Business 101 series – buying a business

Over the years I have been involved in many mergers and acquisitions. This is the concept of buying, selling, dividing and combining of different companies.

Now as a business coach and management consultant I talk to a lot of people who are contemplating, or want to start their own business. Most people imagine starting from scratch, fostering their own ideas and building their business from the ground up.

However – there are alteratives. Instead of starting your own business, you may want to explore purchasing an existing business or franchise. There are some advantages in this option, you get a pre-existing customer base, employees and marketing are already in place, and you will probably get an established cash flow, built-in track record and reputation, good or bad – these all can be yours. There are advantages and disadvantages in both options.

When you buy an existing business you take over the operation which is already generating cash flow and hopefully an acceptable profit. One disadvantage to purchasing an already established business is it will be more costly, this is because someone else has already gone through all the trouble of establishing the company for you. However it will be easier to get financing because the business already has a cash flow and a measurable track record.

Identify your interest
Unless you plan to sit back and let someone else manage and run your business, you need to identify your talents to help determine what type of business you should purchase.

If you enjoy craft making, such as designing jewelry or painting – purchasing a plumbing or muffler repair business is probably not in your best interest.

After you have identified your talents, likes, dislikes, wants and desires – then you can begin to determining what types of businesses align with them.

You should also explore the conditions you are willing to work with, meaning hours of operation, location, heat, cold, heavy customer traffic – things like these. Mc Donalds, Taco Bell, Burger King and Carl’s Jr. all operate seven days a week and are normally open from 5:00 AM to midnight – or longer. They also have heavy customer traffic which means you will be interfacing with the public – a lot. Whereas if you purchase a janitorial supply company chances are real good you may only be open from 8:00 AM to 5:00 PM, and most of your customer base will be telephone generated.

How much money can you invest
The purchase price of an existing business cover a broad spectrum. You can buy a business for as little as five thousand dollars to well over a few million dollars. Have a number in mind that you feel comfortable with. Remember this – just like purchasing a home, prices are negotiable. I advise my clients to enjoy the haggle and if they are uncomfortable with haggling – try to make a game out of it. It may help ease the stress.

Selecting a Business
The best place to start looking is at an industry which you are familiar and understand. Keep in mind that you will probably be spending a lot of time at your new business, so pick something you like and enjoy doing.

Where do you find businesses for sale
You can certainly start looking in your local newspaper’s classified section under “Business Opportunities” or “Businesses for Sale”. However you will only find a handful of businesses here. I suggest contacting a business broker, who much like a real estate agent can help you find the right business. Most brokers are hired by the sellers.

Due Diligence
Once you have identified a business you want to purchase it is time to research that business in detail. I suggest putting together an acquisition team to help you determine how solid the business is. You need to scrutinize:

• Review financial records (tax returned, profit & loss, cash-flow)
• Review legal documents
• Review sales records including forecasted vs actual
• Review employees records and evaluations
• Analyse products and merchandise
• Conduct an inventory audit
• Review services offerings and evaluate pricing model
• Inventory and review all technology
• Inventory all trade equipment and note condition and age
• Review operations procedures

Chose a grading criteria prior to reviewing each category and stick to it. It is easy to overlook a few items here and there. So use a checklist to help you stay on topic.

Furthermore, don’t forget to include the Better Business Bureau and any industry specific associations in your review. You may also want to run a search on Yelp, Insider Pages, CitySquares, Google, Yahoo and Bing.

Now is the time to ask the seller a couple very important question

• Why are they selling the business
• Can you talk to employees and customers
• Will the seller help in the transition of ownership
• What are the existing obligation of the business
• How was the sale price determined

Contract negotiations and sales agreements
I cannot stress this enough – a sales contract is a legal document changing ownership of a business. It will outline what you are buying, when it becomes yours and should identify all assets, which may include real estate, intellectual property, copyrights, patents, pensions and even if the previous may work for you. The contract should have at least these minimum items:

• Names of seller, buyer, and business
• Background information
• Assets being sold
• Purchase price and allocation of assets
• Non-compete clause for a pre-determined time period
• Any adjustments to be made
• Terms of the agreement and payment terms
• List of inventory included in the sale
• List of real estate included in the sale (this may require additional contracts and fees)
• Compliance with the Bulk Sales laws of the state
• Any representation and warranties of the seller
• Any representation and warranties of the buyer
• Determination as to current stock and company shares
• Determination as to the access to any business information
• Determination as to the running of the business prior to closing
• Contingencies
• Possibilities of having the seller continue as a consultant
• Fees, including brokers fees
• Date of closing

I should also note that you will need to independently change ownership using this sales agreement with local, state and federal agencies as well as banks, insurance and payroll vendors.

Determining the Value of a Business
There are no hard and fast rules in setting the price of a business, therefore – before you reach deep into your pocket and pull out your hard-earned cash you need to know what a business is worth. When you determine a businesses value it will help you to determine how profitable that business will be in the near and far future.

You probably started and finished this in your due diligence phase but nonetheless we should look a little into this.

A realistic company valuation requires more than looking at the previous year’s financial statement; it requires a thorough analysis of several years of the business operation and an opinion about the future outlook of the industry, the economy, and how the business will compete.

The Internal Revenue Service (IRS) has defined the term “Fair Market Value“. Many people are under the belief this is what a company should be sold for. However that are many factors involved and many may or may not apply to your circumstances.

There are different methods in determining a business value. Ask the broker or owner how the asking price was determined. Whatever they tell you – you should be able to validate their calculations. However – this does not mean the number they arrived at it the actual valuation of the company, it is only their asking price.

As you drill down into a business financials of the business you will gain a more accurate valuation of the business than relying on the sellers asking price by using a “Multiple of Earnings” model. This is used against SDE (Seller’s Discretionary Earnings). SDE is normally based on a multiple between zero and four, which is then multiplied against the earnings of the business.

Seller’s Discretionary Earnings (SDE) is the net profits of the business with add backs of expenses that benefit the owners but do not necessarily benefit the business. This may include:

• Owner’s salary
• Personal insurance premiums for the owner.
• Wages paid to family members in excess of those wages needed to hire someone to do their jobs.
• Owners vehicles that are paid for through the business but not necessary to the business. This includes gas, tires and other repair expenses
• Personal expenses paid for through the business like medical bills and cell phones.
• Entertainment expenses in excess of that needed to maintain adequate marketing for the business.
• Large, one time expenditures for equipment, uninsured losses, major repairs or space build outs that were expensed during the reporting period.
• Fines or penalties paid that would not necessarily be paid by a new owner.
• Subscriptions and organizational dues that are not necessary to the business operation or marketing.
• Prepaid expenses, usually prorated for the period.
• Depreciation Expenses
• Amortization Expenses
• Interest paid on long-term notes.

Once the SDE is determined, you now have a value that then can be used by both the seller and the buyer during negotiations.

Buying an existing business is a big decision and hiring professional help is always a good decision. Find someone who has been through the mergers and acquisitions process or has purchased a business in the past. You may want to find your own business broker. You should also include your banker and  attorney on your selection team.