Last month we compared the benefits of buying a new store vs. opening your own store. This month, we’re going to expand on that topic a bit by discussing what you need to look at when you review an opportunity to purchase a game store and how to calculate your offer for the store.

Assessing its Viability

Although you could make virtually any situation work if you threw enough money at it, some stores simply aren’t worth saving. If you have to spend $250,000 to make a store work, why would you? Even if the owner gave you the store, it would still be a bad deal in most cases.

Sales

When you first look at an offer, you must know the store’s sales. I don’t mean just last month’s sales or last year’s sales. Ask for a categorized record of sales by month. If possible, look at actual daily sales records.

Look for patterns in the records. Is each category growing slowly over time? That’s good. Are some categories growing while others are not? That could be bad--or a reflection of national sales trends. Is the store faltering? If so, I recommend considering two options.

Option #1 is to stop negotiating. You don’t want to buy a business in distress for your first business. The location could be terrible. Recent superior competition could have opened up nearby. Something else beyond your control could be happening there and you might not be able to reverse the trend. You’re done here.

Option #2 is also to stop negotiating. Let sales drop for three months and see how firm the seller is on his price. In all likelihood, additional cash-flow loss will put tremendous pressure on him to sell at any price. Sure, another buyer might make an offer. If you’re comfortable with that risk, a small amount of patience could pay off extremely well.

When is falling sales a good sign? Steady sales decreases could mean that the current owner is not doing something right. Customer service could be horrible. The store could be dirty or understocked. If you can fix the problem that’s causing the drop in sales, then falling sales will reduce the market price of the store—and that’s to your advantage.

Inventory

The second key item you need to know is the inventory level (always at cost, never at retail). Looking at a flat number tells you nothing. Let’s say the store you’re considering claims an inventory value of $30,000. Is that good or bad?

Remember those word problems in your middle school math books? The answer is “D. Not enough information.”

All products are not equal in value. The current Magic: the Gathering boosters might be as good as cash, but dusty d20 modules might be overpriced at 90% off retail. A computerized point-of-sale system should be able to tell you when the store last sold a certain item. If an entire product line has seen over a year since its last sale, the value of that product line is zero. Sixteen cases of the Young Jedi trading card game are worth less than some Warhammer armies, for example.

Some owners categorize the inventory into different groups. Class A inventory represents high-turn stuff that you know you can sell at full price in a short period of time. Count it at full value. Class B product represents reliable sales over a longer period of time. It might be worth up to 75% of list price. Class C inventory includes lesser RPGs, older miniatures, slower game lines, and oddball accessories that might have been hot at one time. It might be worth half what the POS thinks it’s worth. Class D inventory is the junk that you hope to God will sell one day. It has little, if any, value. While you won’t know which categories each product lines belong to without having any game retail experience, you can estimate based on the store’s sales records, purchase records (no restocks = no sales), consulting with distributors, and even by watching customer activity for few days.

Another point of reference is the rise and fall of inventory over time. Is the store showing a steady increase in inventory? You can tell this by looking at a balance sheet, which should provide information like cash on hand and inventory levels over 2-3 years. You can measure it in the short term by looking at order forms. Pick two consecutive recent months. Count up the total inventory invoices (include standard gaming merchandise from distributors, direct accounts, cash spent for second-hand products, snacks and sodas—all of it.) Divide that amount by the sales for that period. Normal buying cycles might create some variation, but the figure should be between roughly 53% and 63%.

A number lower than the range might mean that the store is cannibalizing inventory to pay the bills. If the store buys $12,000 worth of goods but sells $24,000 worth of product, the store might have a great cost structure, or it might not be spending its money to restock product. Looking at the cost of goods sold will solve that problem for you.

A number higher than the range means that the store is spending more on inventory than sales justify. That same $12,000 purchase on $18,000 in sales means that the store probably sold about $10,000 worth of goods but spend $12,000 replacing them. In the short term, that happens. A new Magic: the Gathering release might cause it. Buying one or more large gaming collections might do it. Adding a new product line might justify it.

Most of the time, however, it means that the buyer (usually the store owner) is not a very disciplined purchaser and buys products faster than the store can sell them. It’s a common problem that will crush a store’s bank account. If the store maintains that practice all year, based off of our sample figures of $12,000 in purchases and $18,000 in sales, the store spends $24,000 too much every year in cash. That will kill virtually any retailer’s bank account.

The store’s turn rate is another meter that can help you determine the store’s health. Turn rate is the number of times the store turns (sells) its inventory. A store doing $120,000 in annual sales should never have an inventory of $80,000. A figure of $20,000 to $30,000 would be healthier.

Retailers vary in their expectation of a turn rate, and it should vary by product mix, sales level, rate of sales growth, and other variables. I will make a bold statement and declare that for a mature game retail store, anything between 2.5 and 4 is probably fine. A newer store still growing quickly will have strange figures, as its current inventory should be vastly different than its inventory from a year ago.

(Technically, you calculate turn rate based on the Cost of Goods Sold of the products you sell, divided by your average inventory over that time period. Thus, the $120,000 in sales might carry a COGS of $72,000, which, in the above example, yields a turn rate of 1.1. That’s untenable.)

The Lease

In most cases when you buy a first store, you’ll take over the seller’s lease. The seller will assign you the lease, which simply means that you’re taking over as primary rent-payer. Often (but not always), the landlord has to approve this assignment.

That means that you might be a committed to a debt of anywhere from $1,500 to $100,000. Make sure the lease is one you’re comfortable with if that’s the case. Otherwise, you might want to talk to the landlord about renegotiating the terms of the lease.

You might also plan to move the store right away. If location is the problem, then moving the store might fix that problem. It also incurs many of the same costs as a startup, and you’ll lose customers in the move. To make buying and moving a store a good choice for your entry into the industry, the deal has to be exceptional.

We’ll do a more in-depth discussion of a commercial lease soon. For right now, you want to look at the rent, the escalation rate, and the length of the lease so you know what you’re getting into. You’ll need the rent and escalation figures to run your financials (you do have the break-even analysis, right?)

Customer Base

Look at the population of the area the store’s in. A town of 2,500 located 15 miles from a population center of 100,000 is a poor location for a game store. Is it old or young? You want young. Wealthy or poor? You want wealthy. Male or female? Good indicators of a large potential customer base include colleges and military bases.

Assessing its Worth

One way--out of many--to start your estimate of the store’s value is to begin with the value of the inventory. It’s not necessarily the best, but it’s the easiest across-the-board method to demonstrate.

Let’s say your letter-categorization of a seller’s $36,000 in listed inventory came to $19,500. He has box loads of Magic singles that you counted as class D, and his RPG section has some current D&D and White Wolf, a shelf full of 4-year old d20 titles, and about half the Conan line (that’s A, B, D and probably C, respectively).

Your baseline offer starts at $20,000. To that, add a percentage of annual sales. Fifteen or 20% is a good starting point. You might add some value for the existing furnishings, fixtures and equipment. Likewise, if the carpet is ratty and you want to replace it, you might wish to reduce your offer. If you plan to change the name, count nothing for any existing signage--you’ll replace that. If the store has a high turn rate, you might wish to add value for that. If it’s clean and attractive, you could place a value on that. Otherwise, subtract value because you’ll have to improve its condition.

Remember that value is relative. What has value to you is different than what has value to somebody else--including the seller. If buying a store saves you from having to spend 4 hours preparing an initial merchandise order, I’m sure you place some value on that time. If it saves you from having to negotiate a commercial lease, you might value that, too.

Your final figure for this store might be anywhere from $10,000 to $100,000. The total number of variables is too long to discuss in a short column, and the combination of variables makes it an extremely lengthy discussion. I plan to write a detailed sample of how I calculated a store’s value recently--one that was actually purchased by somebody else for almost exactly the price I calculated. Read about it in the forum. We might also discussion alternate methods of calculating a store’s value.

Plan B

You could instead hire a specialist to conduct a business valuation for anywhere from $500 to $3,000.

Lloyd Brown
www.lloydwrites.com