Who Is the Buyer?
Buyers buy a business for many of the same reasons that sellers sell businesses. It is important that the buyer is as serious as the seller when it comes time to purchase a business. If the buyer is not serious, the sale will never close. Here are just a few of the reasons that buyers buy businesses:
- Laid-off, fired, being transferred (or about to be any of them)
- Early retirement (forced or not)
- Job dissatisfaction
- Desire for more control over their lives
- Desire to do their own thing
A Buyer Profile
Here is a look at the make-up of the average individual buyer looking to replace a lost job or wanting to get out of an uncomfortable job situation. The chances are he is a male (however, more and more women are going into business for themselves, so this is rapidly changing). Almost 50 percent will have less than $100,000 in which to invest in the purchase of a business. In many cases the funds, or part of them, will come from personal savings followed by financial assistance from family members. The buyer will never have owned a business before, and most likely will buy a business he or she had never considered until being introduced to it.
Their primary reason for going into business is to get out of their present situation, be it unemployment or job disagreement (or discouragement). Prospective buyers want to do their own thing, be in charge of their own destiny, and they don’t want to work for anyone. Money is important, but it’s not at the top of the list, in fact, it probably is in fourth or fifth place in the overall list. In order to pursue the dream of owning one’s own business, buyers must be able to make that “leap of faith” necessary to take the risk of purchasing and operating their own business.
Buyers who want to go into business strictly for the money usually are not realistic buyers for small businesses. Keep in mind the following traits of a willing buyer:
- The desire to buy a business
- The need and urgency to buy a business
- The financial resources
- The ability to make his or her own decisions
- Reasonable expectations of what business ownership can do for him or her
What Do Buyers Want to Know?
This may be a bit premature since you may not have decided to sell, but it may help in your decision-making process to understand not only who the buyer is, but also what he or she will want to know in order to buy your business. Here are some questions that you might be asked and should be prepared to answer:
- How much money is required to buy the business?
- What is the annual increase in sales?
- How much is the inventory?
- What is the debt?
- Will the seller train and stay on for awhile?
- What makes the business different/special/unique?
- What further defines the product or service? Bid work? Repeat business?
- What can be done to grow the business?
- What can the buyer do to add value?
- What is the profit picture in bad times as well as good?
Buying (or Selling) a Business
The following is some basic information for anyone considering purchasing a business. Is may also be of interest to anyone thinking of selling their business. The more information and knowledge both sides have about buying and selling a business, the easier the process will become.
A Buyer Profile
Here is a look at the make-up of the average individual buyer looking to replace a lost job or wanting to get out of an uncomfortable job situation. The chances are he is a male (however, more women are going into business for themselves, so this is rapidly changing). Almost 50 percent will have less than $100,000 in which to invest in the purchase of a business. More than 70 percent will have less than $250,000 to invest. In many cases the funds, or part of them, will come from personal savings followed by financial assistance from family members. He, or she, will never have owned a business before. Despite what he thinks he wants in the way of a business, he will most likely buy a business that he never considered until it was introduced, perhaps by a business broker.
His, or her primary reason for going into business is to get out of his or her present situation, be it unemployment, job disagreement, or dissatisfaction. The potential buyers now want to do their own thing, be in charge of their own destiny, and they don’t want to work for anyone. Money is important, but it’s not at the top of the list, in fact, it is probably fourth or fifth on their priority list. In order to pursue the dream of owning one’s own business, the buyer must be able to make that “leap of faith” necessary to take the plunge. Once that has been made, the buyer should review the following tips.
Importance of Information
Understand that in looking at small businesses, you will have to dig up a lot of information. Small business owners are not known for their record-keeping. You want to make sure you don’t overlook a “gem” of a business because you don’t or won’t take the time it takes to find the information you need to make an informed decision. Try to get an understanding of the real earning power of the business. Once you have found a business that interests you, learn as much as you can about that particular industry.
Negotiating the Deal
Understand, going into the deal, that your friendly banker will tell you his bank is interested in making small business loans; however, his “story” may change when it comes time to put his words into action. The seller finances the vast majority of small business transactions. If your credit is good, supply a copy of your credit report with the offer. The seller may be impressed enough to accept a lower-than-desired down payment.
Since you can’t expect the seller to cut both the down payment and the full price, decide which is more important to you. If you are attempting to buy the business with as little cash as possible, don’t try to substantially lower the full price. On the other hand, if cash is not a problem (this is very seldom the case), you can attempt to reduce the full price significantly. Make sure you can afford the debt structure–don’t obligate yourself to making payments to the seller that will not allow you to build the business and still provide a living for you and your family.
Furthermore, don’t try to push the seller to the wall. You want to have a good relationship with him or her. The seller will be teaching you the business and acting as a consultant, at least for a while. It’s all right to negotiate on areas that are important to you, but don’t negotiate over a detail that really isn’t key. Many sales fall apart because either the buyer or the seller becomes stubborn, usually over some minor detail, and refuses to bend.
Due Diligence
The responsibility of investigating the business belongs to the buyer. Don’t depend on anyone else to do the work for you. You are the one who will be working in the business and must ultimately take responsibility for the decision to buy it. There is not much point in undertaking due diligence until and unless you and the seller have reached at least a tentative agreement on price and terms. Also, there usually isn’t reason to bring in your outside advisors, if you are using them, until you reach the due diligence stage. This is another part of the “leap of faith” necessary to achieve business ownership. Outside professionals normally won’t tell you that you should buy the business, nor should you expect them to. They aren’t going to go out on a limb and tell you that you should buy a particular business. In fact, if pressed for an answer, they will give you what they consider to be the safest one: “no.” You will want to get your own answers–an important step for anyone serious about entering the world of independent business ownership.
The Deal Is Almost Done — Or Is It?
The Letter of Intent has been signed by both buyer and seller and everything seems to be moving along just fine. It would seem that the deal is almost done. However, the due diligence process must now be completed. Due diligence is the process in which the buyer really decides to go forward with the deal, or, depending on what is discovered, to renegotiate the price – or even to withdraw from the deal. So, the deal may seem to be almost done, but it really isn’t – yet!
It is important that both sides to the transaction understand just what is going to take place in the due diligence process. The importance of the due diligence process cannot be underestimated. Stanley Foster Reed in his book, The Art of M&A, wrote, “The basic function of due diligence is to assess the benefits and liabilities of a proposed acquisition by inquiring into all relevant aspects of the past, present, and predictable future of the business to be purchased.”
Prior to the due diligence process, buyers should assemble their experts to assist in this phase. These might include appraisers, accountants, lawyers, environmental experts, marketing personnel, etc. Many buyers fail to add an operational person familiar with the type of business under consideration. The legal and accounting side may be fine, but a good fix on the operations themselves is very important as a part of the due diligence process. After all, this is what the buyer is really buying.
Since the due diligence phase does involve both buyer and seller, here is a brief checklist of some of the main items for both parties to consider.
Industry Structure
Figure the percentage of sales by product line, review pricing policies, consider discount structure and product warranties; and if possible check against industry guidelines.
Human Resources
Review names, positions and responsibilities of the key management staff. Also, check the relationships, if appropriate, with labor, employee turnover, and incentive and bonus arrangements.
Marketing
Get a list of the major customers and arrive at a sales breakdown by region, and country, if exporting. Compare the company’s market share to the competition, if possible.
Operations
Review the current financial statements and compare to the budget. Check the incoming sales, analyze the backlog and the prospects for future sales.
Balance Sheet
Accounts receivables should be checked for aging, who’s paying and who isn’t, bad debt and the reserves. Inventory should be checked for work-in-process, finished goods along with turnover, non-usable inventory and the policy for returns and/or write-offs.
Environmental Issues
This is a new but quite complicated process. Ground contamination, ground water, lead paint and asbestos issues are all reasons for deals not closing, or at best not closing in a timely manner.
Manufacturing
This is where an operational expert can be invaluable. Does the facility work efficiently? How old and serviceable is the machinery and equipment? Is the technology still current? What is it really worth? Other areas, such as the manufacturing time by product, outsourcing in place, key suppliers – all of these should be checked.
Trademarks, Patents & Copyrights
Are these intangible assets transferable, and whose name are they in. If they are in an individual name – can they be transferred to the buyer? In today’s business world where intangible assets may be the backbone of the company, the deal is generally based on the satisfactory transfer of these assets.
Due diligence can determine whether the buyer goes through with the deal or begins a new round of negotiations. By completing the due diligence process, the buyer process insures, as far as possible, that the buyer is getting what he or she bargained for. The executed Letter of Intent is, in many ways, just the beginning.
Buying a Business – Some Key Consideration
- What’s for sale? What’s not for sale? Is real estate included? Is some of the machinery and/or equipment leased?
- Is there anything proprietary such as patents, copyrights or trademarks?
- Are there any barriers of entry? Is it capital, labor, intellectual property, personal relationships, location – or what?
- What is the company’s competitive advantage – special niche, great marketing, state-of-the-art manufacturing capability, well-known brands, etc.?
- Are there any assets not generating income and can they be sold?
- Are agreements in place with key employees and if not – why not?
- How can the business grow? Or, can it grow?
- Is the business dependent on the owner? Is there any depth to the management team?
- How is the financial reporting handled? Is it sufficient for the business? How does management utilize it?
Three Basic Factors of Earnings
Two businesses for sale could report the same numeric value for “earnings” and yet be far from equal. Three factors of earnings are listed below that tell more about the earnings than just the number.
1. Quality of earnings
Quality of earnings measures whether the earnings are padded with a lot of “add backs” or one-time events, such as a sale of real estate, resulting in an earnings figure which does not accurately reflect the true earning power of the company’s operations. It is not unusual for companies to have “some” non-recurring expenses every year, whether for a new roof on the plant, a hefty lawsuit, a write-down of inventory, etc. Beware of the business appraiser that restructures the earnings without “any” allowances for extraordinary items.
2. Sustainability of earnings after the acquisition
The key question a buyer often considers is whether he or she is acquiring a company at the apex of its business cycle or if the earnings will continue to grow at the previous rate.
3. Verification of information
The concern for the buyer is whether the information is accurate, timely, and relatively unbiased. Has the company allowed for possible product returns or allowed for uncollectable receivables? Is the seller above-board, or are there skeletons in the closet?
Three Basic Factors of Earnings
Two businesses for sale could report the same numeric value for “earnings” and yet be far from equal. Three factors of earnings are listed below that tell more about the earnings than just the number.
1. Quality of earnings
Quality of earnings measures whether the earnings are padded with a lot of “add backs” or one-time events, such as a sale of real estate, resulting in an earnings figure which does not accurately reflect the true earning power of the company’s operations. It is not unusual for companies to have “some” non-recurring expenses every year, whether for a new roof on the plant, a hefty lawsuit, a write-down of inventory, etc. Beware of the business appraiser that restructures the earnings without “any” allowances for extraordinary items.
2. Sustainability of earnings after the acquisition
The key question a buyer often considers is whether he or she is acquiring a company at the apex of its business cycle or if the earnings will continue to grow at the previous rate.
3. Verification of information
The concern for the buyer is whether the information is accurate, timely, and relatively unbiased. Has the company allowed for possible product returns or allowed for uncollectable receivables? Is the seller above-board, or are there skeletons in the closet?
What is the Value of Your Business? It All Depends.
The initial response to the question in the title really should be: “Why do you want to know the value of your business?” This response is not intended to be flippant, but is a question that really needs to be answered.
- Does an owner need to know for estate purposes?
- Does the bank want to know for lending purposes?
- Is the owner entertaining bringing in a partner or partners?
- Is the owner thinking of selling?
- Is a divorce or partnership dispute occurring?
- Is a valuation needed for a buy-sell agreement?
There are many other reasons why knowing the value of the business may be important.
Valuing a business can be dependent on why there is a need for it, since there are almost as many different definitions of valuation as there are reasons to obtain one. For example, in a divorce or partnership breakup, each side has a vested interest in the value of the business. If the husband is the owner, he wants as low a value as possible, while his spouse wants the highest value. Likewise, if a business partner is selling half of his business to the other partner, the departing partner would want as high a value as possible.
In the case of a business loan, a lender values the business based on what he could sell the business for in order to recapture the amount of the loan. This may be just the amount of the hard assets, namely fixtures and equipment, receivables, real estate or other similar assets.
In most cases, with the possible exception of the loan value, the applicable value definition would be Fair Market Value, normally defined as: “The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.” This definition is used by most courts.
It is interesting that in the most common definition of value, it starts off with, “The price…” Most business owners, when using the term value, really mean price. They basically want to know, “How much can I get for it if I decide to sell?” Of course, if there are legal issues, a valuation is also likely needed. In most cases, however, what the owner is looking for is a price. Unfortunately, until the business sells, there really isn’t a price.
The International Business Brokers Association (IBBA) defines price as; “The total of all consideration passed at any time between the buyer and the seller for an ownership interest in a business enterprise and may include, but is not limited to, all remuneration for tangible and intangible assets such as furniture, equipment, supplies, inventory, working capital, non-competition agreements, employment, and/or consultation agreements, licenses, customer lists, franchise fees, assumed liabilities, stock options or stock redemptions, real estate, leases, royalties, earn-outs, and future considerations.”
In short, value is something that may have to be defended, and something on which not everyone may agree. Price is very simple – it is what something sold for. It may have been negotiated; it may be the seller’s or buyer’s perception of value and the point at which their perceptions coincided (at least enough for a closing to take place) or a court may have decided.
The moral here is for a business owner to be careful what he or she asks for. Do you need a valuation, or do you just want to know what someone thinks your business will sell for?
Business brokers can be a big help in establishing value or price.