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Author: jumpie Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 15349  
Subject: Buying a business as an investment Date: 6/2/2012 2:54 AM
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I had a hard time finding which board I should post this on - hopefully this is good enough. I've always held the TMF community in high regard, and look forward to high quality feedback...


I have two questions, one specific, one slightly open-ended regarding a situation where I have a chunk of money and two choices of what to do with it.

Option 1 is invest. Option 2 is buy into a small business (retail store). The store is run by someone I trust and have known for 10 years. I'd be buying a 60% share in the store from this person (the other 40% is owned by someone else).

First question is what kind of financial planner/lawyer/CPA can I talk to about the pros and cons of buying the business? I'd like to talk to ONE person who has enough expertise in the relevant areas without having to bounce around between a lawyer, a CPA and a financial planner. (I'm in the San Francisco area if you have specific suggestions)

As for the open-ended question, I'm looking for advice if buying a business is a sane investment. My preliminary math seems to suggest that if the store continues to do as it has in the past, after about 10 years it would be better than investing at a 10% interest rate.

Say I have $100,000 to buy into the store or invest and the store would pay me $30,000 per year.

If I assume (over-simplified but good for comparison I think) 33% taxation on the business profits as well as on investment returns, I get:

Store: $20,000 net profit/year, so in 5 years, I made back the $100,000, in 10 years, that's $200,000

Investing: (assuming non-IRA of course) 10% returns minus 33% tax = 6.6% returns (compounded), so in 5 years $137,653 and in 10 years I have $189,483

(If I stash some of it in an IRA, maybe the investment option looks better? On the other hand, I can also start investing the store profits to bolster that option.)

Of course both scenarios have their risks of lesser returns, but is my basic math correct?
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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 15269 of 15349
Subject: Re: Buying a business as an investment Date: 6/2/2012 10:51 AM
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First question is what kind of financial planner/lawyer/CPA can I talk to about the pros and cons of buying the business? I'd like to talk to ONE person who has enough expertise in the relevant areas without having to bounce around between a lawyer, a CPA and a financial planner.

I don't think that's possible, if you want the correct answers. You need at least an attorney and a CPA to help you evaluate the business in their different areas of expertise. If you want a financial planner to help with investment questions, those questions aren't going to be answered by the attorney or the CPA.

As for the open-ended question, I'm looking for advice if buying a business is a sane investment.

First question I'd have - if the business really is expected to continue to throw off the kind of income that it is currently generating, why does he want to sell? Have you seen the tax returns to confirm it's actually producing that much income? Is there also an investment of your time in the business, that could be used in earning other income? If so, how are you accounting for that? If not, we get back to the question of why he would want to sell a passive income stream that returns 30% annually before taxes.

I would ask over on the tax board about your tax assumptions. How is the business taxed? Corporate rates are different than individual rates, if the business files as a corporation. If the business income flows through to your individual return, are you counting the self-employment tax as part of your taxation?

Your assumptions on 33% taxes on your investment income is incorrect, IMO. Long term capital gains are currently capped at 15%. Add in 8% for CA tax, and you get to 23%, not 33%. Then, you don't have to realize that tax every year - only when you sell - so your compounding assumption is incorrect, if you keep the same investments for more than one year.

AJ

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Author: jumpie Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 15270 of 15349
Subject: Re: Buying a business as an investment Date: 6/2/2012 3:41 PM
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> You need at least an attorney and a CPA to help you evaluate the
> business in their different areas of expertise. If you want a
> financial planner to help with investment questions, those
> questions aren't going to be answered by the attorney or the CPA.

Fair enough. My research seems to be telling me the same thing. Thanks.

> First question I'd have - if the business really is expected to
> continue to throw off the kind of income that it is currently
> generating, why does he want to sell?

As I first started researching businesses for sale (online), I shared your concern, but this appears to be standard pricing for small business sales - the asking price is usually 2 to 4 times the net profit.

In this case, as I said, it's a friend I'd be buying out, so there's less risk in that I know why he's selling (when it's a stranger, you have to take a leap of faith that they are really selling for the stated reasons).

> Have you seen the tax returns to confirm it's actually producing
> that much income?

Yes, of course. As to whether or not it will continue, well, that's the risk part, akin to the risk of investing...

> If the business income flows through to your individual return,
> are you counting the self-employment tax as part of your taxation?

It's a LLC so it's all about my own taxes. I was using 33% based on having owned my own business in the past and seeing that overall, the IRS was taking approximately 33% of my income. So I wasn't breaking it down and instead using an approximate overall percentage of my income. Maybe I should run through an actual scenario on a 1040 or ask a CPA to run the exact numbers.

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 15271 of 15349
Subject: Re: Buying a business as an investment Date: 6/2/2012 8:01 PM
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It's a LLC so it's all about my own taxes. I was using 33% based on having owned my own business in the past and seeing that overall, the IRS was taking approximately 33% of my income. So I wasn't breaking it down and instead using an approximate overall percentage of my income. Maybe I should run through an actual scenario on a 1040 or ask a CPA to run the exact numbers.

Yes, you probably need to ask the CPA about what the impact will be.

However, I still think that one of the big things that you are not taking into account is the value of the time you will have to spend on the business.

AJ

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Author: jumpie Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 15272 of 15349
Subject: Re: Buying a business as an investment Date: 6/4/2012 2:50 PM
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It's absentee, so time isn't an issue.

BTW, re: how you pointed out that tax on an investment might be much lower than 33% -- I understand various rates apply to capital gains, but in my limited experience with investing income, I usually get 1099-INT or 1099-DIV and add them up on, what, I think line 8 or 9 of the 1040 and that just gets added to my income total, so it all ends up as a lump sum subject to the normal taxation rate. That's how I ended up doing my calculations with the 33%....

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 15273 of 15349
Subject: Re: Buying a business as an investment Date: 6/4/2012 3:17 PM
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It's absentee, so time isn't an issue.

Then I'm back to the question of why does the owner want to sell if there truly is an expectation that the business will return 30% pre-tax going forward, since it would only take him a little over 3 years to recover the amount he could get from a sale? But if he's your friend and it seems reasonable to you, then I guess that's your call.

I understand various rates apply to capital gains, but in my limited experience with investing income, I usually get 1099-INT or 1099-DIV and add them up on, what, I think line 8 or 9 of the 1040 and that just gets added to my income total, so it all ends up as a lump sum subject to the normal taxation rate. That's how I ended up doing my calculations with the 33%....

Close, but not exactly.

For the 2011 1040, taxable interest ends up on line 8a of the 1040, and tax-exempt interest ends up on line 8b of the 1040. Taxable interest is added to your income, and tax exempt interest doesn't.

However, there are also 'various rates' that apply to dividends. There are 'qualified' divdends that are currently taxed at a maximum of 15%. All dividends end up on line 9a of the 1040, but then you put any qualified dividends on line 9b.

Then, on line 44 of the 2011 1040, when calculating the tax on your taxable income, you will either fill out a 'Schedule D Tax Worksheet' or a Qualified Dividends and Capital Gains Tax Worksheet' where the lower rates are applied to capital gains and qualified dividends, as appropriate.

AJ

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Author: jumpie Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 15274 of 15349
Subject: Re: Buying a business as an investment Date: 6/7/2012 6:44 PM
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>> It's absentee, so time isn't an issue.
>
> Then I'm back to the question of why does the owner want to sell if
> there truly is an expectation that the business will return 30%
> pre-tax going forward, since it would only take him a little over
> 3 years to recover the amount he could get from a sale? But if he's
> your friend and it seems reasonable to you, then I guess that's
> your call.

I already commented on this: first, I find that this appears to be standard pricing for buying a small business, second I understand and trust my friend's reasons. If you have additional input in reply to my thoughts in this regard, please do respond, but repeating yourself isn't helpful (with due respect).

> For the 2011 1040, taxable interest ends up on line 8a of the 1040,
> and tax-exempt interest ends up on line 8b of the 1040. Taxable
> interest is added to your income, and tax exempt interest doesn't.
>
> However, there are also 'various rates' that apply to dividends.
> There are 'qualified' divdends that are currently taxed at a maximum
> of 15%. All dividends end up on line 9a of the 1040, but then you put
> any qualified dividends on line 9b.
>
> Then, on line 44 of the 2011 1040, when calculating the tax on your
> taxable income, you will either fill out a 'Schedule D Tax Worksheet'
> or a Qualified Dividends and Capital Gains Tax Worksheet' where the
> lower rates are applied to capital gains and qualified dividends, as
> appropriate.

OK, I understand. Obviously, I haven't had to do that before. THANK YOU for pointing it out!!!

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Author: ToddTruby Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 15275 of 15349
Subject: Re: Buying a business as an investment Date: 6/23/2012 7:17 PM
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I already commented on this: first, I find that this appears to be standard pricing for buying a small business, second I understand and trust my friend's reasons. If you have additional input in reply to my thoughts in this regard, please do respond, but repeating yourself isn't helpful (with due respect).

I challenge the "standard pricing" assumption. I would get the CPA opinion on the value of the business.

I also would challenge the 30% passive income expectation. Especially with an online retail business. Online changes constantly, so straight line assumptions 5 years out are very risky.

Other risks include what if you have to invest more or lose everything. Not an uncommon scenario in a small business.

Sometimes you just have to do a reality check, even before spending a bunch on due diligence. What kind of investment provides the kind of return you are expecting from this venture and what kind of risk in involved. If it is truly as simply as you are being told, there it would not be a big secret and others would be all over it.

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Author: ems79 Two stars, 250 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 15277 of 15349
Subject: Re: Buying a business as an investment Date: 6/29/2012 3:41 PM
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Said by:
Author: kahunacfa | Date: 6/28/2012 1:07:05 AM | Number: 15276
You may want to consider contacting a San Francisco SCORE Capter - http://www.SCORE.org, the National Web-site will help you locate a local SCORE office. Oftentimes a SCORE office is co-located with a Small Business Administration office. I have also been a SCORE Counselor since January 1997 in the Kansas City office: http://www.SCOREKC.org.

I'm going to second SCORE.

My father has been volunteering in that organization for a few years now, he seems to feel that it's a good bunch of people, at least in our area.

At the very least they make a good sounding board for ideas until you get to the specifics of implementation phase, then you will probably need individual professional advice.

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