Tips for Buyers and Sellers
We have included the following articles on buying and selling businesses:
· Tips for the Seller – Getting Your Business Ready for Sale
· The Business Buyers – Who are They?
· Price Justification Formula – How To Justify the Price of a Business
· Due Diligence – Know the Business Before You Buy
· Closing the Sale of Your Business – Follow These Ten Commandments to Avoid Losing the Deal
Tips for the Seller
Getting Your Business Ready for Sale
A business owner should start now to get his business ready for sale even if he doesn’t intend to sell the business for several years. Sometimes a business needs time to be prepared for a sale. Remember: A properly prepared seller understands that a buyer pays you based on the past, but he is really buying the future. Therefore, the seller must explain the past to help sell the future. Here are some tips to help you get ready for the sale:
- Hire an intermediary to advise you how to get your business ready for sale and to manage the negotiation process. When negotiations heat up, a third party, such as a business broker or M&A provider, will maintain a cooler head, which may save the deal. It will also give you time to think about negotiation points.
- Seek professional advice immediately from your attorney and CPA. They can also help you get your business ready for sale. They can advise you along the way if they are aware of your strategic direction.
- Clean and spruce up your operations and keep it that way. If the operation is clean and orderly, a prospective buyer will “perceive” the business to be well managed. We have all heard the rule about first impressions.
- Develop a management team so that it doesn’t appear that your company is dependent on one person. Management depth adds value to your business.
- Adopt standards of public companies by developing first-class financial statements, strategic plans, budgets, forecasts and business plans. This will enhance your image and increase the value of your company.
- Audited or reviewed financial statements are much more reassuring to a potential buyer. Financial statements should also show figures relating to “Earnings Before Interest, Taxes, Depreciation and Amortization” (EBITDA). Financial statements are the best indicator of future performance of the business because they establish past-to-present trends.
- Breakdown revenues and profits in as much detail as possible – subsidiary, division, department, profit center, cost center, product line or in any other meaningful way. It will enhance your ability to manage the business and simply make it easier for a prospective buyer to understand the business.
- Breakdown expenses to show cost of goods sold, operations, sales and marketing, administrative and non-operating expenses.
- Historical financial statements should be “Recasted” to eliminate the owner’s personal expenses, one time non-recurring expenses and irrelevant costs that the buyer will not have in the future. You must carefully explain and justify every dollar eliminated. Recasting allows you to explain the past and sell the future.
- Keep the transaction confidential to the very end. Telling employees, friends and others will only threaten the deal and cast doubt on your integrity. Employees may “panic” because of “perceived” uncertainty regarding their position after the sale. Your best employees are usually the first to leave. After all, they have the most to offer another employer.
- Disclose everything. Problems uncovered in “due diligence” or late in the process impugn your integrity and threaten either the price, or the entire deal. By disclosing the problem early, you can present it in a way to minimize its impact. Remember, trust means “everything” in the sale or acquisition of a business.
- Run the business, right up to closing, as if it will be yours indefinitely because “it just might be yours indefinitely”. Resist the urge to make decisions based on what you think a buyer would want. Protecting your business for yourself is a higher priority.
Who are they?
Buyers of small businesses are often replacing lost jobs or searching for a happier alternative to corporate life. Buyers of mid-sized and large companies are, typically, expansion minded corporations or private investment groups seeking businesses to build and eventually sell for a profit. Each type of buyer has distinctive characteristics that correlate to the motivation behind the purchase of a business. In addition, the price each is willing to pay for a company is directly proportional to the motive. There are five types of buyers:
This is typically an individual who will purchase a business and be directly involved with the day-to-day management of the company. Many of them have come out of corporate America and are first time buyers. Others are buyers who have owned a business in the past and are looking once again to become their “own boss”. They generally will attempt to match their type of background or experience with a given business opportunity. The individual buyer usually seeks a business that is financially healthy that will pay them a reasonable salary and any debt service required to purchase the business. Their financing sources are generally SBA loans, owner financing, loans from family members, or, occasionally, bank loans. They very rarely will pay all-cash for a business.
This buyer is almost always a company, having as its goal entering new markets, increasing market share, gaining new technology, or eliminating some element of competition. In essence, it is part of this buyer’s “strategy” to acquire other businesses as part of a long-term plan. Strategic buyers can be either in the same business as the company under consideration, or a competitor. Strategic buyers will be looking chiefly at businesses with sales in the mid-market range, with proprietary product and/or unique market share, effective management in place and willing to remain.
The synergistic category of buyer is usually a company looking to grow by acquiring products or services of a complimentary nature. The joining of the two companies will produce more, or be worth more than just the sum of the parts. After the acquisition, they will have the opportunity to sell additional products or services to the existing customer base.
This type of buyer is often a competitor or a highly similar operation. This buyer already knows the industry well, and, therefore, does not generally pay for the expertise and knowledge of the seller. The industry buyer is interested mainly in combining manufacturing facilities, consolidating overhead, and utilizing the combined sales forces, or expanding their operations geographically. These buyers will pay for assets but in most cases they will not pay for goodwill, covenants not to compete, or seller consulting agreements.
Financial buyers are influenced by a demonstrated return on investment, coupled with their ability to get financing on as large a portion of the purchase price as possible – a leveraged transaction. Working on the theory that debt is the lowest cost of capital, these buyers purchase businesses with the sole purpose of making the maximum amount of money with the least amount of their capital invested.
Price Justification Formula
How to justify the price of a business
Determining the value of a business should be the first and foremost step in buying and selling a business. The value is related to the risks involved in operating the business and the future ability of the business to generate cash flow to the owner. The value of the underlying hard, tangible assets as well as intangible assets also must be considered.
Evaluating a price when buying a business creates anxiety for both buyer and seller. Numerous approaches can be used to calculate the value of a business. In the final analysis, the buyer must believe that the price to be paid for the business is justified. A handy method to evaluate the reasonableness of a price is the Price Justification Formula.
The Price Justification Formula helps show whether the discretionary cash flow generated by the business is sufficient to justify the price paid. The basic formula is as follows:
Add Owners Discretionary Cash Flow – Net income plus add-backs that accrue to the benefit of cash flow to the owner, including the owner’s salary.
Less Annual Debt Service – Principal and interest payments to service the debt used to buy the business.
Less Managers Salary – Market rate salary that would be paid to a manager to run the business.
Less Capital Expenditures – This is the amount that must be paid in a typical year to maintain and replace the furniture, fixtures, equipment and other fixed assets of the business. A benchmark might be to replace all assets over a five-year period. Therefore, the market value of such assets divided by five is reasonable.
Less Miscellaneous Expenses – This is an extra amount to acknowledge the fact that unexpected expenses do happen. A reasonable figure is ten percent of operating expenses.
Equals Cash Flow Remaining – This is the cash remaining after all the new owner’s obligations are met.
If, and only if, the cash flow remaining is sufficient to make the new owner feel justified
in taking on the risk of owning the new business, will the purchase be completed. This is
also a great sanity check for sellers to go through to help them determine whether the
price and terms they are asking are reasonable.
Know the Business Before You Buy
So you have found a business that you want to buy. The seller has provided you with basic information that has lead to an offer or non-binding “Letter of Intent” and you believe the business concept and the customer base can support the price that has been offered. Where do you go from here to obtain assurance that the representations made to you by the seller can be relied upon?
Due Diligence is the process of obtaining an understanding of how a business is run and evaluating the representations made by the seller. While this may seem rather simple, there are many issues that need to be addressed as part of the due diligence process. Seeking independent advice from a professional experienced in the buying and selling of businesses can keep you from making a costly mistake. The professional should investigate significant variations in representations made by the seller through management interviews and by independent review or audit of the information provided by the seller. Following is a list of some of the information that should be reviewed:
- Legal Information – Review the type of organization such as corporation (C-Corp., S-Corp., other), partnership or sole proprietorship; owner’s names, number of shares and percent ownership; federal, state and local licenses; business licenses; company guarantees, warranties, patents and trademarks; current or prior lawsuits, whether plaintiff or defendant; and compliance with federal, state and local laws.
- Financial Information – Review financial statements, three to five years and determine whether audited, reviewed or internally prepared; strategic plans, forecasts, budgets and business plans; three years federal and state income tax returns; fixed and intangible assets to be acquired; assets to be excluded from the sale; and revenue by location, product line, etc.
- Customer Information – Review names and locations of customers; revenue and customer pricing data; customers who represent more than ten percent of total revenue volume; accounts receivable aging; customer accounts recently lost; and special deals, terms and pricing.
- Operations Information – Review operating and sales locations with a description of each facility, owned or leased; cost, size and terms of space leases; and written policies and procedures.
- Market Information – Review key competitors in each market served by the seller; size of the market; market share; advertising and promotion programs; and copies of ads, literature, brochures and other promotional materials.
- Personnel Information – Review biographies of key personnel; a personnel organization chart; the number of employees by facility and department; an employee census including salaries, bonuses, other compensation, job titles, dates of hire, and last review dates; employee benefit programs; copies of employee handbooks and manuals; and a list of key personnel who recently left the company.
Closing the Sale of Your Business
Follow these ten commandments to avoid losing the deal
1. Place a Reasonable Price on Your Business
An inflated figure either turns off or slows down potential buyers, rely on your business broker to arrive at the best “win-win” price. An “unrealistic price” discourages many buyers from even looking at a business.
2. Carry on “Business as Usual”
Don’t become so obsessed with the transaction that your attention wavers from day-to-day demands, affecting sales, costs and profits.
3. Engage an Expert Business Broker
An expert business broker can ensure confidentiality and provide the experience and expertise to successfully close the deal.
4. Prepare for the Sale Well in Advance
A good business broker will prepare an offering portfolio for the business to have ready for qualified buyers. The business owner can help in the process by “housecleaning”, as well as literal sprucing up of the facilities.
5. Anticipate Information the Buyers and Their Financing Sources May Require
In order to obtain financing, the buyer may need appraisals on assets. Lenders will require at least three years tax returns and financial statements.
6. Achieve Leverage Through Buyer Competition
A good business, priced properly, many times will create interest from multiple buyers and create a competitive situation.
7. Be Flexible
Don’t be the kind of seller who wants all-cash at closing, or who won’t accept any contingent payments or an asset transaction. Depend on the advice of your business broker for their knowledge of financing and tax implications.
8. Negotiate; Don’t Dominate
You’re used to being your own boss, but be prepared to learn that the buyer may be used to having his own way, too. Follow the advice of your business broker. He has done this before.
9. Keep Time From Dragging Down the Deal
To keep the momentum up, work with your business broker to be sure that potential buyers stay on time schedule and that offers and counter-offers move in a timely fashion.
10. Be Willing to Stay Involved
Even if you are feeling burnt-out, realize that the buyer may want you to stay within arm’s reach for a while. Consult with your business broker to determine how you can best effect a smooth transition.
Heritage Business Services, Inc.
Mergers & Acquisitions
Westchester, IL 60154
Contact: Michael Kelly
Web Site: hbsinet.com