Posts Tagged ‘ 3-2-1 rule ’

What kind of business do I buy and how much can I *really* afford?

The ‘what do I buy’ question deserves a bunch of blog entries.  Let’s deal with the second part – the how much question.

 There’s a useful rule-of-thumb for cautious investors – a rule of thumb that makes sense after you’ve chosen the type of business you want to buy.

 Let’s say you have $40,000 to invest. Not a king’s ransom by any means, but certainly enough to buy a tidy little business that can give you an equally tidy income.

 There’s something called the 3-2-1 rule.

 So, what’s the “3?”

Most business buyers set aside operating expenses of the company they want to purchase — for a month or two.  For the sake of an argument, assume it costs $3000 to keep your new business open for a month (we’re assuming that customers stop coming through your doors).   Here – assume you’ll not see a single customer for 3 months.  Multiply that by the monthly operating expenses … and you get $9000.  Take that away from your $40,000.

 The “2?”

Assume you will have to shoulder all your monthly personal expenses for two months.  (if you don’t see any income – ANY – you’re in deep doo doo).  Burn rate of $5000 a month?   Multiply it by 2, you get $10,000 and subtract THAT from your $40,000.

 And the “1?”

Simply throw in another $1000 for some small, niggling little expense that invariably pops up.  Yep – that that from the 40K.

 

At this point, we’ve subtracted $20,000 from the original $40,000.  In other words, your modest investment total has been halved. Luckily few business purchases involve paying the seller the full price with wheelbarrows of cash.  Down payments do the little leverage magic we’ve all read about in first year economics and finance survey courses.

 

And so  – back to the ‘3-2-1’ guide.

 “3” is a reminder that a lot of down payments are about a third of the total business price.  So, in such cases, your $20,000 is a 30-33% payment.  Specifically, your 20K is a 1/3 payment of a small venture that’s being sold for (about) $60,000.

 And “2?” It’s a reminder that down payments are often about a fifth – 20% – of the total business price.  So, in these cases, your $20,000 is a  20% payment.  20K is a 1/5 payment of a small venture that’s being sold for (about) $100,000.

 (This is where the 3-2-1 rule peters out.  There IS no ‘1’ for this part of the rule of thumb)

What you’re left with is the sober reminder that buying a business is a constant trade-off between your hope of personal gain and risk. 

 The good news is that in most areas, there still are a lot of small business opportunities were 60-100K will get you into the entrepreneurial door!

 And … all in all, that’s pretty good news…