Buying a Funeral Home

Guide to Buying a Funeral Home

Many funeral directors dream of owning their own funeral home. They want to be rewarded for their long hours, hard work and time away from family. They want to be in control of their career and future retirement.

If you think buying a funeral home is the right path for you, ask yourself a few key questions first.  Am I an entrepreneur?  Do I have the drive and attention to detail that it takes to be successful? Do I have the personality to interact successfully with customers and employees?

How Much Can You Offer?

Once you find a business you would like to purchase, how much can you offer? Following are some general guidelines on the most common situations encountered when buying a funeral home. Several assumptions are made, including: the buyer will obtain bank financing to make the purchase; the buyer has excellent credit, strong industry experience and the ability to make a modest down payment; any seller financing will be at similar rates and terms as the bank financing; the buyer will own and operate the business for profit as a stand-alone facility; the value of the individual assets of the business, including real estate, are not greater than the overall value of the business.
An important point to remember when buying any business is that most good businesses sell in the price range of three to six times Seller’s Discretionary Earnings or total cash flow available to the owner. Seller’s Discretionary Earnings or SDE is calculated by adding together several components, including business profit or (loss), owner’s salary, discretionary expenses, non-recurring expenses and non-cash expenses (i.e.: interest, depreciation and amortization).
An important point to remember when buying any business is that most good businesses sell in the price range of three to six times Seller’s Discretionary Earnings or total cash flow available to the owner. Seller’s Discretionary Earnings or SDE is calculated by adding together several components, including business profit or (loss), owner’s salary, discretionary expenses, non-recurring expenses and non-cash expenses (i.e.: interest, depreciation and amortization).
Where your offer falls in this price range depends on the industry and the individual characteristics of the business. In industries where inventory and equipment are of significant value, those items are added to the purchase price, with the purchase price often being expressed in terms of sales revenue, plus inventory and equipment. In the funeral industry, most businesses sell in a price range between four to six times SDE. This price range typically includes all operating assets of the business.

Are Funeral Homes Profitable?

Most potential buyers wonder if funeral homes are profitable. That’s why it makes sense to determine how much cash will be available to pay debt service after the purchase. This is also the method used by banks to determine how much they can loan on a purchase. SDE or cash flow available to the owner is often expressed in terms like adjusted cash flow, seller’s discretionary earnings and adjusted EBITDA (earnings before interest, taxes, depreciation and amortization). All of these terms are used to describe SDE. SDE is a higher number and is not the same as cash flow available to service debt.

Cash flow available to service debt is always a lower number than SDE and it is calculated by subtracting a normal salary for the borrower from SDE. Most lenders require a borrower budget the minimum salary needed to take care of his or her personal liabilities and living expenses. They also require a small margin of safety over and above the actual debt service requirement which we will discuss shortly.
The minimum salary required by the borrower will vary depending on their personal debt level. A good rule of thumb to budget and estimate a borrower’s personal salary requirement is to multiply their annual personal liabilities by two. For example, a borrower with annual personal liabilities of $15,000 will require a minimum personal salary of $30,000, which is then subtracted from SDE to arrive at cash flow available for debt service. Cash flow available for debt service or CDS is then used to determine how much the borrower can borrow for the purchase, which then allows the borrower to estimate how much they can offer the seller.
In addition to subtracting a salary requirement, most banks will build in a margin of safety when calculating the actual debt payments they are comfortable with. This margin of safety is referred to as debt coverage and is usually expressed in a ratio called the debt coverage ratio. Some banks require a minimum debt coverage ratio of at least 1.25 and some up to 1.50. For example, if a bank required a minimum debt coverage ratio of 1.25 and the CDS was $125,000, the bank would only be comfortable with annual debt payments up to $100,000. This total would then be used with the amortization term and interest rate to determine how much the borrower could borrow for the purchase.

How Much Does It Cost
to Own a Funeral Home?

 In order to determine how much it will cost to own a funeral home, take a look at the minimum salary requirement and the debt coverage margin. Let us say over the past three years a business has achieved average SDE of $350,000. The borrower’s personal salary requirement is estimated to be at least $50,000, which is then subtracted from SDE to arrive at CDS of $300,000. Let us say the lender is conservative and requires debt coverage of at least 1.5 on loans of this size. Dividing CDS of $300,000 by the minimum debt coverage ratio of 1.5 leaves $200,000 for total annual debt payments. In this example, $200,000 in annual debt payments over 15 years at 8.00% would allow the buyer to borrower approximately $1.7 million to make the purchase. If the buyer planned to put down $300,000 in cash, the buyer could offer the seller approximately $2.0 million for the business.

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Time-Consuming and Stressful Process

Working long hours, being underpaid and having an entrepreneurial spirit are all factors that drive employee funeral directors to begin looking for ownership. These factors also often create an ownership drive so strong it can overshadow logic when it comes to researching an opportunity.
Buying a business can be time-consuming and stressful. Just finding a quality business for sale can be a daunting task. Once you find a business for sale, the real work of evaluating that business begins. Finding a business for sale and evaluating that business is a process. Like most processes, each step is important to achieving ownership. The goal of this Buying Basics series is to introduce buyers to key elements in the buying process.
In the funeral industry, sellers typically do not want their competitors to know they are considering a sale. So even though there may be a lot of funeral homes for sale at any given time, it may be difficult to find out which ones are available.
Personal networking is probably the best way a buyer can find out who might be considering a sale. Depending on the relationship you have with your current employer, your personal network should begin with people you can trust. This network will probably include a select group of your peers, existing funeral home owners and industry sales representatives located in the geography you would like to buy in. Another way to locate businesses for sale is to watch trade publications and industry websites for classified ads.
Paramount in your search for a business for sale is to be on the lookout for several common seller situations. The first seller situation is when the business is for sale, but not at a price you can afford to pay. The common statement that everything is for sale at the right price applies to situations like this when the seller isn’t really for sale but is merely “fishing” around for a buyer willing to pay an exorbitant price.
The second common seller situation is when a business is for sale, but the business is not viable long term. Most businesses are for sale for a reason. Finding out why a business is for sale is one of the most important questions you will need to answer. The most likely reason a business may be for sale is that the current owner wants to retire and transition the business to a well-qualified buyer. A less desirable reason a business may be for sale is that the market has changed and business volume isn’t what is used to be.
A third common seller situation is when a business is for sale, but the business doesn’t fit your needs. It sounds great if the business is for sale for a positive reason and has been doing consistent sales revenue. It doesn’t mean this business is the right fit for you. The funeral business is personal and most owners enjoy a close relationship with their customers. These relationships are critical to the long-term success of the funeral home. Transitioning these relationships to a new owner doesn’t always go off without a hitch. When there are competitors in the market, new owners often see a downswing in business revenue or volume of 10 percent or more during their first year. If these customer relationships are not transitioned effectively, the new owner may see even greater downswings in revenue and volume. Closely evaluate the non-financial aspects of the opportunity.

Buyers Shouldn’t Go Through the Process Alone

Working long hours, being underpaid and having an entrepreneurial spirit are all factors that drive employee funeral directors to begin looking for ownership. These factors also often create an ownership drive so strong it can overshadow logic when it comes to researching an opportunity. Remember, funeral directors prioritize family interaction over administrative tasks. They are tired, underpaid and are often willing to do anything to achieve ownership. This puts them at a distinct disadvantage when reviewing opportunities and dealing with the various parties to a transaction.

Buying a funeral home is complex. There are many details that need to be handled in the transaction process. There are legal, financial and tax issues that need to be addressed in every business purchase. A buyer should always seek the appropriate legal, financial and tax advice when going through a transaction. Buyers who go it alone often pay the price in terms of poorly designed legal agreements, overly burdensome transaction structures, heavy tax consequences and unfavorable financing terms. Steve Jobs, the founder of Apple Inc., once said: “Great things in business are never done by one person. They’re done by a team of people.”

Almost every buyer working on a transaction will have some type of an advisor during the process. A competent advisor can help you prepare your personal information, locate a business for sale, evaluate and negotiate the purchase price, assist in due diligence and structure competitive financing terms.
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