chapter 5: buying a business 1 copyright 2002 prentice hall publishing company buying an existing...

Chapter 5: Buying a BusinessChapter 5: Buying a Business 11Copyright 2002 Prentice Hall Publishing CompanyCopyright 2002 Prentice Hall Publishing Company

Buying An Existing Business

Buying An Existing Business

For Sale


After going through this chapter, After going through this chapter, you will be able to:you will be able to:

1- 1- Understand (A) the advantages and (B) the disadvantages of Understand (A) the advantages and (B) the disadvantages of buying an existing business.buying an existing business.

2- 2- Define the steps involved in the right way to buy a business.Define the steps involved in the right way to buy a business.

3- 3- Describe the various techniques for determining the value of Describe the various techniques for determining the value of a business.a business.

4-4-Understand the seller’s side of the buyout decision and how Understand the seller’s side of the buyout decision and how to structure the deal.to structure the deal.

5-5-Understand how the negotiation process works and identify Understand how the negotiation process works and identify the factors that affect it.the factors that affect it.


Key Questions to Consider Key Questions to Consider BeforeBefore Buying a BusinessBuying a Business

Prospective buyers must be sure that they discover Prospective buyers must be sure that they discover the answers to the following fundamental questions:the answers to the following fundamental questions:Is the right type of business for sale in the market Is the right type of business for sale in the market in which you want to operate?in which you want to operate?What experience do you have in this particular What experience do you have in this particular business and the industry in which it operates?business and the industry in which it operates?How critical is experience in the business to your How critical is experience in the business to your ultimate success?ultimate success?What price and payment method are reasonable What price and payment method are reasonable for you and acceptable to the seller?for you and acceptable to the seller?


Key Questions to Consider Key Questions to Consider BeforeBefore Buying a BusinessBuying a Business

(continued)(continued)

Should you start the business and build it from Should you start the business and build it from the ground up rather than buy an existing one?the ground up rather than buy an existing one?

What is the company’s potential for success?What is the company’s potential for success? What changes will you have to make – and how What changes will you have to make – and how

extensive will they have to be – to realize the extensive will they have to be – to realize the business’s full potential?business’s full potential?

Will the company generate sufficient cash flow Will the company generate sufficient cash flow to pay for itself and leave you with a suitable to pay for itself and leave you with a suitable return on your investment?return on your investment?


What Are the Advantages and What Are the Advantages and Disadvantages of Buying an Existing Disadvantages of Buying an Existing

Business?Business?

If you want to start your own business, the number of If you want to start your own business, the number of choices available are almost infinite: starting from choices available are almost infinite: starting from zero, buying a franchise, partnering. If you don't have zero, buying a franchise, partnering. If you don't have previous business experience, however, it may make previous business experience, however, it may make sense to consider buying an existing business, which sense to consider buying an existing business, which can put you ahead of the competition by throwing you can put you ahead of the competition by throwing you directly into the business world. Before you make the directly into the business world. Before you make the final decision, though, here are some of the pros and final decision, though, here are some of the pros and cons of previously established businesses and how to cons of previously established businesses and how to deal with them. deal with them.


The Advantages of Buying an The Advantages of Buying an Existing BusinessExisting Business

It gives you the advantage of an established customer It gives you the advantage of an established customer base. People will already know the place, so the costs base. People will already know the place, so the costs of advertising will be less. You will also avoid the of advertising will be less. You will also avoid the uncertain initial period, where attracting customers to uncertain initial period, where attracting customers to the business can turn into a full-time job in itself.the business can turn into a full-time job in itself.

A business plan and marketing method should A business plan and marketing method should already be in place.already be in place.

A market for the product or service will have already A market for the product or service will have already been demonstrated been demonstrated


The Advantages of Buying an The Advantages of Buying an Existing BusinessExisting Business

An Existing Business May Already Have An Existing Business May Already Have the Best Locationthe Best Location

When the location of the business is critical to its success (as is When the location of the business is critical to its success (as is often the case in retailing), it may be wise to purchase a often the case in retailing), it may be wise to purchase a business that is already in the right place.business that is already in the right place.

Employees and Suppliers Are Established Employees and Suppliers Are Established An existing business already has experienced employees who An existing business already has experienced employees who

can help the new owner through the transition phase. can help the new owner through the transition phase. Experienced employees enable a company to continue to Experienced employees enable a company to continue to earn money while a new owner learns the business.earn money while a new owner learns the business.


A Successful Existing Business May A Successful Existing Business May Continue to Be Successful Continue to Be Successful

The previous management team already has The previous management team already has established a customer base, built supplier established a customer base, built supplier relationships, and set up a business system. relationships, and set up a business system. The customer base inherited in a business The customer base inherited in a business purchase can carry an entrepreneur while he purchase can carry an entrepreneur while he studies how the business has become studies how the business has become successful and how to build on that success. successful and how to build on that success.


Equipment Is Installed and Productive Capacity Is Known Equipment Is Installed and Productive Capacity Is Known

In an existing business, a potential buyer can determine the In an existing business, a potential buyer can determine the condition of the plant and equipment and its capacity before condition of the plant and equipment and its capacity before buying. The previous owner may have established an efficient buying. The previous owner may have established an efficient production operation through trial and error, although the new production operation through trial and error, although the new owner may need to make modifications to improve it.owner may need to make modifications to improve it.

Inventory Is in Place and Trade Credit Is Established Inventory Is in Place and Trade Credit Is Established

The proper amount of inventory is essential to both controlling The proper amount of inventory is essential to both controlling costs and generating adequate sales volume. If a business has costs and generating adequate sales volume. If a business has too little inventory, it will not have the quantity and variety of too little inventory, it will not have the quantity and variety of products it needs to satisfy customer demand. However, if a products it needs to satisfy customer demand. However, if a business has too much inventory, it is tying up excessive capital business has too much inventory, it is tying up excessive capital unnecessarily, thereby increasing costs and reducing unnecessarily, thereby increasing costs and reducing profitability. In addition, previous owners have established trade profitability. In addition, previous owners have established trade credit relationships with vendors that can benefit the new owner. credit relationships with vendors that can benefit the new owner.


The New Business Owner Hits the Ground The New Business Owner Hits the Ground Running Running

Entrepreneurs who purchase existing Entrepreneurs who purchase existing businesses avoid the time, costs, and energy businesses avoid the time, costs, and energy required to launch a new business.required to launch a new business.

Entrepreneurs who buy existing successful Entrepreneurs who buy existing successful businesses do not have to invest a lifetime businesses do not have to invest a lifetime building a company to enjoy its success.building a company to enjoy its success.


The New Owner Can Use the Experience of the The New Owner Can Use the Experience of the Previous OwnerPrevious Owner

The new owner can trace the impact on costs and The new owner can trace the impact on costs and revenues of the major decisions that the previous owner revenues of the major decisions that the previous owner made and can learn from his mistakes and profit from made and can learn from his mistakes and profit from his achievements. In many cases, the previous owner his achievements. In many cases, the previous owner spends time with the new owner during the transition spends time with the new owner during the transition period, giving the new manager the opportunity to learn period, giving the new manager the opportunity to learn about the policies and procedures in place and the about the policies and procedures in place and the reasons for them. After all, most owners who sell out reasons for them. After all, most owners who sell out want to see the buyer succeed in carrying on their want to see the buyer succeed in carrying on their businesses.businesses.


Easier Financing Easier Financing

Attracting financing to purchase an existing Attracting financing to purchase an existing business often is easier than finding the business often is easier than finding the money to launch a company from scratch. money to launch a company from scratch. Many existing businesses already have Many existing businesses already have established relationships with lenders, which established relationships with lenders, which may open the door to financing through may open the door to financing through traditional sources such as banks. traditional sources such as banks.


It’s a Bargain It’s a Bargain

Some existing businesses may be real bargains. The Some existing businesses may be real bargains. The current owners may need to sell on short notice, current owners may need to sell on short notice, which may lead them to sell the business at a low which may lead them to sell the business at a low price.. The more specialized a business is, the price.. The more specialized a business is, the greater the likelihood is that a buyer can find a greater the likelihood is that a buyer can find a bargain. If special skill or training is required to bargain. If special skill or training is required to operate a business, the number of potential buyers operate a business, the number of potential buyers will be significantly smaller. If the seller wants a will be significantly smaller. If the seller wants a substantial down payment or the entire selling price substantial down payment or the entire selling price in cash, few buyers may qualify; however, those in cash, few buyers may qualify; however, those who do may be able to negotiate a good deal.who do may be able to negotiate a good deal.


Disadvantages of Buying an Existing Disadvantages of Buying an Existing BusinessBusiness

You will inherit all problems that run with the You will inherit all problems that run with the business. If the previous owner had trouble business. If the previous owner had trouble attracting new customers, paying the lease, or attracting new customers, paying the lease, or running new campaigns, you will have to deal with running new campaigns, you will have to deal with everything to set things right before you can even everything to set things right before you can even start to think about moving forward. If the business start to think about moving forward. If the business has a history of disappointing customers, you may has a history of disappointing customers, you may also have a hard time convincing people that things also have a hard time convincing people that things will change under your direction. will change under your direction.


Disadvantages of Buying an Disadvantages of Buying an Existing BusinessExisting Business

It’s a “Loser” It’s a “Loser”

A business may be for sale because it is struggling and the A business may be for sale because it is struggling and the owner wants out. In these situations, a prospective buyer owner wants out. In these situations, a prospective buyer must be wary. Business owners sometimes attempt to must be wary. Business owners sometimes attempt to disguise the facts and employ creative accounting disguise the facts and employ creative accounting techniques to make the company’s financial picture appear techniques to make the company’s financial picture appear much brighter than it really is. Few business sellers much brighter than it really is. Few business sellers honestly state “It’s losing money” as the reason for putting honestly state “It’s losing money” as the reason for putting their companies up for sale... If an analysis of a company their companies up for sale... If an analysis of a company shows that it is poorly managed or suffering from neglect, shows that it is poorly managed or suffering from neglect, a new owner may be able to turn it around.a new owner may be able to turn it around.


The Previous Owner May Have Created Ill Will The Previous Owner May Have Created Ill Will

Just as ethical, socially responsible business dealings create goodwill for a Just as ethical, socially responsible business dealings create goodwill for a company, improper business behavior creates ill will. Customers, company, improper business behavior creates ill will. Customers, suppliers, creditors, or employees may have extremely negative suppliers, creditors, or employees may have extremely negative feelings about a company’s reputation because of the unethical actions feelings about a company’s reputation because of the unethical actions of its current owner. of its current owner.

Employees Inherited with the Business May Not Be Suitable Employees Inherited with the Business May Not Be Suitable

Previous managers may have kept marginal employees because they were Previous managers may have kept marginal employees because they were close friends or because they started with the company. A new owner, close friends or because they started with the company. A new owner, therefore, may have to make some very unpopular termination therefore, may have to make some very unpopular termination decisions. For this reason, employees often do not welcome a new decisions. For this reason, employees often do not welcome a new owner because they feel threatened by change. Some employees may owner because they feel threatened by change. Some employees may not be able to adapt to the new owner’s management style, and a not be able to adapt to the new owner’s management style, and a culture clash may result. If it reveals that existing employees are a culture clash may result. If it reveals that existing employees are a significant cause of the problems a business faces, the new owner will significant cause of the problems a business faces, the new owner will have no choice but to terminate them and make new hires..have no choice but to terminate them and make new hires..


The Business Location May Have Become The Business Location May Have Become Unsatisfactory Unsatisfactory

Prospective buyers should always evaluate the existing market Prospective buyers should always evaluate the existing market in the area surrounding an existing business as well as its in the area surrounding an existing business as well as its potential for expansion. Buyers must remember that they are potential for expansion. Buyers must remember that they are buying the future of a business, not merely its past. A buying the future of a business, not merely its past. A location in decline may never recover. If business success is location in decline may never recover. If business success is closely linked to a good location, acquiring a business in a closely linked to a good location, acquiring a business in a declining area or where demographic trends are moving declining area or where demographic trends are moving downward is not a good idea. downward is not a good idea.


Equipment and Facilities May Be Obsolete or Equipment and Facilities May Be Obsolete or Inefficient Inefficient

Potential buyers sometimes neglect to have an expert evaluate Potential buyers sometimes neglect to have an expert evaluate a company’s facilities and equipment before they purchase a company’s facilities and equipment before they purchase it. Only later do they discover that the equipment is it. Only later do they discover that the equipment is obsolete and inefficient and that the business may suffer obsolete and inefficient and that the business may suffer losses from excessively high operating costs.losses from excessively high operating costs.

Change and Innovation Are Difficult to ImplementChange and Innovation Are Difficult to Implement

It is easier to plan for change than it is to implement it. It is easier to plan for change than it is to implement it. Methods, policies, and procedures the previous owner used Methods, policies, and procedures the previous owner used in a business may have established precedents that a new in a business may have established precedents that a new owner finds difficult to modify.owner finds difficult to modify.


Inventory May Be Outdated or Obsolete Inventory May Be Outdated or Obsolete Inventory is valuable only if it is salable.Inventory is valuable only if it is salable.

Smart buyers know better than to trust the Smart buyers know better than to trust the inventory valuation on a firm’s balance inventory valuation on a firm’s balance sheet.sheet.

A prospective buyer must judge inventory by A prospective buyer must judge inventory by its market value.its market value.


The Business May Be Overpriced The Business May Be Overpriced

Each year, many people purchase businesses atEach year, many people purchase businesses at

prices far in excess of their value, which can impair prices far in excess of their value, which can impair the companies’ ability to earn a profit and generate the companies’ ability to earn a profit and generate a positive cash flow. If a buyer accurately values a a positive cash flow. If a buyer accurately values a business’s accounts receivable, inventories, and business’s accounts receivable, inventories, and other assets, he or she will be in a better position to other assets, he or she will be in a better position to negotiate a price that will allow the business to be negotiate a price that will allow the business to be profitable..profitable..


Five Critical Areas for AnalyzingFive Critical Areas for Analyzingan Existing Businessan Existing Business

1.1. Why does the owner want to sell.... the Why does the owner want to sell.... the realreal reason?reason?

2.2. What is the physical condition of the business?What is the physical condition of the business?

3.3. What is the potential for the company's What is the potential for the company's products or services?products or services?

• Customer characteristics and composition.Customer characteristics and composition.

• Competitor analysis.Competitor analysis.

4.4. What legal aspects must I consider?What legal aspects must I consider?

5.5. Is the business financially sound?Is the business financially sound?


The Steps in Acquiring a BusinessThe Steps in Acquiring a BusinessThe steps involved in the right way to buy a The steps involved in the right way to buy a business are :business are :Analyze your skills, abilities, and interest.Analyze your skills, abilities, and interest.Prepare a list of potential candidates Prepare a list of potential candidates (Remember the “hidden market.”)(Remember the “hidden market.”)Investigate and evaluate candidate Investigate and evaluate candidate businesses and select the best one.businesses and select the best one.Explore financing options.Explore financing options.Ensure a smooth transition.Ensure a smooth transition. Kwik-Mart


Analyze Your Skills, Abilities, and Analyze Your Skills, Abilities, and InterestsInterests

The primary focus is to identify the type of business The primary focus is to identify the type of business you you will be happiest and most will be happiest and most successful owning. Consider, for example, the following questions:successful owning. Consider, for example, the following questions:What business activities do you enjoy most? Least? Why?What business activities do you enjoy most? Least? Why?Which industries or markets offer the greatest potential for growth?Which industries or markets offer the greatest potential for growth?Which industries interest you most? Least? Why?Which industries interest you most? Least? Why?What kind of business do you want to buy?What kind of business do you want to buy?What kinds of businesses do you want to What kinds of businesses do you want to avoidavoid??What do you expect to get out of the business?What do you expect to get out of the business?How much time, energy, and money can you put into the business?How much time, energy, and money can you put into the business?What business skills and experience do you have? What skills and experience do What business skills and experience do you have? What skills and experience do you lack?you lack?How easily can you transfer your skills and experience to other types of How easily can you transfer your skills and experience to other types of businesses?businesses?In what kinds of businesses would that transfer be easiest?In what kinds of businesses would that transfer be easiest?How much risk are you willing to take?How much risk are you willing to take?


Prepare a List of Potential Prepare a List of Potential CandidatesCandidates

Once you know what your goals are for acquiring a business, Once you know what your goals are for acquiring a business, you can begin your search. Do not limit yourself to only those you can begin your search. Do not limit yourself to only those businesses that are advertised as being “for sale.” In fact, the businesses that are advertised as being “for sale.” In fact, the hidden market of companies that might be for sale but are not hidden market of companies that might be for sale but are not advertised as such is one of the richest sources of top-quality advertised as such is one of the richest sources of top-quality businesses. Many businesses that can be purchased are not businesses. Many businesses that can be purchased are not publicly advertised but are available either through the owners publicly advertised but are available either through the owners or through business brokers and other professionals. Although or through business brokers and other professionals. Although they maintain a low profile, these hidden businesses represent they maintain a low profile, these hidden businesses represent some of the most attractive purchase targets a prospective some of the most attractive purchase targets a prospective buyer may find.buyer may find.


Investigate and Evaluate Candidate Investigate and Evaluate Candidate Businesses and Evaluate the Best OneBusinesses and Evaluate the Best One

Finding the right company requires patience. Although some buyers find a Finding the right company requires patience. Although some buyers find a company after only a few months of looking, the typical search takes much longer, company after only a few months of looking, the typical search takes much longer, sometimes as much as two or three years. Once you have a list of prospective sometimes as much as two or three years. Once you have a list of prospective candidates, it is time to do your homework. The next step is to investigate the candidates, it is time to do your homework. The next step is to investigate the candidates in more detail:candidates in more detail:What are the company’s strengths? Weaknesses?What are the company’s strengths? Weaknesses?Is the company profitable? What is its overall financial condition?Is the company profitable? What is its overall financial condition?What is its cash flow cycle? How much cash will the company generate?What is its cash flow cycle? How much cash will the company generate?Who are its major competitors?Who are its major competitors?How large is the customer base? Is it growing or shrinking?How large is the customer base? Is it growing or shrinking?Are the current employees suitable? Will they stay?Are the current employees suitable? Will they stay?What is the physical condition of the business, its equipment, and its inventory?What is the physical condition of the business, its equipment, and its inventory?What new skills must you learn to be able to manage this business successfully?What new skills must you learn to be able to manage this business successfully?


Explore Financing OptionsExplore Financing OptionsThe next challenging task in closing a successful The next challenging task in closing a successful deal is financing the purchase. Although financing deal is financing the purchase. Although financing the purchase of an existing business usually is easier the purchase of an existing business usually is easier than financing a new one, some traditional lenders than financing a new one, some traditional lenders shy away from deals involving the purchase of an shy away from deals involving the purchase of an existing business. Those that are willing to finance existing business. Those that are willing to finance business purchases normally lend only a portion of business purchases normally lend only a portion of the value of the assets, and buyers often find the value of the assets, and buyers often find themselves searching for alternative sources of themselves searching for alternative sources of funds.funds.


Ensure a Smooth TransitionEnsure a Smooth TransitionOnce the parties strike a deal, the challenge of making a smooth transition immediatelyOnce the parties strike a deal, the challenge of making a smooth transition immediately

arises. No matter how well planned the sale is, there are arises. No matter how well planned the sale is, there are always always surprises. For instance,surprises. For instance,

the new owner may have ideas for changing the business—sometimes radically—thatthe new owner may have ideas for changing the business—sometimes radically—that

cause a great deal of stress and anxiety among employees and the previous owner.cause a great deal of stress and anxiety among employees and the previous owner.

To avoid a bumpy transition, a business buyer should do the following:To avoid a bumpy transition, a business buyer should do the following:Concentrate on communicating with employees. Business sales are fraught withConcentrate on communicating with employees. Business sales are fraught with

uncertainty and anxiety, and employees need reassurance.uncertainty and anxiety, and employees need reassurance.Be honest with employees. Avoid telling them only what they want to hear. ShareBe honest with employees. Avoid telling them only what they want to hear. Share

with the employees your vision for the business in the hope of generating a heightenedwith the employees your vision for the business in the hope of generating a heightened

level of motivation and support.level of motivation and support.Listen to employees. They have first-hand knowledge of the business and its strengthsListen to employees. They have first-hand knowledge of the business and its strengths

and weaknesses and usually can offer valuable suggestions for improving it.and weaknesses and usually can offer valuable suggestions for improving it.Consider asking the seller to serve as a consultant until the transition is complete. TheConsider asking the seller to serve as a consultant until the transition is complete. The

previous owner can be a valuable resource, especially to an inexperienced buyerprevious owner can be a valuable resource, especially to an inexperienced buyer


The Legal Aspects of Buying a BusinessThe Legal Aspects of Buying a Business

Lien Lien –– creditors’ claims against an asset. creditors’ claims against an asset. Bulk transfer Bulk transfer –– protects business buyer protects business buyer

from the claims unpaid creditors might from the claims unpaid creditors might have against a company’s assets.have against a company’s assets.

Contract assignment Contract assignment –– buyer’s ability to buyer’s ability to assume rights under seller’s existing assume rights under seller’s existing contracts.contracts.


The Legal Aspects of Buying a BusinessThe Legal Aspects of Buying a Business(continued)(continued)

Restrictive covenant Restrictive covenant –– contract in which a contract in which a business seller agrees not to compete with business seller agrees not to compete with the buyer within a specific time and the buyer within a specific time and geographic area.geographic area.

Ongoing legal liabilities Ongoing legal liabilities –– physical physical premises, product liability, and labor premises, product liability, and labor relations.relations.

Figure 5.1 The Acquisition ProcessFigure 5.1 The Acquisition Process

Negotiations

1. Identify1. Identifyand approachand approachcandidate candidate

2. Sign2. Signnondisclosurenondisclosurestatementstatement

3. Sign3. Signletter ofletter ofintentintent

4. Buyer’s 4. Buyer’s due diligencedue diligenceinvestigationinvestigation

5. Draft the5. Draft thepurchase purchase agreementagreement

6. Close 6. Close the finalthe finaldealdeal

7. Begin the 7. Begin the transitiontransition

1. Approach the candidate. If abusiness is advertised for sale, theproper approach is through the channel defined in the ad.Sometimes, buyers will contact business brokers to help them locate potential target companies.If you have targeted a company inthe “hidden market,” an introduction from a banker,accountant, or lawyer often is thebest approach. During this phase,the seller checks out the buyer’s qualifications, and the buyer beginsto judge the quality of the company.2. Sign a nondisclosure document. If the buyer and the seller are satisfiedwith the results of their preliminaryresearch, they are ready to beginserious negotiations. Throughout thenegotiation process, the seller expectsthe buyer to maintain strict confidentiality of all of the records,

documents, and information he receives during the investigation andnegotiation process. The nondisclosure document is a legally binding contract that ensures the secrecy of the parties’ negotiations.3. Sign a letter of intent. Before a buyermakes a legal offer to buy the company, he typically will ask the seller to sign a letter of intent. The letter of intent is a non-binding document that says that the buyer and the seller have reached asufficient “meeting of the minds” to justify the time and expense of negotiatinga final agreement. The letter should state clearly that it is non-binding, giving eitherparty the right to walk away from the deal. It should also contain a clause calling for“good faith negotiations” between theparties. A typical letter of intent addressesterms such as price, payment terms, categories of assets to be sold, and a deadlinefor closing the final deal.

4. Buyer’s Due Diligence. Whilenegotiations are continuing, the buyeris busy studying the business and evaluating its strengths and weaknesses.In short, the buyer must “do his homework”to make sure that the business is a goodvalue. 5. Draft the Purchase Agreement. Thepurchase agreement spells out the parties’final deal! It sets forth all of of the details of the agreement and is the final product of thenegotiation process.6. Close the final deal. Once the parties havedrafted the purchase agreement, all that remains to making the deal “official” is theclosing. Both buyer and seller sign the necessary documents to make the sale final.The buyer delivers the required money, and the seller turns the company over to the buyer.7. Begin the Transition. For the buyer, the realchallenge now begins: Making the transitionto a successful business owner!

Sources: Adapted from Buying and Selling: A Company Handbook, Price Waterhouse,( New York: 1993) pp.38-42;Charles F. Claeys, “The Intent to Buy,” Small Business Reports, May 1994, pp.44-47.


The Five P’s of Negotiating

Preparation - Examine the needsof both parties and all of the

relevant external factors affectingthe negotiation before you sit

down to talk.

Poise - Remain calm during thenegotiation. Never raise your voice

or lose your temper, even if thesituation gets difficult or emotional.It’s better to walk away and calm

down than to blow up and blowthe deal.

Persuasiveness - Know whatyour most important positions are,articulate them, and offer support

for your position.

Persistence - Don’t give in at thefirst sign of resistance to your

position, especially if it is an issuethat ranks high in your list of priorities.

Patience - Don’t be in sucha hurry to close the deal that

you end up giving up much of whatyou hoped to get. Impatience is

a major weakness ina negotiation.


Determining the Value of a BusinessDetermining the Value of a Business

Balance Sheet Technique Balance Sheet Technique Variation: Adjusted Balance Sheet Variation: Adjusted Balance Sheet

TechniqueTechnique Earnings ApproachEarnings Approach

Variation 1: Excess Earnings ApproachVariation 1: Excess Earnings Approach Variation 2: Capitalized Earnings ApproachVariation 2: Capitalized Earnings Approach Variation 3: Discounted Future Earnings Variation 3: Discounted Future Earnings

ApproachApproach Market ApproachMarket Approach


Question #1: "When Did the Owner Decide to Sell the Business?"Question #1: "When Did the Owner Decide to Sell the Business?" In some ways, buying an existing business is like buying a used car. If you've In some ways, buying an existing business is like buying a used car. If you've

ever bought a used car, you probably asked the dealer why the previous ever bought a used car, you probably asked the dealer why the previous owner sold the car in the first place. And then the car dealer probably told owner sold the car in the first place. And then the car dealer probably told you that the previous owner was a little old lady who only drove it church and you that the previous owner was a little old lady who only drove it church and was recently placed in a nursing home.was recently placed in a nursing home.

Business buyers have a similar curiosity about the owner's decision to sell. Business buyers have a similar curiosity about the owner's decision to sell. Owners usually respond with an answer from the seller's playbook. Owners usually respond with an answer from the seller's playbook. Variations of "I'm ready to retire," "It's time to do something else," and "It's Variations of "I'm ready to retire," "It's time to do something else," and "It's time to give someone else a chance" lead the pack.time to give someone else a chance" lead the pack.

Yet much of the time, the reason behind the owner's decision to sell is less Yet much of the time, the reason behind the owner's decision to sell is less important than when the owner decided to put the business on the market.important than when the owner decided to put the business on the market.

Ideally, the answer buyers should look for is that the listing didn't arise Ideally, the answer buyers should look for is that the listing didn't arise suddenly, but came as the result of a well-thought out, multi-year plan suddenly, but came as the result of a well-thought out, multi-year plan conceived by the owner as a means of achieving his personal and business conceived by the owner as a means of achieving his personal and business goals. If that's true, the owner should be able to provide the buyer with a copy goals. If that's true, the owner should be able to provide the buyer with a copy of the plan upon request.of the plan upon request.

But if the owner's decision to list the business happened quickly, that could be But if the owner's decision to list the business happened quickly, that could be a red flag that the business is in trouble, that there are economic threats on a red flag that the business is in trouble, that there are economic threats on the horizon, or that the owner hasn't taken the the horizon, or that the owner hasn't taken the time to properly prepare time to properly prepare due diligence materials.due diligence materials.


Question #4: "What Would the Seller Do to Increase Question #4: "What Would the Seller Do to Increase Sales and Profits"Sales and Profits"

More than anything else, buyers need to create More than anything else, buyers need to create opportunities to inject a dose of reality into the buying opportunities to inject a dose of reality into the buying decision. Presumably, the person who is most qualified to decision. Presumably, the person who is most qualified to offer a realistic perspective about the business and its offer a realistic perspective about the business and its future growth prospects is its owner. Yet sellers often future growth prospects is its owner. Yet sellers often prefer to paint a rosy portrait of the company rather prefer to paint a rosy portrait of the company rather than simply telling it like it is.than simply telling it like it is.

One of the ways a buyer can break through a reluctant One of the ways a buyer can break through a reluctant seller's defenses is to invite the owner to make seller's defenses is to invite the owner to make suggestions about how to increase capacity, market share suggestions about how to increase capacity, market share and profitability. With the right approach, a buyer's and profitability. With the right approach, a buyer's appeal to owner expertise can change the seller's posture appeal to owner expertise can change the seller's posture from defensive to collaborative.from defensive to collaborative.


Buying an existing business is a big decision. It is critical that, as a prospective buyer, you spend Buying an existing business is a big decision. It is critical that, as a prospective buyer, you spend time investigating the business prior to making the decision to purchase. Obtaining information time investigating the business prior to making the decision to purchase. Obtaining information about the business can help you make a well-informed decision. You must be prepared to about the business can help you make a well-informed decision. You must be prepared to carefully assess all business records and risks while searching for any "skeletons in the closet."carefully assess all business records and risks while searching for any "skeletons in the closet."

The following is a checklist of information to gather about the business. This checklist serves as a The following is a checklist of information to gather about the business. This checklist serves as a guide in investigating the business. Throughout the process, consider your goals, objectives, and guide in investigating the business. Throughout the process, consider your goals, objectives, and strategic plans for the business. Analyze your financial expectations and time constraints to strategic plans for the business. Analyze your financial expectations and time constraints to confirm that you can make the business succeed. Keep in mind that a good investment for one confirm that you can make the business succeed. Keep in mind that a good investment for one person may not be a good choice for someone else.person may not be a good choice for someone else.

Much of the information in the checklist can be obtained by interviewing the seller and asking Much of the information in the checklist can be obtained by interviewing the seller and asking questions. Other information can be learned by obtaining important business documents such as questions. Other information can be learned by obtaining important business documents such as financial statements, tax returns, leases, etc. You can also gain information through observations financial statements, tax returns, leases, etc. You can also gain information through observations or by talking with employees (if given permission by the seller).or by talking with employees (if given permission by the seller).

Keep in mind that communication between the prospective buyer and the seller is important. The Keep in mind that communication between the prospective buyer and the seller is important. The seller provides invaluable experience and knowledge that the prospective buyer needs in order to seller provides invaluable experience and knowledge that the prospective buyer needs in order to make a decision about purchasing the business. The seller also has a great deal of knowledge that make a decision about purchasing the business. The seller also has a great deal of knowledge that would be beneficial after transfer of ownership. However, be mindful of the seller's point-of-view would be beneficial after transfer of ownership. However, be mindful of the seller's point-of-view when gathering information. The seller likely has invested much time, energy, and money in the when gathering information. The seller likely has invested much time, energy, and money in the business. A tactful approach to the investigation process can be advantageous during the business. A tactful approach to the investigation process can be advantageous during the negotiation phase.negotiation phase.


Obtaining Financing for a Business PurchaseObtaining Financing for a Business Purchase

Before spending time investigating a business for a potential purchase, first gain an Before spending time investigating a business for a potential purchase, first gain an understanding about the realities of obtaining financing. Review the following understanding about the realities of obtaining financing. Review the following ASBTDC articles: ASBTDC articles: Obtaining Small Business FinancingCan I Qualify for a Business Loan

Keep in mind that it is unlikely you'll be able to obtain 100% financing to purchase a Keep in mind that it is unlikely you'll be able to obtain 100% financing to purchase a business. Lenders typically require buyers to contribute their own cash equity towards business. Lenders typically require buyers to contribute their own cash equity towards the business purchase. The general rule-of-thumb is that lenders like to see at least the business purchase. The general rule-of-thumb is that lenders like to see at least 20% to 30% of the project in the form of owner's equity (buyer's cash). If the business 20% to 30% of the project in the form of owner's equity (buyer's cash). If the business purchase price contains substantial "goodwill," the expected equity contribution may purchase price contains substantial "goodwill," the expected equity contribution may be greater.be greater.

Those seeking financing to purchase a business should develop a loan proposal. Much Those seeking financing to purchase a business should develop a loan proposal. Much of the information you gather about the business will be required by a lender and of the information you gather about the business will be required by a lender and should be contained in your loan proposal. In addition, you will also have to compile should be contained in your loan proposal. In addition, you will also have to compile information for your loan proposal including financial projections, collateral information for your loan proposal including financial projections, collateral information, and personal financial information. Another issue to consider is whether information, and personal financial information. Another issue to consider is whether or not the business will provide enough income to make loan payments and provide or not the business will provide enough income to make loan payments and provide return to the owner. Loan repayment ability is extremely important to a potential return to the owner. Loan repayment ability is extremely important to a potential lender. To learn about all of the information that should be in a loan proposal, review lender. To learn about all of the information that should be in a loan proposal, review ASBTDC information about developing a loan proposal:ASBTDC information about developing a loan proposal:


A Checklist of Information to GatherA Checklist of Information to Gather Financial InformationFinancial Information

A prospective buyer should request access to business financial records. This financial A prospective buyer should request access to business financial records. This financial information is key to understanding past profitability of the business as well as information is key to understanding past profitability of the business as well as projected future success. If the seller cannot provide adequate information, the buyer projected future success. If the seller cannot provide adequate information, the buyer must make the decision to either terminate efforts or move forward at his/her own must make the decision to either terminate efforts or move forward at his/her own risk. If bank financing is involved, the lender will require adequate financial risk. If bank financing is involved, the lender will require adequate financial information.information.

Obtain the proposed selling price and determine what is included in the sale. How Obtain the proposed selling price and determine what is included in the sale. How much of the selling price is allocated towards real estate, goodwill, equipment, much of the selling price is allocated towards real estate, goodwill, equipment, inventory, etc.? What is the actual market value of those assets?inventory, etc.? What is the actual market value of those assets?

Determine the type of sale. Will it be an asset or stock purchase?Determine the type of sale. Will it be an asset or stock purchase? Establish whether or not the buyer will assume any business obligations or debts such Establish whether or not the buyer will assume any business obligations or debts such

as unpaid balances of accounts payable. If so, obtain all current loan terms, as unpaid balances of accounts payable. If so, obtain all current loan terms, documents, etc.documents, etc.

Acquire business balance sheets and income statements (for at least three year-end Acquire business balance sheets and income statements (for at least three year-end statements and interim for current year), and federal business tax returns (at least statements and interim for current year), and federal business tax returns (at least the past three years). Confirm that all past taxes (state and federal) originating from the past three years). Confirm that all past taxes (state and federal) originating from the business are paid.the business are paid.

Determine whether additional working capital will be needed to conduct business Determine whether additional working capital will be needed to conduct business operations after the sale.operations after the sale.


Business and Operational InformationBusiness and Operational InformationObtain business history. What kind of reputation does the business have? How long has this Obtain business history. What kind of reputation does the business have? How long has this business been established? Include the development/progress of the business and ownership business been established? Include the development/progress of the business and ownership structure.structure.Determine whether upgrades are required as well as identify needed changes to business Determine whether upgrades are required as well as identify needed changes to business operations. Are any leasehold improvements, equipment purchases, or general updates to the operations. Are any leasehold improvements, equipment purchases, or general updates to the business necessary? What would be the costs of these updates?business necessary? What would be the costs of these updates?Obtain a copy of the franchise agreement, if applicable. Will another franchise fee or a Obtain a copy of the franchise agreement, if applicable. Will another franchise fee or a transfer fee have to be paid?transfer fee have to be paid?Obtain a copy of the proposed buy/sell agreement (unsigned) or information in writing Obtain a copy of the proposed buy/sell agreement (unsigned) or information in writing about the proposed terms of the buy/sell transaction.about the proposed terms of the buy/sell transaction.Request an explanation of seller's reason for selling the business.Request an explanation of seller's reason for selling the business.Investigate any business leases for equipment, property, etc. Are leases transferable?Investigate any business leases for equipment, property, etc. Are leases transferable?Investigate zoning laws to ensure compliance.Investigate zoning laws to ensure compliance.Determine whether or not the buyer will be able to continue utilizing the firm's intellectual Determine whether or not the buyer will be able to continue utilizing the firm's intellectual property such as business name, patents, trademarks, trade secrets, product names, and any property such as business name, patents, trademarks, trade secrets, product names, and any other proprietary information.other proprietary information.Research any licenses that may be required to maintain business operations. What are the Research any licenses that may be required to maintain business operations. What are the costs?costs?Determine whether or not the seller will offer a non-compete agreement after transfer of Determine whether or not the seller will offer a non-compete agreement after transfer of ownership.ownership.Investigate whether there are any customer product warranties issued by the company that Investigate whether there are any customer product warranties issued by the company that may be future obligations.may be future obligations.


InformManagement/Personnel ationInformManagement/Personnel ationLearn about staffing requirements and key employees. Analyze the roles and Learn about staffing requirements and key employees. Analyze the roles and salaries of all employees in the business. Will you keep existing employees salaries of all employees in the business. Will you keep existing employees and/or key management during the transition? Do you have the experience and and/or key management during the transition? Do you have the experience and expertise to manage this new acquisition?expertise to manage this new acquisition?Obtain a copy of existing employee contracts and benefit packages, if Obtain a copy of existing employee contracts and benefit packages, if applicable.applicable.Determine the likelihood that existing employees will stay with the business Determine the likelihood that existing employees will stay with the business after the transfer of ownership.after the transfer of ownership.Establish whether or not the seller is willing to stay on for a period of time Establish whether or not the seller is willing to stay on for a period of time after ownership transfers in order to provide knowledge and supportafter ownership transfers in order to provide knowledge and support


Market and Industry InformationMarket and Industry InformationIdentify the products/services the firm provides. What is the current pricing system? Do Identify the products/services the firm provides. What is the current pricing system? Do you plan to alter the product/service mix? Are existing inventories and supplies included you plan to alter the product/service mix? Are existing inventories and supplies included with the sale? What level of inventory will be in the business at the time of transfer? Does with the sale? What level of inventory will be in the business at the time of transfer? Does inventory consist of high quality saleable inventory or predominantly old inventory that inventory consist of high quality saleable inventory or predominantly old inventory that will be difficult to sell?will be difficult to sell?Acquire a list of competitors, suppliers, and clients/customers, if possible. Can you Acquire a list of competitors, suppliers, and clients/customers, if possible. Can you retain customers and sustain revenues? Will existing vendors offer the new owner the retain customers and sustain revenues? Will existing vendors offer the new owner the same terms as the current owner? Will you forge new relationships with different same terms as the current owner? Will you forge new relationships with different suppliers or continue with current operations?suppliers or continue with current operations?Determine the market area of the business and method of distribution. Fully understand Determine the market area of the business and method of distribution. Fully understand the business's customer geography and target market. How large is the current customer the business's customer geography and target market. How large is the current customer base? Is there an opportunity to grow the customer base?base? Is there an opportunity to grow the customer base?Research the industry. Is this industry growing? What are its strengths and Research the industry. Is this industry growing? What are its strengths and weaknesses? Are their any emerging opportunities or threats? Gather information on weaknesses? Are their any emerging opportunities or threats? Gather information on current demand, seasonality, buying patterns, etc. Consider changes in the business current demand, seasonality, buying patterns, etc. Consider changes in the business environment which would affect operations and profit potential. The seller may have environment which would affect operations and profit potential. The seller may have access to industry journals and information. In addition, outside industry research will access to industry journals and information. In addition, outside industry research will likely be necessarylikely be necessary


The interested buyers checklist

Documents involved when you buy a business

Before you sign the contract:seller has to provide contract of sale, copy of lease, section 52 statementprepare proposed assignment of leaseobtain title searchobtain search of business name or company name.

When you sign the contract:seller has to provide signed contractreturn signed copy of contract to sellerpay preliminary or full deposit and seller to supply receipt for deposit.Immediately after settlement:

lodge applications for transfer of registration of business nametransfer all necessary permits, licences, registrations and certificates


How to Buy a How to Buy a BusinessBusinessStarting from scratch isn't the only way to Starting from scratch isn't the only way to get started. Buying an existing business can get started. Buying an existing business can help you hit the ground running. Here's help you hit the ground running. Here's what you need to know to find a great deal. what you need to know to find a great deal.


When most people think of starting a When most people think of starting a business, they think of beginning from business, they think of beginning from scratch--developing your own ideas and scratch--developing your own ideas and building the company from the ground up. building the company from the ground up. But starting from scratch presents some But starting from scratch presents some distinct disadvantages, including the distinct disadvantages, including the difficulty of building a customer base, difficulty of building a customer base, marketing the new business, hiring marketing the new business, hiring employees and establishing cash flow...all employees and establishing cash flow...all without a track record or reputation to go without a track record or reputation to go on.on.


Buying an Existing BusinessBuying an Existing BusinessIn most cases, buying an existing business is less risky than starting from In most cases, buying an existing business is less risky than starting from scratch. When you buy a business, you take over an operation that's already scratch. When you buy a business, you take over an operation that's already generating cash flow and profits. You have an established customer base, generating cash flow and profits. You have an established customer base, reputation and employees who are familiar with all aspects of the business. reputation and employees who are familiar with all aspects of the business. And you don't have to reinvent the wheel--setting up new procedures, systems And you don't have to reinvent the wheel--setting up new procedures, systems and policies--since a successful formula for running the business has already and policies--since a successful formula for running the business has already been put in place.been put in place.

On the downside, buying a business is often more costly than starting from On the downside, buying a business is often more costly than starting from scratch. However, it's easier to get financing to buy an existing business than scratch. However, it's easier to get financing to buy an existing business than to start a new one. Bankers and investors generally feel more comfortable to start a new one. Bankers and investors generally feel more comfortable dealing with a business that already has a proven track record. In addition, dealing with a business that already has a proven track record. In addition, buying a business may give you valuable legal rights, such as patents or buying a business may give you valuable legal rights, such as patents or copyrights, which can prove very profitable. Of course, there's no such thing copyrights, which can prove very profitable. Of course, there's no such thing as a sure thing--and buying an existing business is no exception. If you're not as a sure thing--and buying an existing business is no exception. If you're not careful, you could get stuck with obsolete inventory, uncooperative employees careful, you could get stuck with obsolete inventory, uncooperative employees or outdated distribution methods. To make sure you get the best deal when or outdated distribution methods. To make sure you get the best deal when buying an existing business, be sure to follow these steps.buying an existing business, be sure to follow these steps.

chapter 5: buying a business 1 copyright 2002 prentice hall publishing company buying an existing...

Documents

existing business n

business plan

particular business

business world

business continued n

previous business experience

right type of business

business prospective