30 Things I Have Learned About Buying and Selling Child Care Businesses Over the Last 30 Years
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8his year, I celebrate 30 years of helping people build, buy, grow, and sell childcare businesses. It is hard to believe that 30 years have passed. I can still recall starting my business brokerage and consulting company and selling the first child care business. I was speaking with a child care owner the other day, and he said, “I bet you have seen a lot and learned many things about improving, valuing, and selling child care businesses in the last 30 years.” Yes, I have learned many things, and I thought I would share 30 of the most important lessons I have learned over the years.
#1 Selling a child care business often takes longer than expected.
Many childcare owners mistakenly compare selling their childcare business to selling a home. Having sold their last home in three or four months, they believe the sale of their childcare business will be relatively quick. When I started 30 years ago, the average time to sell a business was nine to twelve months. Due to various factors, including a lower number of qualified buyers, a lack of financing, and increased regulations in the child care industry, among others, the average time to sell a child care business is typically one to two years. Do some sell faster? However, on average, you should plan on a one- to two-year marketing timeframe.
Of course, you can “give” your child care business away pretty quickly. “Looking for a steal – bargain hunting child care business buyers searching for their next deal” can readily be found moreover, when they find a “burned-out” child care business owner, anxious to get out quickly no matter what the price, they know, in the end, they will pay far less than the listed price.
Jokingly, I always tell childcare business owners to make sure they contact me about selling their business when they are just feeling a little uneasy around the edges. If they wait until they are completely “toast,” their burnout will lead to a lower sale price and frustration with the average length of time necessary to market a childcare business and receive the highest price fully.
So, plan ahead – take your childcare business to market early enough to allow plenty of time for a qualified buyer willing to pay fair market value to be identified and a structured, business-preserving transfer to take place. And, should you get lucky and your childcare business sells quickly, well, that means you’ll get to start the next chapter of your life sooner – retirement, moving to the beach, or spending more time with family and friends.
#2 Loose lips sink ships. Confidentiality is SOOOOO important.
It cannot be overstated the importance of keeping the potential sale of your child care business completely confidential. Even minor breaches of confidentiality often result in the loss of employees and enrolled children. Breaches of confidentiality can lead to a reduction in the purchase price or the business being taken off the market, requiring months or years to rebuild enrollment and business value.
Too often, when considering the sale of their child care business, owners seek advice from individuals who lack knowledge about selling a child care business and the sensitivity of parents and staff to a potential change in ownership. An attorney, accountant, or real estate agent tells them the best way to sell a business is to let everyone know it is for sale – tell your employees, parents, and call your competition and see if they would like to buy your child care business – very bad and ultimately very expensive advice!
I recently spoke with a child care owner who had done just that – let everyone know she was looking to sell. Having heard the same story hundreds of times, I could have recited it to her. She shared that she had shown the business to more than a dozen potential buyers and had not received a single legitimate offer. Several individuals, having no money, wanted her to lease them the childcare business and building with no money down – just come in and start running the business, making monthly lease payments for everything. She had lost a few key teachers to her competitors, and her enrollment and business value had declined. Each day, she had to spend time addressing her employees’ and parents’ concerns about what potential buyers might do with the business – would they be qualified, what changes would they make, and would they lose their jobs, among other concerns. She, of course, wished that she had reached out to someone who specialized in helping people buy and sell child care businesses confidentially. Fearing her business would continue to decline, she considered closing the childcare business and leasing the building to a man who wanted it for another type of business. Once a thriving, profitable childcare business, operating for twenty-plus years with a stellar reputation, was on the brink of closing its doors. Ultimately, the total financial loss is likely to be several hundred thousand dollars. Yes, loss of lips sinks ships and childcare businesses – confidentiality in selling a childcare business cannot be overstated.
All marketing efforts, meetings, business showings, completing the steps of due diligence, notifying licensing of the sale, and the desire to change ownership – all the way up to the day of closing must be handled confidentially. Over the years, I have developed processes and procedures to minimize the risk of confidentiality breaches. It requires a vigilant focus on following proven best practices and constantly reminding everyone involved – seller, buyer, lenders, attorney, and accountant – of the need for extreme confidentiality. The continued successful child care business operations and business value depend on it.
#3 Increased regulation decreases the business value and sales price.
I have worked on child care brokerage and consulting projects in many states across the country. And, with more, of course, in my home state of North Carolina. Over the last two decades, child care regulations in North Carolina have undergone substantial increases. Regulations, particularly burdensome ones, increase the cost of doing business and decrease profits, thereby decreasing the value and potential sales price.
As a child care operator, you must reevaluate your business operations with the release of each new regulation. Moreover, when necessary, make changes in your business not only to meet mandatory regulations but also to, as much as possible, maintain profits. I often see child care businesses that have made changes to meet new regulations. Still, they have not reevaluated their child care profitability considering the new regulatory impact on business profits. You should always be asking yourself, “How can I meet regulations, license law, and provide quality child care – but also increase my business profitability?” There is often more than one way to meet regulatory requirements, with some options being more expensive than others. How can you spend less money and still meet all requirements? Every dollar of profit you preserve not only provides you with more personal Income but also makes your child care business more valuable and easier to sell should you choose to sell your child care business.
#4 Increased regulation reduces desirability.
Over the years, I have successfully sold childcare businesses to individuals already in the industry, such as directors and teachers. Today, when asked if they are interested in buying their own child care business, often the response is – “Are you crazy? It is challenging enough to be a director or teacher in childcare today. I would never want to deal with what I see the owner going through every day.” Today, we have an abundance of buyers (chains and private equity groups) ready to purchase large childcare businesses and multi-location programs. Still, fewer child care business buyers today than in years past seek to purchase a small or medium-sized single-location child care program. Fewer buyers increase the time it takes to sell a child care business.
Given that each state’s regulatory environment is different, states with high childcare licensing regulations are less appealing to national chain buyers. States with overly burdensome regulations decrease profits and increase overall operational complexity. Therefore, it is common for national chains to prefer expansion in some states over others due to the regulatory environment.
#5 Organized financial records increase the purchase price.
Most child care owners (like most small business owners) are not accountants. Keeping up with the financial records often “takes a back seat” to many other activities necessary to operate a child care business. Specialized childcare software programs can make keeping track of tuition and expenses easier. At a minimum, you should have a monthly Profit and Loss (P&L) Statement either prepared in-house or by an accountant. And, of course, the annual corporate tax return should reflect the information contained in the monthly P&L Statements.
The tax code offers numerous legal tax deductions that reduce taxes at both the corporate and individual levels. Some business owners write off many expenses that have nothing to do with the operation of the child care business. These expenses may reduce the state and federal taxes due; they will also decrease the value or selling price of the childcare business. Many buyers, their accountants, lenders, and other advisors are not interested in discussing which expenses were business-related and which were personal expenses run through the childcare business. They often will not be willing to add the unnecessary expenses back to reflect a higher cash flow and value in valuing the business.
If you want to receive the highest price possible for your childcare business, stop running personal expenses through the business – clean up your financials and maintain an organized, clear paper trail of all revenue and expenses to support the financial statements, tax returns, and accurate cash flow and business value.
#6 Facilities built for child care with a good layout increase the price.
As you might expect, buildings designed and built for child care have the highest value. In addition, newer buildings are often more desirable to childcare buyers since they usually have fewer building code issues, requiring fewer updates.
Over the years, the student-to-teacher ratio has changed for each age group. Child care centers with rooms that are neither too small nor too large offer the greatest flexibility. And the ability to rearrange classrooms to meet changing ratios and enrollment needs.
Of course, when most people start in child care, building a new facility is not a financially viable option. Therefore, remodeling or repurposing a building for child care is necessary. Existing structures – supports, doors, windows, electric, plumbing, and layout must be analyzed with the thought of creating the most usable, highest licensed space possible – your future child care business profits and ability to sell your child care business someday depend on it.
#7 Child care Business Value is determined today, not after closing.
Over the years, I have heard and read articles written by other child care business brokers that state, “the value of your child care business is determined by its value after closing.” Each buyer will indeed assign a different value or price to your child care business based on factors important to them – “beauty is in the eye of the beholder.” However, the value and fair market price of your childcare business are based on how you operate it today.
The value of your child care business has nothing – absolutely nothing to do with how a buyer may operate the child care business after purchasing it from you. Homes, land, a car, and childcare businesses are all valued as of a specific date (today) based on current operations, profits, and conditions. Some buyers may not be willing to pay you what your child care business is worth because the way they plan to operate your child care business may not be as profitable.
I have always found it interesting how child care brokers and the buyers they represent attempt to negotiate a lower value for a child care business based on how the buyer plans to operate the business after closing – their corporate overhead, additional management labor costs, and other expenses that will decrease profits. How a buyer operates the childcare business after they buy it is their responsibility, not yours. Why should you accept a lower price because the buyer cannot operate your business as profitably as you do? Of course, these same buyers are never willing to offer you more money if they see changes they can make that will increase profits.
It is important to know “who does the child care business broker represent” – you or the buyer? Many child care business brokers will tell you they represent you, list your child care business for sale, but then only expose your child care business to a limited number of buyers, usually the larger chain operations, and negotiate against you based on the low price child care chain operators want to pay. Ensure your child care business broker is truly working on your behalf and not on behalf of the buyers.
#8 Participating in the Federal Food Program (CACFP) Increases Profits.
Over the years, I have heard many reasons and excuses for not participating in the Federal Food Program – I have just never heard a good one. Unless you are in a very high-income demographic area and can keep your center full with all private-pay parents, it is crazy not to participate in the Federal Food Program. If you follow the program, complete it, and file on time, the reimbursement will cover food costs, labor costs for food preparation, and some administrative program costs.
Look at it this way: you lose money if you are not on the Federal Food Program. For example, a center spending $5,000 a month on food and another $3,000 (or more) for kitchen staff without the Federal Food Program has $8,000 per month in costs with the Federal Food Program; you would probably have recovered most, if not all, of the $8,000 cost.
#9 Selling to an employee is highly unlikely.
Child care owners often hope to sell their child care business to a long-term, loyal employee, like a director or lead teacher. Transferring a childcare business to someone already familiar with the business, including employees, parents, and children, has advantages. However, in 30 years of selling child care businesses, I have only sold one center to an existing employee.
Employees often lack the financial resources to purchase a childcare business. Unless the childcare owner is willing to provide extensive seller financing and make other concessions, a transaction is often not possible. Now I hear you, “Yes, many child care employees dream of owning a child care business.” However, only two percent of people who start out trying to buy a childcare business (or any business) ultimately end up buying one – pretty slim odds. Those childcare employees who venture out on their own usually try to purchase a small center or open a new one due to limited financial resources.
Another important consideration is that the employer-employee relationship is often strained when an employee is unsuccessful in purchasing the childcare business where they are employed. I’ve known several childcare owners who lost a great, long-term employee when a potential business sale fell through. Before approaching an employee to buy your child care business, you should give it considerable thought – the stats are not in your favor.
#10 Preventive maintenance saves and makes money.
Skimping on interior and exterior preventive maintenance will ultimately cost you more money in the long run. Having a set schedule to address all the small and large preventive maintenance items in a childcare facility is essential. Setting up a simple “Preventive Maintenance To-Do List” broken down into Quarterly and Monthly will ensure that your childcare facility always looks good and helps to decrease large repair bills from deferred maintenance problems.
#11 A buyer will buy your child care business for its potential – they won’t pay you for it.
Child care business owners often list all the changes a buyer could make to increase business profits. It is true that some child care buyers will buy your child care business for its potential, but they will not pay you for potential. The realization of potential requires hard work and often additional capital expenditures in the childcare business. A buyer is unlikely to pay you for this potential that they must then invest additional capital and exert considerable effort to achieve. If you think your child care business could increase potential profits by adding an after-school program or summer camp, you need to add the program if you expect to be paid for it. If you think your profits could be higher through better labor cost management. In that case, you need to implement measures to decrease your labor costs if you want a buyer to pay you a higher price because your labor costs are within normal operating ratios. Whatever the “potential item” might be, you need to have implemented it, and your financial records should reflect the savings or increased profits if you want the sales prices to reflect your child care business’s “true potential.”
#12 Owner financing is often required and increases the purchase price.
About 99% of the childcare owners I have represented over the last 26 years would have preferred to receive all of their money at closing. Outside of selling to a large regional or national child care chain, 90% of all business transfers will include selling financing. This is for three main reasons.
- Seller financing results in a higher sales price. Everyone has heard – You can have your price or terms, just not both. Business sales that involve seller financing tend to sell for more money.
- It is often a “red flag” to business buyers and lenders if the child care business owner is not willing to offer a reasonable amount of owner financing. The concern is that the seller is aware of potential issues in the child care business, such as market trends, state regulations, or other upcoming changes that may negatively impact the business, so the seller wants to receive all of their money at closing. Demanding all cash at closing will limit the number of buyers, their ability to obtain financing, and the purchase price.
- Without some owner financing, buyers often cannot obtain a loan to purchase the business. So, how much owner financing? Under the new Small Business Administration (SBA) guidelines, guaranteed loans would normally require 10% or more of the total purchase price to be held in a seller-financed note. If the buyer were obtaining a conventional bank loan (not guaranteed by the SBA), a higher down payment would be required, usually in the 20 to 30% range. The seller often must be willing to provide a higher amount of financing for a buyer to obtain a conventional loan.
#13 Excess labor costs decrease profits and reduce the value of childcare businesses.
The cost of labor – salaries, benefits, and associated employment taxes for teachers, staff, and management is often the largest expenditure in a child care business. Controlling labor costs is essential in child care, regardless of the size of your child care business. Although there are many factors to consider when analyzing labor within a childcare business, the greatest labor cost savings are often achieved through better employee scheduling, particularly for employees involved in the classroom, such as lead teachers, assistant teachers, and floaters. Common things I see in child care businesses that result in higher labor costs:
- Having too many teachers in a classroom – know your state-required teacher-to-student ratios for each age group and make sure you meet the ratio in each classroom. If ratios indicate one lead teacher and one assistant teacher, having two lead teachers or one lead teacher and two assistant teachers will be above ratios and result in excess labor costs.
- Using too many part-time employees. Utilizing more full-time employees and fewer part-time employees often results in more effectively managed labor costs, particularly for teaching staff. In childcare, part-time employees are better utilized (if truly needed) in positions such as floater, cook, driver, or office administrative roles. Instead of having two or three part-time employees, can you combine roles or job descriptions and have one full-time employee complete the same job functions?
Small changes in labor-management can have a significant impact on reducing labor costs, increasing childcare business profits, and enhancing overall childcare business value.
#14 Make sure your child care business broker represents your interests.
It is important to know “whom does the child care business broker represent” – you or the buyer?
The “laws of agency” – which party the broker represents vary for each state. Some states permit brokers to represent only one party, typically either the seller or the buyer. Other states allow dual agency, which allows the broker to represent both the seller and the buyer. To add to the confusion, other states allow the broker not to represent either the buyer or seller – often referred to as transaction brokerage – they represent the deal, not the parties.
Selling a childcare business is a very complex process. To obtain the best price and transaction terms, it is essential that the business broker you hire specializes in selling childcare businesses and represents your interests exclusively.
#15 The Goal – Sell a Child Care Business for Fair Market Value
When selling a childcare business, the goal is to obtain fair market value for both the business and the real estate (including the building and land) if part of the transaction. The fair market value of a business or real estate is defined as the price a willing and knowledgeable buyer would pay to a seller under the following conditions:
- Both parties – buyer and seller are looking out for their interests and have a reasonable level of knowledge about the value of the child care business and real estate. A seller wants the highest price, and a buyer wants the lowest price. For example, if a child care owner sells the business to a family member for a very low price, the price would not be considered fair market value.
- Neither the buyer nor the seller is under any undue pressure to complete the transaction. The foreclosure sale of a childcare business is not considered “fair market value” because the seller is often under great duress, and it is an involuntary sale.
- The child care business is offered on the open market (confidentiality of course) for a reasonable amount of time.
To meet these three simple conditions for “fair market value” in the sale of a child care business, the seller must have a reasonable level of knowledge about the value of their child care business and the value of the real estate if included in the transaction. Most childcare business owners have limited knowledge of the value of their childcare business or associated real estate. Therefore, having an experienced child care business broker or business appraiser help in determining the fair market value is essential.
Second, the child care business owner must be voluntarily selling the business – it is not a forced sale due to foreclosure, forced liquidation, or other involuntary transfer, such as a divorce, partnership dissolution, or similar event.
Moreover, to obtain the fair market value for a child care business, the business must be marketed openly (confidentially, of course) for a reasonable amount of time. Too often, a child care business broker will only market the child care business to a small number of buyers, typically a handful of regional or national chain buyers. Little to no effort is made to locate an individual, private buyer. A childcare business broker should employ a multifaceted approach to marketing your childcare business, including internet marketing, print marketing, personal contact with buyers, and exposure to both local, regional, and national childcare operators looking to expand, as well as private individuals. Without extensive marketing (confidentiality, of course), not all possible buyers will be identified, resulting in fewer offers and often lower offers. Be sure (before you sign a listing agreement) that the broker you are hiring will expose your child care business to as many buyers as possible – both individual private buyers and corporate buyers, not just a handful of corporate chain buyers they have sold centers to in the past.
#16 The availability of financing impacts both the sales price and the ability to sell a childcare business.
The availability of financing, or lack thereof, has a significant impact on the ability to sell a childcare business and the sales price. Without financing, it is challenging to sell a well-operated and profitable childcare business. Several factors influence the availability of financing. However, the economy has the most significant impact, both positive and negative, on business financing. During good economic times, obtaining financing to purchase a business is easier. Conversely, during an economic downturn or recession, securing financing can be almost impossible. Without financing, there are fewer buyers seeking to purchase a business. The fewer the number of business buyers, the lower the sales price for a business.
During the “Great Recession,” the availability of financing to purchase a business was almost nonexistent. Yes, SBA loans (loans guaranteed by the Small Business Administration – government-backed) were still being made, but only to the most qualified buyers for businesses that the economic downturn had not negatively impacted. Conventional lending (loans made by banks held in-house and serviced by the bank) was nowhere to be found, especially during the early years of the “Great Recession.” Banks often required a down payment of 30 to 50 percent from the buyer to obtain a conventional loan for purchasing a business.
The takeaway: The best time to sell a childcare business is during periods of economic growth. Child care businesses typically experience full enrollments and profits during periods of economic growth. Therefore, the value of the child care business will be higher. Moreover, during a good economy, there is more readily available financing with favorable terms, and more folks are looking to buy a business.
#17 Employee education level is important when selling a child care business.
Most states have education requirements for child care teachers, assistant teachers, and often management directors. Moreover, staff education is often tied to licensure, ratings, and public tuition funding. Maintaining an acceptable level of employee education is important. Many corporate and individual buyers seek to acquire childcare programs with employees who meet all educational requirements. In many states, the buyer will operate under a temporary license for a period following the business transfer. It is during the temporary license period that the buyer must prepare for the program evaluation to obtain a permanent license. Buyers are reluctant to purchase childcare businesses that do not have employees with the required educational levels. Buyers do not want to replace employees after closing, and given the shortage of qualified teachers in many areas, buyers fear being unable to find qualified teachers quickly.
Child care programs with qualified teachers are more valuable and appeal to more potential buyers.
#18 Having an Exit Strategy is the best way to go.
Child care business owners (actually business owners of all types of businesses) agonize about possibly selling their business for about three years before moving forward with listing and marketing the business. On a good day, they think – things are going great, I can hang in here a few more years. Moreover, on the not-so-good days, business owners often wish they had started the sales process sooner.
Given the number of years a childcare business owner thinks about selling, I have always been surprised at the lack of exit planning most engage in. During the years of contemplating selling, most child care business owners do little if any research or planning in regards to the value of their business, tax consequences of the sale, the value of their real estate (if owned), what is involved in selling a child care business, or planning what they will do after the sale.
It is never too early to start planning your exit from your child care business. In fact, before starting or buying a child care business, you should consider what options will be available for exiting the business in the future. Will you pass it on to a family member? Who will be the most likely buyer? What price would you hope to sell the child care business someday?
Exit Strategy Planning helps you to prepare not only your child care business for sale, but also prepares you for life after selling your child care business. A well-planned exit can have a profoundly positive impact on selecting the optimal time to take your childcare business to market, securing the highest price possible, and ensuring a smooth transaction. We have found that an excellent exit strategy for a child care business can be developed and implemented over a two- to three-year time frame, allowing a child care business owner to capitalize on their years of ownership and hard work.
#19 High enrollment, dependent on public funding, decreases business value.
To clarify, my statement is unrelated to the numerous reasons why all children should have access to quality childcare and early education. The statement is based on a common characteristic of any business and its impact on value, customer concentration.
Customer concentration refers to the percentage of business revenues attributed to one customer or a group of customers. For instance, a manufacturing business where one customer accounts for, say, 25% of gross revenues is considered risky. Why might you be asking? Well, let’s say for some reason the customer is lost, well, there goes 25% of the business.
A high customer concentration – child care enrollment dependent on public funding increases business risk. Increased business risk results in a lower business value or sales price, as well as a reduced ability to sell a business.
Many things impact public funding for child care:
- Federal and state budgets and budget cuts
- In some states, the availability of funds is limited to specific age groups.
- In some cases, public funding tuition rates are not comparable to private pay rates.
- Many states have tied the continuation of public funding for child care to compliance with child care licensing, program evaluations, and program infractions.
In recent years, many regional and national child care chain operators have revised their acquisition criteria to prioritize only those child care businesses with a high percentage of private pay enrollment. Some will still purchase child care businesses with around 30% public pay enrollment, often those centers meeting the 25% minimum to participate in the CACFP (Federal Food Program).
Therefore, you should reevaluate your childcare business, including your level of public and private pay enrollment, as well as your customer concentration. Can you, over time, decrease your business risk by limiting the concentration of your public pay customers? If you have a high percentage of public pay enrollment, it does not mean that selling your child care business will be impossible. It will take longer, and the ultimate sale price is often less.
UPDATE – Due to the impact of COVID-19 on the childcare industry, the economy, and the proposed increase in public funding for childcare, we may see individual buyers and national childcare operators pivot and begin to maintain higher levels of public-funded enrollment. Stay tuned!
#20 Policies, Procedures, and Systems create great child care businesses and business value.
Child care owners often think they need to have more money to spend on their program, to buy this or that to make it more valuable. Having adequate funds to develop and maintain programs is indeed essential. However, one important way to improve the value of your childcare business – without spending a dime – is to develop policies, procedures, and systems that are consistently followed.
Policies, procedures, and systems provide for the consistency of operations. Consistency fosters steady enrollment and employee retention, both of which contribute to higher revenues and profits.
Most centers have a Parent Handbook and an employee handbook that outline general information. These simple handbooks are a good start, but should not be the only written rules and guidelines. Every aspect of your child care business operation should be documented – who, what, when, where, and why things are to be completed in a prescribed manner. Moreover, you should have a set system to accomplish each task, such as opening procedures, closing procedures, handling parent conferences, and collection procedures, among others.
Child care businesses with good policies, procedures, and systems are often better operated, more profitable, and have better reputations in the community, as they are perceived as well-organized and efficient. They also often receive a higher valuation and sales price.
#21 High building rent decreases profits and limits the ability to sell a child care business.
Second, in addition to wages, building rent or mortgage is typically the next largest expense in operating a childcare business. All too often, childcare business owners lease or buy a building or space with a rental rate or mortgage payment that exceeds the standard benchmark operating guidelines. For instance, the monthly rent or mortgage should not exceed 18% of gross revenues—the closer to 15% of gross revenues or less, the better.
I could name several childcare buildings – nice facilities built for childcare – but the monthly rent or mortgage will likely always be above the standard benchmark operating guidelines. Over the years, I have received calls from not the first, but the second, third, and yes, the fifth or sixth child care operator in the building, struggling to make it because the rent or mortgage is too high. Moreover, I have had the same discussion with landlords and real estate developers numerous times about market rental rates for childcare versus office or retail space. Rarely will a childcare business be able to pay the same square footage rental rate as charged for Class A office or retail space.
Before signing a lease agreement for the building, space (or buying a building) in which to operate your child care business, make sure that the monthly rent or mortgage will be less than 15% of conservatively projected gross revenues. Most commercial leases contain a corporate and personal guarantee. In other words, the landlord can pursue payment of the monies agreed upon in the lease from your corporation and you personally, should you go out of business and default on the lease. When you cannot make the numbers work, you will most likely not be able to close the child care business and walk away without fulfilling the lease terms and required rent payments.
Child care businesses encumbered with high building rental rates are very difficult to sell. Do inexperienced childcare buyers with overly optimistic goals take over these childcare businesses and leases? Sure – but it is far more common for one of the buyers’ advisors – an accountant, attorney, partner, lender, or Uncle Charlie – to tell the buyer that the child care business cannot support the monthly rent, and they move on to a better opportunity where the numbers work.
#22 Unreported Income decreases the business value and limits buyers’ ability to obtain financing.
Although not as common as it was 30 years ago when I started my business brokerage practice, some childcare owners today still tell me that their business tax return does not include all the tuition income they have collected. Well, unreported income is not something that I, as a business broker, have any interest in representing. In the eyes of the “law,” unreported income is considered tax fraud. When a broker represents a potential business buyer, there’s unreported income – that’s referred to as the perpetuation of fraud. I love my child care business owner clients – just not enough to go to jail for them. So, I only represent the financial information submitted on the business’s federal tax return.
Three important things to know about the effects of unreported income in a child care business:
- Unreported income decreases the business value because the reported gross revenue is less than the actual revenue generated by the business. Unreported income causes all expense categories to appear higher when compared as a percentage of gross revenues.
- Buyers are not impressed when a childcare business owner shares that they have not been reporting all their income. From the buyer’s perspective, he is often thinking. If the seller is willing to take a high risk and provide false information to “Uncle Sam,” the federal government. In that case, the seller might also provide me with “false” information to get me to buy the business. In my experience, business buyers and sellers must establish a level of trust for the deal to reach closing. Telling a buyer about unreported income does not build trust.
- Buyers, their advisors, and lenders rely on financial information to help determine the value of the business, make an informed offer, and secure financing. Professional advisors have substantial liability for the consulting services and recommendations they provide. Attorneys, accountants, and other professional advisors are quick to tell the business buyer to pass if the business numbers do not look right. Moreover, if the numbers do not look right or work, the buyer will not be able to obtain a loan to purchase the childcare business.
My advice is always to run the business, reporting all income and work, and bringing all expenses into normal benchmark ranges. Once you have three years of accurate tax returns, you will be able to get a higher value for your business, and the buyer will have a much better chance of getting a loan.
#23 Small and Medium-Sized Child Care Businesses – Your Most Likely Buyer
I have been selling child care businesses since 1995 and speaking with hundreds of child care owners and potential buyers each year. In my discussions with child care owners, I often find that they have been planning for years to sell their child care business to a buyer or “type of buyer” that will most likely have little to no interest in their child care business.
Owners of small and medium-sized childcare businesses may be pinning their hopes on selling to a large regional or national childcare chain for an equally large price. Unfortunately, things rarely work out that way. Large regional and national child care chains are only interested in buying large child care centers. Many of these buyers note a minimum license capacity of 125 or even higher as their target acquisition. Moreover, in states with increased licensing regulations, some chain buyers will only consider very large child care businesses. They cannot make the financial numbers work in small or even medium-sized centers.
Small and medium-sized child care businesses are most often purchased by someone already working in child care or early education – maybe as a teacher, director, assistant director or elementary school teacher. Alternatively, the owner of another child care business either within the market area or a distance that does not require too long of a commute. Moreover, the ability to market child care businesses confidentially on the internet sometimes allows for the sale of a child care business to someone living hours away or in another state, but willing to relocate for the right opportunity.
Unlike the large regional and national child care chains, these individual buyers often have limited financial resources to purchase a child care business. Ninety-plus percent will need to obtain either a substantial amount of seller financing, a bank loan, or both to buy a child care business. Therefore, the childcare business must have good financial records showing sufficient profitability, or the buyer will have difficulty convincing a bank to lend the funds for the purchase.
Owners of small and medium-sized child care businesses must:
- operate the business with high enrollments,
- charge market rates,
- Keep very tight controls on labor costs,
- eliminate all unnecessary expenses,
- Keep accurate, supportable financial records, and
- create enough profit to allow the buyer to obtain financing
In summary, the buyers of small to medium-sized childcare businesses are typically individual buyers, rather than regional or national childcare chains. Individual buyers have limited funds and can only obtain a loan to purchase a profitable child care business. As the owner of a small to medium-sized child care business, you must understand the most likely buyer or “buyer type” for your child care business and operate your business in a manner that will provide the profitability for a buyer to purchase your business someday.
#24 Large child care chains – regional and national often make the lowest offers for single-unit locations.
Why? A large childcare operator is often only looking for a great location, high enrollment, and cash flow, rather than program-specific features. Childcare chain operations must have the same proven systems and programs implemented in each location to maintain consistency and profitability.
Many individual private child care operators believe that a child care chain will be interested in their child care business due to its special programs, features, or curriculum, but this is usually not the case. The child care chain buyer must implement their standard program after the purchase. Therefore, special program features you have implemented in your child care business will often have little or no value to the child care chain buyer. However, your special program features may be viewed very favorably by individual buyers. Moreover, unlike the experienced child care chain buyer, the private individual buyer will most likely need your experience and expertise during the early days following the purchase to ensure a smooth transition. Individual buyers almost always pay more than child care chain buyers for single-unit locations.
#25 Profitability starts with setting profitable tuition rates
I often find that a child care business is not profitable because the tuition rates are too low. It is not uncommon to find tuition rates hundreds of dollars less each month (across all age groups) than area market rates.
The owner has decided not to charge higher rates to help their parents afford childcare. Now, please don’t misunderstand what I’m about to say next and accuse me of being heartless. I understand the financial burden that the cost of child care can be for the average family. However, charging tuition rates that are too low results in two and sometimes three undesirable things;
- Low or no profits, which puts the child care business and the owner in a constant financial struggle.
- Low profits lead to limited business value.
- And, number three, low tuition rates often result in the inability to sell a child care business. No buyer wants to be the “bad guy” who buys a childcare business and substantially increases tuition rates, which causes lost enrollment and a poor reputation in the community.
As an owner, you should reevaluate the tuition rates you charge for each age group or classroom. (If you need help calculating your breakeven point and calculating tuition for profit, please give me a call. I am happy to help you.) And, as an owner, make sure you fully understand the impact of low tuition rates on your child care business’s financial health, program quality, and the compounding effect of low business value and the diminished ability to sell your child care business.
#26 Nothing changes an industry faster than a pandemic.
As I write this, it is the fall of 2021. We have been dealing with COVID-19 for almost two years. COVID has impacted every industry and every area of our daily lives. I can list many things that have changed in the child care industry due to COVID. But, I think it is too soon to draw too many conclusions about the long-term impact on the child are industry. As we say in the south, “we are not out of the woods yet.” The new variants of COVID outbreaks and cases continue. Experienced child care industry folks, including myself, have fluctuating opinions about the long-term changes COVID will produce in the child care industry. Although our opinions and predictions may differ, we all agree that COVID will forever change the child care industry.
Circle back here in a couple of months as I will be detailing the impact of COVID on the child care industry short-term and long-term. I’ll share my thoughts on COVID’s impact on the financial operations of child care businesses, business value, buying and selling, and changes owners should consider in planning their exit strategy.