I
want to start a business but don’t want to work
from scratch. How do I go about buying an existing business?
(continued)
Intangible Value
Some business owners try to sell goodwill as an asset.
Normally, in everyday accounting procedures, most companies
put down perhaps one dollar as the value of goodwill.
There is no doubt that goodwill has value, particularly
if the business has built up a regular trade and a strong
base of accounts. But it is the financial value of the
accounts, not their psychological value, that should be
placed on any financial statements.
Goodwill as such is not an asset. You as a buyer would
assess the business based on the return on investment.
Certain rules of the game may change when you enter the
fields of acquisition and merger. Suppose you buy out
your competition, merge all your facilities, and double
your volume. Now the labor and overhead factors are much
lower. Thus, even if the seller was losing perhaps 5 percent
a year, if you bring them into your company, which is
making 15 percent a year, it might allow you to increase
sales and end up making 20 percent.
Deciding on a price, however, is just the first step in
negotiating the sale. More important is how the deal is
structured. David H. Troob, chairman of Geneva Companies,
a national mergers and acquisitions services firm, suggests
that you should be ready to pay 30 to 50 percent of the
price in cash, and finance the remaining amount.
You can finance through a traditional lender, or sellers
may agree to "hold a not," which means they
accept payments over a period of time, just as a lender
would. Many sellers like this method because it assures
them of future income. Other sellers may agree to different
terms--for example, accepting benefits such as a company
car for a period of time after the deal is completed.
These methods can cut down the amount of upfront cash
you need; Troob advises, however, that you should always
have an attorney review any arrangements for legality
and liability issues.
An individual purchasing a business has two options for
structuring the deal (assuming the transaction is not
a merger). The first is asset acquisition, in which you
purchase only those assets you want. On the plus side,
asset acquisition protects you from unwanted legal liabilities
since instead of buying the corporation (and all its legal
risks), you are buying only its assets.
On the downside, an asset acquisition can be very expensive.
The asset-by-asset purchasing process is complicated and
also opens the possibility that the seller may raise the
price of desirable assets to off-set losses from undesirable
ones.
The other option is stock acquisition, in which you purchase
stock. Among other things, this means you must be willing
to purchase all the business assets--and assume all its
liabilities.
The final purchase contract should be structured with
the help of your acquisition team to reflect very precisely
your understanding and intentions regarding the purchase
from a financial, tax and legal standpoint. The contract
must be all-inclusive and should allow you to rescind
the deal if you find at any time that the owner intentionally
misrepresented the company or failed to report essential
information. It's also a good idea to include a no compete
clause in the contract to ensure the seller doesn't open
a competing operation down the street.
Remember, you have the option to walk away from a negotiation
at any point in the process if you don't like the way
things are going. "If you don't like the deal, don't
buy," says Troob. "Just because you spent a
month looking at something doesn't mean you have to buy
it. You have no obligation."
Alternatives to Cash
Short on cash? Try these alternatives for financing
your purchase of an existing business:
- Use the seller's assets. As soon as
you buy the business, you'll own the assets--so why not
use them to get financing now? Make a list of all the
assets you're buying (along with any attached liabilities),
and use it to approach banks, finance companies and factors
(companies that buy accounts receivable).
- Buy co-op. If you can't afford the
business yourself, try going co-op--buying with someone
else that is. To find a likely co-op buyer, ask the seller
for a list of people who were interested in the business
but didn't have enough money to buy. (Be sure to have
your lawyer write up a partnership agreement, including
a buyout clause, before entering into any partnership
arrangement.)
- Use an Employee Stock Ownership Plan (ESOP).
ESOPs offer you a way to get capital immediately by selling
stock in the business to employees. If you sell only non-voting
shares of stock, you still retain control. By offering
to set up an ESOP plan, you may be able to get a business
for as little as 10 percent of the purchase price.
- Lease with an option to buy. Some sellers
will let you lease a business with an option to buy. You
make a down payment, become a minority stockholder and
operate the business is if it were your own.
- Assume liabilities or decline receivables.
Reduce the sales price by either assuming the business's
liabilities or having the seller keep the receivables.
Don't be too anxious when you're looking to buy a business.
As we've mentioned already, if you're too anxious, this
can affect the price.
Tremendous mistakes are made by people who are anxious.
Business consultants called in by anxious buyers can sometimes
salvage the situation, but oftentimes consultants are
not called until a deal has been closed. And once your
signature goes on that dotted line, you're stuck with
the purchase. So keep in mind that anxiety or impatience
isn't going to help you buy a business. Take your time.
Recognize that there's always time to reflect on the business
that's for sale. No matter what a business broker, a business
seller, or any other person may tell you, there's always
time. Nine times out of 10, the business that's up for
sale is going to be around for awhile. And if it's not,
then it's the seller who is going to be the anxious one;
and the seller's anxiety, of course, is something that
can be manipulated to your advantage as buyer.
Some of the more common mistakes are:
- Buying on price. Buyers don't take
into account ROI. If you're going to invest $20,000 in
a business that returns a five-percent net, you're better
off putting your money in stocks and commodities, the
local S&L, or municipal bonds. Any type of intangible
security is going to produce more than five percent.
- Cash shortage. Some buyers use all
their cash for the down payment on the business, though
cash management in the startup phase of any business,
new or existing, is fundamental to short-term success.
They fail to predict future cash flow and possible contingencies
that might require more capital. Further, there has to
be some revenue set aside for building the business via
marketing and PR efforts. So, if you have $20,000 to invest,
make sure you don't invest the entire amount. Keep some
of the capital. Though figures vary from industry to industry,
a common contingency is 10 percent. Additionally, you
may want to set aside a sum that you regard as your working
capital, which in a number of businesses is enough to
cover about three months' worth of expenses.
- Buying all the receivables. It generally
makes good sense to buy the receivables, except when they
are 90 or 120 days old, or older. Too often buyers take
on all the receivables, even those beyond 90 days. This
can be very risky because the older the account, the more
difficult it'll be to collect against. You can protect
yourself by having the seller warrant the receivables;
what's not collectible can be charged back against the
purchase price of the business. For receivables beyond
90 days, give those to the owner, and see if he or she
can collect.
- Failure to verify all data. Most business
buyers accept all the information and data given to them
by the seller at face value, without the verification
of their own accountant (preferably a CPA, who can audit
financial statements). Most sellers want to get their
cash out of the business as soon as possible, and buyers
frequently allow them to take all the quick assets such
as receivables, cash, and equipment inventories, and sometimes
bring in equipment. The seller talks the buyer into virtually
anything, knowing that the buyer wants the business badly.
- Heavy payment schedules. Novice business
owners often overestimate their revenue during the first
year and take on unduly large payments to finance the
buyout. Generally, however, revenue rarely pans out. During
the first year of any operation, the owner experiences
numerous non-recurring costs such as equipment failures,
employee turnover, etc. For this reason, it makes sense
to have a payment schedule that begins fairly light, then
gets progressively heavier. This is something that can
be negotiated with a seller and should not be difficult
to arrange.
- Treating the seller unfairly. People
think that, because they are buying a business, the seller
is at their mercy. All too often, the buyer will be cold,
rigid and hard-headed. Sellers with savvy will throw such
people out and tell them not to come back. Just because
you have some money and may be interested in purchasing
the business, that doesn't meant that you aren't going
to have to give a little in the process of negotiation.
Transition Time
The transition to new ownership is a big change for employees
of a small business. To ensure a smooth transition, start
the process before the deal is done. Make sure the owner
feels good about what is going to happen to the business
after he or she leaves. Spend some time talking to key
employees, customers and suppliers before you take over;
tell them about your plans and ideas for the business's
future. Getting these key players involved and on your
side makes running the business a lot easier.
Most sellers will help you in a transition period during
which they train you in operating the business. This period
can range from a few weeks to six months or longer. After
the one-on-one training period, many sellers will agree
to be available for phone consultation for another period
of time. Make sure you and the seller agree on how this
training will be handled, and write it into your contract.
If you buy the business lock, stock and barrel, simply
putting your name on the door and running it as before,
your transition is likely to be fairly smooth. On the
other hand, if you buy only part of the business's assets,
such as its client list or employees, then make a lot
of changes in how things are done, you'll probably face
a more difficult transition period.
Many new business owners have unrealistically high expectations
that they can immediately make a business more profitable.
Of course, you need a positive attitude to run a successful
business, but if your attitude is "I'm better than
you," you'll soon face resentment from the employees
you've acquired.
Instead, look at the employees as valuable assets. Initially,
they'll know far more about the business than you will;
use that knowledge to get yourself up to speed, and treat
them with respect and appreciation. Employees inevitably
will feel worried about job security when a new owner
takes over. That uncertainty is multiplied if you don't
tell them what your plans are. Many new bosses are so
eager to start running the show, they slash staff, change
prices or make other radical changes without giving employees
any warning. Involve the staff in your planning, and keep
communication open so they know what is happening at all
times. Taking on an existing business isn't always easy,
but with a little patience, honesty and hard work, you'll
soon be running things like a pro.
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