Why cashflow counts when buying the business.
Signing a lease is a significant step in the process of setting up in business. The numbers are important because these financials are the foundation of your ongoing costs.
Specialist retail valuer and arbitrator Don Gilbert, who provides independent advice to landlords, prospective investors and tenants, says his best advice echoes the words of former Westfield GM Allan Briggs: “What are you buying? You certainly are not buying a lovely little shop in a lovely centre - you are buying the cashflow, the business.”
When it comes to business, starting a business or buying a business, it is all about numbers, says Gilbert.
“When people enter into leases, at worse they do not do their numbers properly; often marry their leases and other family assets to their homes by way of personal guarantees; and have not negotiated the lease terms based on hard numbers.
“To put this in perspective, the 1997 Fair Trading Inquiry addressed some important points about what one signs before starting or buying a business, with goodwill and cashflow being thoroughly teased out by landlord representatives to the committee.
“The concept of goodwill was discussed in the context of security of tenure,” Gilbert explains. The committee chairman asked Allan Briggs whether a business in a major shopping centre had “goodwill”, particularly at the end of its lease. His response, as reported by Hansard:
“The value of the goodwill decreases, depending on the term available to the merchant... There is no goodwill attached to a lease, except if a merchant has a five-year lease, let us say, then it has some value… one year into the lease it has four years, two years in it is three years, and so on as it gradually diminishes. But at the end of the lease there is no goodwill.”
Your business success depends on negotiating lease terms that give
you a chance to write off your investment within its time frame.
Briggs further said the value of any business is driven by the income earned and by the bottomline profit. “Our industry is no different from any other … If there is a suspicion the rentals will not be maintained, then the valuer is duty bound to base his valuation on that instinct or knowledge or premise.”
It was also made clear that lease renewal is no certainty, and a business is technically worthless by lease end, points out Gilbert.
“In franchised businesses you do not have to build a brand. Many business systems are in place, such as stock ordering. But this comes at a cost.
“In every business, $1 equals 100 cents. You cannot add extra to a customer’s bill “because my landlord and my franchisor want more money” Extra expenses come out of your pocket - your family home, if you have put that on the line.”
The time to get these things in order, or to quit, is before signing up to a lease.
The term “goodwill” as used here is “superprofit” after you have paid yourself a reasonable wage, says Gilbert. “That is the money needed to fully amortise (write off) investment over the term granted under a lease, in taking on that business risk in the first place. As many leases are over-priced it is not possible to amortise costs.”
You certainly are not buying a lovely little shop in a lovely centre - you are buying the
cashflow, the business.