Things You'll Need:
- Three years of audited financial reports (income statement, balance sheet, cash flow statement)
- Summary of inventory
- Sources and uses for invested funds
- Lawyer
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Step 1
Review the audited financial reports for the store. Using the income statement, confirm that the store is profitable and that it has been growing both revenue and profits over the past three years. Use the balance sheet to determine the amount of debt the store currently has; if the store has more debt than owner's equity, you should be very cautious about investing. Use the cash flow statement to determine that the store generates positive cash flow. Pay particular attention to the working capital needs (current assets minus current liabilities), which can be substantial for stores.
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Step 2
Break down the store's revenue growth into growth in number of items sold vs. growth in average selling price. This information will be available on the income statement. You should be concerned if most of the growth is coming from price increases and even more concerned if the number of items sold has declined for several years in a row. Increased pricing is an unsustainable way to grow a store's revenue.
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Step 3
Analyze the value and age of the store's inventory. The value of the inventory should be reasonable and the inventory not too old, which increases the risk of obsolescence, spoilage and unsalable inventory. The age of the inventory will depend on what type of product the store sells; generally, you should be wary of investing in a store for which a majority of the inventory is greater than 60 days old.
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Step 4
Review the sources and uses analysis, which will tell you valuable information about how your funds will be used as well as other potential investors. On the sources side, note who will be investing alongside you in the store. Will most of the invested funds be debt or equity? What other equity investors will participate? On the uses side, make sure that the invested funds will stay in the store and be used for business purposes. Do not invest if the money is going to be used to pay a dividend to the existing management team.
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Step 5
Calculate your ownership percentage in the store by dividing your equity investment by the total amount of equity invested. Suppose the sources-and-uses analysis tells you that a total of $1,000 in equity will be invested in the store, and you intend to invest $250. In this example, your ownership percentage will equal $250/$1,000 = 25 percent.
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Step 6
Negotiate the purchase and sale agreement in conjunction with your lawyer. Pay particular attention to what rights you have relative to other investors in the store. For example, do other debt or equity investors have a senior claim to any proceeds from the store (i.e. will they get money before you do in the event of a liquidation)?
