Welcome to part two of building your exit strategy.
In the last episode, we taught you the fundamentals of figuring out how much your gym is worth.
Missed part one? No problem.
In this episode, we chat about:
- The difference between good debt and bad debt, and what that means for your exit strategy.
- Thom’s recommendation for re-investing back into your gym to maximize the sale value.
- How to justify your sales price when you go to sell your gym.
And so much more!
This episode is perfect for you if you’re planning for the future and looking to maximize the value of your business.
Want to instantly make your gym more valuable? We can help! Naamly makes it incredibly easy to scale your gym operations, leading to more productivity with less work. Start your FREE trial now!
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Thomas Plummer: so, so Tom,
Sumit: welcome back to another episode of just one thing. We’re training gym owners get actionable insights to build a dream business. I’m going to make this a men multi-part use. I’m not even going to think how many parts now, but in the last episode we talked about, um, uh, selling the business and you gave this wonderful formula, right?
Sumit: Yup. So one question that I get a lot asked and, and is let’s, let’s go to the owners part of it, like you were saying, we take a salary and we take an owner’s draw.
Now, if I take a less salary. Then my earnings go up right on the, on the books at least. And if I take more, owner’s draw then from the optics perspective, my valuation goes up. But if I’m a savvy buyer, I will see that. And I’ll say, you know what? I have to normalize this because there’s no way in hell that you’re for the role that you’re playing, you’re only going to be taking 30 grand or 40 grand.
Uh, per annum. So, so walk me through that, like from a one is from an owner’s perspective, how much, like, how much normalization would happen from a salary perspective, uh, in the, in the eyes of the buyer. Does that make sense? I mean, yeah, but
Thomas Plummer: the, the formula it’s already built. So, what we didn’t talk about in the first segment of this is if somebody wants to buy my gym one, just say, great, thank you.
I’ll give you an offering sheet. Never unless ever, ever. Give them a verbal, um, just say, yeah, I think it’s worth 200, you know, stuff like that. No, just give them an offering sheet. And the offering sheet is a one-page sheet and I handed to my potential buyer. Well, it has several factors on there. Important one is, here’s what I think it’s worth.
Here’s how it came up with it and I will use the EBITDA formula. But remember, if we remember from the first one of this series is we know we, that, that 3.5, that’s your secret number. That’s what it’s worth, but that’s not what it’s really. That it’s just not there. Um, I tried to buy an old D did get the sale done, but I tried to buy an old red 67 Mustang and go ahead up for sale.
And I drove by, it’s like, oh man, that is such a cool old car. So I said how much? And he goes 26,000 and I go, what do you, based on that, because that’s what I want. Yeah. And I go, so I went and looked it up and I go, that particular car was worth like, you know, 19 or something. And I said, I’ll give you a 19.
And we started to debate because I knew, but he, then he started to tell me that, you know, it had some history and all this, but I looked at him this dude, just give me an offering sheet, give me a sheet, the details, all this crap in your head justify the value of this. And I just, he had no justification for this.
There was nothing. So when I give you an offering sheet, if I give you a verbal it’s, there’s no justification for that. It’s just a number like the old guy pulled out for his car. But if I, if he would have had a sheet and how he. The value of the car had some history when a car showed years ago and all this stuff, they started to tell me, I might’ve been interested in paying a couple thousand bucks, but the way we handled this, like, I don’t even want to deal with you.
You’re just, you’re not, you’re making stuff up. That’s what people think about when they buy it. But, Hey, you want to buy my gym summit? Here’s an offering sheet. Here’s what I want for it. I give them the EBITDA formula, but keep in mind that secret number is this. So if I’m selling that car, I might list it at 26, but I know in my head that my drop dead lowest price is 21.
So I’ve got. I can negotiate between 21 and 26. So if I know the value based on this formula, so my gym is worth by that formula 600,000 and then I ask 800, I’ve got a $200,000 range, but you always have to know in your head. What is the number, what you and your family has and sit down and say, what is the number we were really take for this?
So we know the 3.5 is what it’s probably really worth. And we started six to seven multiple, and then that difference is my way that I have to negotiate. Of course, we always want that. Even though we know three, five, they really do sell for four, four to 4.5. They do sell more. If you’ve got the 12 months receivable and stuff, we talk about.
The owner’s comp in there is built into the formula. So on that offering sheet, the value, the formulation, and I put down owner’s comp because that shows in the formula when I give it to them that this is it. And I took out owner’s comp last year, I took out a 65,000 salary. I took out a hundred thousand in bonuses.
I took out, you know, uh, $3,600 in car payment, and I took out $12,000 insurance for my family. So. I just, I assume the owner isn’t sophisticated ever and give them everything on the offering sheet. Then I have that, then I have the lease information and then I have approximate number of members and are they on a receivable base?
So I know might give it anybody that if they want validation of all that, that they should sign a nondisclosure. Which means that they, you know, they, he can’t get all the information then open across the street. Cause he thinks I got a great area of town, so I will give him my offering sheet. But when he wants me to prove all these numbers, I say, I certainly will.
You got to sign a non disclosure. So the offering sheet is there, but when we explain it to what, that’s your question directly. That’s how the salary becomes irrelevant, because it’s just clearly stated this is coming back to you as a purchaser. This is why it took out. Of course, when I’m gone, that’s your money and this nice of when it says
Sumit: there’s something I did want to point out though, Tom, like from an owner’s comp perspective, what’s going on in my head is I’m also doing work in the business.
So there’s a component of the owner’s comp that I am doing for maybe playing the GM role, maybe playing the trainer coach role, they playing the admin role, whatever it is, the janitorial role, which the buyer needs to replace with an actual human being to do the work. So, so I’m, I’m almost thinking, unless I’m getting this wrong, that the owners come there really two competence to it.
One competent is that replaceable. Salary that you would need to pay. The buyer would need to pay you by my gym to replace me. And then there’s the other owner who ha stuff. Uh, passing through the business, but I’m really pocketing like the insurance payments, car payment, cell phone payment, which is not really supposed to go through the business.
It’s really a personal expense, which you will come to benefit from. Is that not fair?
Thomas Plummer: Uh, yeah, but w if you remember what we just said about it on the offering sheet, I said I had down that I took 50,000. And I took a hundred thousand as bonuses to owner the 50,000 salary. That would be what I would pay to a manager to run the gym so that, so the expense side’s already showing the burden of paying a manager.
Sumit: Right. But that will get normalized. Right. Because now if I’m a savvy or gym owner, The night. I know that a manager really gets 50,000, but I’m only paying myself 30,000 as a manager because I’m trying to take, because
Thomas Plummer: these I’m saying, well, this is a particular example from the first session of the thing I stayed is always pay yourself a base salary of 40 to $50,000 depending on the market, because that does impact.
What are you exactly what you’re saying? That emulates the role of the manager. Got it. So then, so that’s there. So when you say normalize, I’m saying it’s already in the expenses, I took out 50,000 salary. That part would probably stay in because you’re going to have to pay a manager or that becomes your base salary, but that makes all the other key performance indicators valid because I only, now I also assume it took out a hundred thousand dollars in bonuses to own it.
Okay. So that goes to you as a buyer, but the 50, you may take as your, if you’re going to work your gym or that’s what you may use as a starting salary to pay a manager, to run your gym. So we are in essence, normalizing it by leaving one segment, instead of just saying, I took out 300,000 last year.
Owner’s comp. Well, what the hell does that mean? How does that work? Nope. I took out 50 here, a hundred year car payment, insurance and cell phones. And all those are right. Offs, all those are things that I can legitimately write off through taxes if I keep the right records on them. But I agree with you a hundred percent.
That’s why we split it. That’s why we’ll always want the owners to take out a base salary, but then show all the bonuses over here because that makes the sale much easier. You’re absolutely right. But yes, we’re building that into the formula, but we’re also building that into the expense session versus payouts bonuses to owner or shareholder.
Fair enough.
Sumit: So, so that’s on the owner side, um, going back to the formula on the debt minus the debt, right. Um, so does it make sense for me to have debt, not have debt because I’m going to subtract it anyways from a, from a valuation perspective, but that could also be a good thing, right, Tom, because I get it a cheap, why will I not take it?
So w so talk me to. Owner perspective, knowing that I’m running the gym. And I have to be mindful that five years from now, I want to sell it. Maybe I never will, but I may have to, what do I do with the debt competent as I get ready to sell it? Like, should I reduce the debt? Should I increase the debt at that time?
Like what a tricks that I should be doing with that competent because we, that competent doesn’t get spoken about too much.
Thomas Plummer: The, the, the debt is. It’s very, it’s kind of just kind of visualizing the whole rant on this, but it’s that the debts is not controversial, but inexperienced gym owners really messed that part up.
So if I’m selling it before we get off that track it minus the debt. That means if there’s a hundred thousand. So if the gym’s worth 800,000. But there’s a hundred thousand dollars in debt. So when you buy the gym, I have to pay that a hundred off. So that will lower the, about the price of, you know, you’re paying less because you know, I’ve got to pay that debt off.
I can’t, but some owners have debt structure so they can pass it to, to the buyer that keeps their payments. You know, so that’s, so the gym, if it’s worth 800 minus a hundred, the gym’s really were $700,000, but I’ve got to pay that a hundred thousand dollars off somewhere either he pays it off the buyer, or I pay it off as the seller.
So, you know, or the debt is passed through and service by the owner, the fee, the buyer, because at that point, then he can get a cheaper because he just assumes his dad is part of the value of the. Right. So the bigger picture you said is something I just love to rant on is, uh, probably the worst owners are the ones that, and, and I take all kinds of crap on this.
When I used to teach us and workshops is the, I’d say the worst owners are the ones that are debt-free and they like, and they dislike, you know, that’s crazy. You know, my dad said, or my accountant said, I said, well, what you’re telling me is you don’t reinvest in your. You know, debt is good manage debt, but not just debt, but managed debt.
So if we look at a gym and we use it, the first segment of this, so your rent factor is normally about one third of the expense of operating. So if I look at that, so $15,000 rent by overhead might be a brown 45,000. Now in the higher Metro markets, that can go a little higher, but just for the example today.
So if I’m in Manhattan, for example, my rent might be a quarter of my operating costs. So that might be a $60,000 because the cost of labor is so much. But for the sake of most owners, unless you’re in New York, downtown San Francisco markets like that, the one third tends to work pretty across the board.
So if I look at that and say, okay, it’s 45. So for example, example, we’re rounded off to, I’ve got a $15,000 rent, $50,000. If I pay all my bills, well, 10% of that should be long-term. Long-term debt is five years or longer. I prefer seven, seven to 10 year debt. And some of the new, uh, SBA instruments, for example, can be 20 years steps, but there’s a point where you’re paying too much interest.
So you five, seven to 10 is good twenties. Okay. But I’m going to pay some extra payments and we’ll come back to that. Now what I do to say, if I take off. $200,000 in, in alone. And I have a ten-year structured debt and I make the payments as promised for three years. And let’s say, I reduce it by approximately $30,000.
[At that three years, I can go good. I project the debt out fresh. I go back to the bank and say, I want to turn this into a new 10 year note. I’ve got seven years left. The payment either comes down because I have less to finance. Or the payment stays the same because I take the 30,000 back out and put it back into the gym for new turf new, uh, update my equipment, update something because I’m used to that payment.
I just project the payment ahead. So I can either lower the payment because I don’t need to reinvest, or I take the 30 back out because I’ve already made the payment based on 200, but now it’s 170 notes. I just take that fresh note out. So either take a fresh. All right, take 170 and finance it out for the lower payment.
So every two to three years, you should push your debt ahead. Now short-term debt is stuff that’s three years or less garbage debt. And when you first opened the first two to three years, you will have an additional about 5% of your expenses in garbage. Um, you know, you put $20,000 on your credit card because, oh my God, I forgot.
I needed that extra air conditioner. You, you know, you’ve got, uh, equipment leases that are only three years. I prefer five, but you get into a short equipment lease. And all of a sudden, you know, you’ve got that extra depth. So if I’ll only get $50,000, I can handle 10,000 or 10% of that. Or in this case, 5% debt long-term debt forever.
Like my, my business plan works in a training gym with a 5% debt ratio show forever. But the first three years of operation, I run like 10% and then I got the extra five. And then over the first three years, it should come back down toward 10 as I pay off the garbage stack. So that means in this case, I can handle an extra $2,500 in garbage debt.
You know, we debt is it. It’s not good, but in a gym, it’s a business that it’s managed as part of upbringing, a business to keep the business.
[Constantly fresh and new going back to our EBITDA format. Our first session, one of the things we were talking about is how do I continue to build value? Well, I have to keep the gym every three years. I have to reinvest back into the gym to keep it up a side formula on that is. I, I think you need to invest roughly the equivalent of $150 per thousand square feet, uh, every month to keep your gym fresh.
So if I have a 5,000 foot gym times that I’ve got 750 times 12, well, that’s what it takes to keep my paint fresh. Uh, to repair the damage in the bathroom, but new stainless steel stuff for my coat racks in the winter, you know, that wall, that wall needs to come down and it’s grody. So $150 per thousand square feet for capital improvement and $150 per thousand square feet, uh, for repair and maintenance.
So I run those as separate times. And that was slow should be thought of as separate. I put those as line items on my budget for my gym, because if I don’t spend it this much, I sweep it to what’s called an accrual account. A cruel account is money. I know I’m going to have to spend, but I’m not going to spend it today.
So for example, I know I’m going to have to buy a hot water heater someday. They always blow up. Yup. So I just put $150 a month or a hundred, 150 times. Thousand square feet. So in this case, 750 a month and repair and maintenance, I just move it into the. I didn’t need it this month. Next month I move another seven 53rd month and another seven 50 and the toilet blows up.
So somebody sits down and Viola stumbles knocks. It crashed my toilet. Okay. You know, I got the money. I don’t have to take it out of my operating expense because I did it. Capital improvements, the same thing for equipment and the big picture thinks turf flooring. I can cure it here. I usually kind of look at flooring and stuff.
Capital improvement. I’m constantly keeping it up. Those two budget lines really help you do this without incurring more debt, because I actually build the cost of the operation of the business into a savings account that can’t be touched down because I’m going to spend it sooner or later that $2,000 water heater is going to go poof.
And you know what? I don’t scramble to have put on my credit card because I’ve been saving every month for the last year, knowing something’s going to blow up. I just didn’t know.
Sumit: No, I think that’s a, that’s a great point. That’s, that’s a life lesson right out there. Uh, do it with everything. Like, you know, even when the cars are paid off, like you were saying, Tom, I still set aside $200 a month into a car account just because I know something will happen.
Uh, it’s bound to, and then once you, once it does happen, then you’re like, yep. I have the money. It’s all good. You don’t even miss a beat then.
Thomas Plummer: But yeah, it’s so hard to get young owners to start their, see their life and the totality of the debt.
So the reality is we always get to that point where we have to choose between depths and. And the less debt I have, the more freedom I have to live life on my own terms. So one of the earliest things you can start to learn is just short-term garbage debt, which is 2, 3, 4 year debt with high interest rates is really, you just got to move away from that.
So debt is freedom to not. I have to live, check to check and be scared and how you’re going to eat tomorrow. What you’re going to do with your kids tomorrow. And what am I going to do with my spouse? I can’t even take care of that person. So if you start to understand debt in relationship to your business, the same rules do apply to your personal life is a house.
Cool. All right. So on that note, Tom, let’s, let’s end this let’s have another session on, I have so many questions going back to the valuation piece, so we’ll we’ll go there.