supplies. There are no policy and procedures, no client book. She does have a logo but she has no brand presence so the logo isn’t worth very much. Plus the logo was likely developed with the run away partner, so I would not continue to use it.

    The only value is the custom pedicure benches fixtures, build out . The benches physically can not be moved to another the site. The owner will either stay in business or walk away from 25,000 custom benches. Although the layout and custom benches are gorgeous. Presently as a small business owner,I would never pay 25,000 for custom benches. Especially in a leased space and the pedicure benches can’t be moved.

    It is likely I will pass on this venture. However I plan to speak to the owner again today. At this point I,

    1. Highly recommend business liability insurance as it is necessary to protect clients and the business.
    2. I cannot be a partner. However I am willing to manage the salon at 50% of the profits with the option to take over the lease at any point during the first year. If I take over the lease I will pay an additional $10,000 for salon fixtures/ equipment.
    3. The lease take over provision remains in effect even if she terminates me from the managing position.
    4. The owner must agree not to sell business during this one year period
    5. Attorney prepared agreement.

    Based on the initial budget. I believe the business can profit at least $7000 a month starting in the third month. Median monthly profit income around $12,000. I can use the 50% split to invest in training or another business venture. After I take over the lease, new LLC, new salon license, who knows I may be able to sell the business.

    Prior to signing the agreement I will interview staff. Ultimately if there is not a good pool of qualified talent with flexible hours and willing to work commission initially this venture will not work.

    Secondly we will need to go over and my written responsibilities as her employee . ( Working hours, sales goals, training of staff, staff recruitment, etc).

    Again thank you so much for your blog and your reply. If any other suggestions pops up please feel free to post. Thank you for encouraging me to dig a little deeper.

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  6. Hi Cindy,
    I am in the process of purchasing an existing salon, in the Carolinas. It has been established for 6 years is in great operating condition located in a good location in an upscale community. There are 9 styling stations and the salon employs 4 commissioned stylists,one booth renter & owner would like to stay on 16-20 hrs pwk as a booth renter. I don't have an objection to her booth renting, but I do with the other renter, it is not the culture I want to build, but may need to keep things as is to ease into this takeover. Whats your thought on this???
    Being from out of state, I would also like your opinion on this: I will give a brief background. I am currently living out of state.I lived in the current area in 04 & 05 ,so I am familiar & have a few contacts, but not many.Have done my market research & working on my business plan. I have over 25 yrs experience in the industry as a small independent owner and the last 8yrs I have been employed by a very large successful salon as an educational director / master stylist with a very large clientele.I have had the great opportunity to receive top notch education globally and feel the time is right for me to enter into salon ownership now and am aware of the risks involved. The salon Is making a small profit and is growing. The owner, just does not have the time to devote to her salon at this time. I feel the salon has alot of potential to continue as I reestablish a clientele and build the salon further. What do you think?

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  7. I agree with you on the booth rent situation. I think it's difficult (impossible) to build a team culture when you have part employee/part booth rent. I'd question keeping the owner on too, though. Will having the former boss renting from you make it more difficult for you to assert yourself as the owner? You will certainly want to make some changes and a former owner may not take well to them. If you want to keep them (one or both) in the short-term to avoid shaking things up too much, I understand, but I think long-term you need to have no booth renters.
    It sounds like you are going into this with you eyes wide open. In a way, it's good that you don't have established clientele in this area because you will have time to develop your staff and create the team you want. Even as you grow, make sure you schedule enough time to work on the business -- don't spend all your time behind the chair.
    Is the salon profitable only because the owner is behind the chair or will it generate some cash flow for you from the start? Make sure you understand the cash flow position so you can plan for it. Expect it to take longer to grow than you think it will and be prepared financially.
    Also, understand that some of the stylists may not share your enthusiasm to grow the business and make it great(er) so you may lose some people. Pace yourself, be firm but patient with your team as they get to know you. It will take them a while before they trust you so they may be resistant to any chanes at first. More communication is better. Try to keep things positive - give them lots of positive feedback. When you want to change something, see if you can lead them to it first, rather than just pushing it on them. They will always accept their ideas more readily than yours.

    Good luck and if you have specific issues when you get in there, I'd love to help you sort them out.

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  8. Cindy, Thank you so much for your advice! Is it possible to consult with me privately? I would really really appreciate another professional opinion before I sign on the dotted line???

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  9. Hello Cindy. I am negotiating to take over a nail salon. I would like to ask what licenses I need to have to operate the salon and where I can apply for those license. Also, I really do not know when I will close the sale? Should I pay them after signing the lease or after having the legal entity for my business? Is there any complicated process from the state board if I change the name of the business? Can you please help me with those questions? Many thanks in advance.

    Jay

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    1. Many of your questions depend on your particular state board. You will need to contact the board to determine what licenses are necessary, how to transfer license, name change, etc. Try by googling your state name and Board of Cosmetology.
      Your agreement to purchase the business needs to be contingent upon your ability to sign a lease with the landlord. Your lease with the landlord will become effective upon your purchase of the salon. Will you be taking over their lease? That requires landlord involvement. You certainly don't want to pay them without knowing you have a lease, nor do you want to sign a lease without knowing you will acquire the business.
      Set your legal entity up first because that is the entity subject to the lease.
      Lastly, you are not "taking over the business," you are purchasing the assets of the business and using them in your own new business (that happens to be located in the same space, employing the same people). This is an important distinction. If you buy their LLC or Corporation you are also buying all their liabilities. If they didn't pay all their payroll taxes that debt would be yours. You want your legal entity to buy the assets of their legal entity, then their legal entity shuts down and is responsible for any outstanding debts. You should not do this without an attorney.

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  10. Hi Cindy.

    Thank you so much for your very clear explanation. I really do not if I am able to take over the lease but the current owner said that the landlord can let him cosign with me. Based on your advice, I think I need to do a lot of things before making the bargain.

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