Why Do Deals Fall Apart?

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In many cases, the buyer and seller reach a tentative agreement on the sale of the business, only to have it fall apart. There are reasons this happens, and, once understood, many of the worst deal-smashers can be avoided. Understanding is the key word. Both the buyer and the seller must develop an awareness of what the sale involves–and such an awareness should include facing potential problems before they swell into floodwaters and “sink” the sale.

What keeps a sale from closing successfully? In a survey of business brokers across the United States, similar reasons were cited so often that a pattern of causality began to emerge. The following is a compilation of situations and factors affecting the sale of a business.

The Seller Fails To Reveal Problems
When a seller is not up-front about problems of the business, this does not mean the problems will go away. They are bound to turn up later, usually sometime after a tentative agreement has been reached. The buyer then gets cold feet–hardly anyone in this situation likes surprises–and the deal promptly falls apart. Even though this may seem a tall order, sellers must be as open about the minuses of their business as they are about the pluses. Again and again, business brokers surveyed said: \”We can handle most problems . . . if we know about them at the start of the selling process.

The Buyer Has Second Thoughts About the Price
In some cases, the buyer agrees on a price, only to discover that the business will not, in his or her opinion, support that price. Whether this “discovery” is based on gut reaction or a second look at the figures, it impacts seriously on the transaction at hand. The deal is in serious jeopardy when the seller wants more than the buyer feels the business is worth. It is of prime importance that the business be fairly priced. Once that price has been established, the documentation must support the seller\’s claims so that buyers can see the “real” facts for themselves.

Both the Buyer and the Seller Grow Impatient
During the course of the selling process, it\’s easy–in the case of both parties–for impatience to set in. Buyers continue to want increasing varieties and volumes of information, and sellers grow weary of it all. Both sides need to understand that the closing process takes time. However, it shouldn’t take so much time that the deal is endangered. It is important that both parties, if they are using outside professionals, should use only those knowledgeable in the business closing process. Most are not. A business broker is aware of most of the competent outside professionals in a given business area, and these should be given strong consideration in putting together the “team.” Seller and buyer may be inclined to use an attorney or accountant with whom they are familiar, but these people may not have the experience to bring the sale to a successful conclusion.

The Buyer and the Seller Are Not (Never Were) in Agreement
How does this situation happen? Unfortunately, there are business sale transactions wherein the buyer and the seller realize belatedly that they have not been in agreement all along–they just thought they were. Cases of communications failure are often fatal to the successful closing. A professional business broker is skilled in making sure that both sides know exactly what the deal entails, and can reduce the chance that such misunderstandings will occur.

The Seller Doesn\’t Really Want To Sell
In all too many instances, the seller does not really want to sell the business. The idea had sounded so good at the outset, but now that things have come down to the wire, the fire to sell has all but gone out. Selling a business has many emotional ramifications; a business often represents the seller\’s life work. Therefore, it is key that prospective sellers make a firm decision to sell prior to going to market with the business. If there are doubts, these should quelled or resolved. Some sellers enter the marketplace just to test the waters; to see if they could get their “price,” should they ever get really serious. This type of seller is the bane of business brokers and buyers alike. Business brokers generally can tell when they encounter the casual (as opposed to serious) category of seller. However, an inexperienced buyer may not recognize the difference until it\’s too late. Most business brokers will agree that a willing seller is a good seller.

Or…the Buyer Doesn’t Really Want To Buy
What\’s true for the mixed-emotion seller can be turned right around and applied to the buyer as well. Buyers can enter the sale process full of excitement and optimism, and then begin to drag their feet as they draw closer to the “altar.” This is especially true today, with many displaced corporate executives entering the market. Buying and owning a business is still the American dream–and for many it becomes a profitable reality. However, the entrepreneurial reality also includes risk, a lot of hard work, and long intense hours. Sometimes this is too much reality for a prospective buyer to handle.

And None of the Above
The situations detailed above are the main reasons why deals fall apart. However, there can be problems beyond anyone’s control, such as Acts of God, and unforeseen environmental problems. However, many potential deal-breakers can be handled or dealt with prior to the marketing of the business, to help ensure that the sale will close successfully.

A Final Note
Remember these components in working toward the success of the business sale:

  • Good chemistry between the parties involved.
  • A mutual understanding of the agreement.
  • A mutual understanding of the emotions of both buyer and seller.
  • The belief, on the part of both buyer and seller, that they are involved in a good deal

A Private Equity Glossary

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“Deep-pocketed investors often set aside money to buy into private equity funds.  Such investments tend to be riskier but can generate higher returns than stocks or bonds.  Here are some of the key players and terms in the world of private equity investments.

• Private equity firms: A broad category.  It includes venture capitalists and buyout specialists who raise money from limited partners and use it to help companies develop products and markets.

• Limited partners: Investors in venture capital or buyout funds.  These are typically pension funds, foundations, university endowments, insurance companies, or wealthy individuals.

• Venture capital firms: Firms that use their investment funds to finance start-ups, often in their early stages and typically in the technology, life sciences, or telecommunications fields.

• Buyout firms: They usually raise larger funds and invest them in more mature, later-stage companies of all kinds, often taking controlling interests and sometimes buying the companies outright.  (The terms “private equity” and “buyouts” are often used interchangeably.)”

Source: Robert Weisman, in an article from The Boston Globe

Women Business Owners: Coming on Strong

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If there were any doubt that women owners are an ever-growing force on the independent business scene, new studies of leading female entrepreneurs around the world supplies incontrovertible proof. The National Foundation for Women Business Owners (NFWBO) has been hard at work, researching the small business climate for women and identifying strong trends.

Fifty Top Women Show Trends

In one study done jointly with IBM, the NFWBO used as its subjects 50 top women business owners (plus 10 more up-and-coming) to compile these findings:

  • These women owners cover a wide range of industry categories, for example: 27 percent in manufacturing, 25 percent in retail trade, and 10 percent in real estate.
  • Slightly less than half (46 percent) of these women inherited their businesses, and more than half began their own: 34 percent by themselves, and 17 percent with others.
  • As a group, the study subjects generate $139 billion in revenue and employ more than 150,000 workers. And, the numbers keep increasing.

The Majority of Women Owners Prefer “Small”

More research from the NFWBO shows another picture: that women owners, taken as a whole, prefer pared-down operations — the very smallest, in fact.  Among the approximately eight million women-owned businesses in the U.S., 75 percent of these are one-person operations with no employees. Ownership of such a small business gives women maximum flexibility with work schedules and offers a better chance of keeping their home lives healthy as well.

Ignoring the big-business gurus who claim that small does not equal successful, women owners continue to prefer keeping their businesses small. Although the NFWBO research reveals that fewer than one percent of these businesses have more than $1 million in sales, women owners are showing strength in numbers and gaining respect from many quarters necessary for their support and growth. The Small Business Administration, for example, offers a number of free counseling and assistance programs, as well as its loan guarantee program–all helping the woman-owned business to flourish.

Women Owners Triumph over Bank Loan Inequities

Another NFWBO study shows that women business owners, for the first time ever, are experiencing access to business loans from banks nearly equal to that of male owners. A number of U.S. banks, among them BankAmerica and Wells Fargo, offer special loan programs for women business owners. Partly thanks to the rise of women to high bank positions, the woman-owned business is being seen for its untapped potential.

With easier access to loans, women owners can now be less dependent on high-cost credit card loans for financing, and they have more leeway to reinvest earnings. According to the NFWBO, all this means that women-owned businesses have developed into more sophisticated operations.

Although male and female entrepreneurs may have equal access to loans, a related NFWBO finding shows that the sexes still approach the use of credit differently. Men owners tend to use this money to help out with cash flow or to consolidate debt; women put the dollars towards business growth.

In addition to these specific discoveries, NFWBO studies also showed that, on an international scale, women owners come from similar backgrounds and voice the same concerns about important business issues. They constitute between one-fourth and one-third of the world’s independent business owners. They are also vocal, as was evidenced at an international conference in Paris sponsored by the Organization for Economic Cooperation and Development (OECD). Approximately 350 delegates from 35 countries attended the multilingual sessions and workshops.

Saying “Hello” — More Important than You Think

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The telephone rings, the caller receives a message welcoming them, then she is asked to dial the extension of the person she wants to talk to. Since she doesn’t know the extension, she has to wait and listen to the office directory; then presses the extension number only to discover that the person being called is not there.

Most Americans have called a credit card company, their bank or any other large company only to get lost in the maze with no way of talking to an actual person. Then there is the “hold music,” the commercial while you wait, with more “amusements” popping up all the time. Who knows what the future holds in telephone communication.

While it used to be that the telephone was a visitor’s first contact with your business, that tradition is changing. Now it is your Web site. Today’s busy buyer now goes to the Internet to look for whatever he or she is considering purchasing. It is even easier for potential clients or customers to find your telephone number from your Web site rather than the telephone book. They can even get directions to your place of business.

In business every call or Web site visitor is a potential customer or client. You can’t afford to lose even one. After all, if someone goes to the trouble of finding your telephone number or locating you on the Web, they must be at least half-serious.

Make sure your telephone system is as user-friendly as you can make it. If it isn’t, change it. One sale or new client will more than pay for this improvement.  What is the status of your Web site? Pay a little extra to insure that it is also user-friendly. Your Web site should provide interesting and useful information on your company, your products or services, your personnel (including contact information), and anything else that will make you look like the well-established professional that you are. The more user-friendly and informative the site, the more business you will get.

Understand that the first contact potential customers or clients have with your business is either the telephone or your Web site – and probably both.

Lessons Learned: Comments from Those Who Failed

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The following appeared in a study, Financial Difficulties of Small Businesses and Reasons for Their Failure, prepared for the Small Business Administration (SBA). They are statements made by individuals whose business was in financial difficulty and subsequently failed. Their comments are listed under the stated reason for failure.

Tax Troubles

  • IRS stepped in and took over the bank account.
  • The IRS threatened to repossess [our] tools of trade if [we] did not pay the $20,000 back taxes immediately.
  • When the IRS agent told us that they will put padlocks on our doors if we can\’t come up with the money in one month.
  • Pressure from IRS. The IRS is “merciless.”
  • IRS was attempting to reach the non-debtors wife\’s income (i.e., levy) for the tax liabilities, which all preceded her marriage to the debtor.
  • The IRS changed the locks on the business, and the business had to declare bankruptcy in order for the owners to be able to even get into the building.

Personal Profiles

  • Bank was not going to refinance her business because of divorce settlement.
  • Inability to control blood glucose level, cholesterol, etc. due to stress of dealing with creditors.
  • His wife has a nervous breakdown. He just knew they couldn’t handle their bills.
  • The injury to his arm.
  • She could not pay her medical bills. She had filed bankruptcy as soon as she couldn’t pay her bills, rather than get behind in payments.
  • Creditors were hounding him to pay his wife\’s credit card. He had not canceled the cards after the divorce. He returned his but never closed the accounts.
  • “I had lost court case in trying to settle child support but lost. Was given 48 hours to settle $36,000 of debt which was impossible.”
  • And, finally, some comments regarding those who suffered a calamity that pushed them into failure, and subsequent bankruptcy.
  • The engine blew in the truck and they couldn\’t afford to buy another one.
  • His van was stolen and he could no longer transport the equipment necessary to carry on his business.
  • The organization they were linked with sold out and was taken over by another organization that was hard to work with.
  • The gas explosion.
  • Death of foreman.
  • The State came in and tore up the road.

Despite the above comments, the study also suggests that entrepreneurs are often not the callow amateurs they are portrayed as being, but business veterans who have the gumption to take the risks inherent in starting a new enterprise. They are people who are often prepared to shrug off the effects of a business failure and try again; a process made possible by the “fresh start” philosophy of U.S. bankruptcy laws. Failure does not always have to be viewed negatively. It can offer an opportunity for the entrepreneur to learn and gain from the experience in order to do a better job next time.

The Independent Contractor Revisited

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As the federal government and the state governments look for more ways to bring in money, the independent contractor status is a likely place for them to look. After all, by using independent contractors rather than employees, employers don’t have to withhold taxes, provide workers’ compensation, contribute to unemployment compensation, or provide any benefits such as 401-k programs, health insurance or other benefits. Plus you can use and discontinue independent contractors as needed.

Certainly, in this age of home-based businesses, the use of outside sources makes a lot of sense. Outsourcing a lot of business needs has been done for years and will only increase with growth of small business. Most one-person and small businesses don’t need full-time employees. Many requirements can be outsourced to independent contractors who in turn outsource many of their requirements.
It is the use of workers who are classified as independent contractors, but are really employees that can cause legal issues. FedEx Ground has been in the middle of this type of legal dispute for several years. FedEx claimed that their drivers were franchisees and therefore independent contractors; several drivers (and later the IRS) challenged that status, claiming that the drivers were really employees.

Here are some basic distinctions between independent contractors and employees:

Lack of employers’ direction is one major difference. In other words, the worker is left to his or her devices and does what the particular job requires without direction from the employer.
Is the worker working primarily for one employer or working for several employers on an as needed basis?

The worker is not in the same general business as the employer. A full-time consultant in the same line of business as the employer might be considered an employee. If the employee has his or her own business and also works for other companies, he probably would be considered an independent contractor.

Just because the worker creates an LLC or even an S-corporation doesn’t necessarily protect both sides from being classified as an independent contractor.

The federal government and the states are narrowing the definition of an independent contractor. One must definitely be truly independent to be considered an independent contractor. FedEx franchises (for lack of another term) wear FedEx garb, have FedEx logos on their trucks, and deliver FedEx packages on defined routes. However, we understand that they buy their own trucks and can sell their FedEx routes. But, consider the old saying: If it looks like a duck, acts like a duck and makes duck-like noises, there is a very good chance it is a duck. The battle goes on, but the penalties for violating the status of your people can be very expensive.

Entrepreneurship Is Alive and Well!

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A recent article in the Boston Globe reported that although more attention is on the large, primarily publicly held companies, more and more people are making their living by operating their own businesses. In fact, nationally, over 500,000 new businesses are started every year.  What this means is that over 10 percent of workers are “either starting a business or working at one that is less than 3 1/2 years old.”  And, as indicated by frequent reports, new businesses create new jobs.

Those people who start businesses generally do not have their own funds available for start-up expenses. This is due in part to the fact that bank and SBA funding is not available to them.  In addition, fewer than seven percent of new or prospective business owners will receive actual venture capital funds.  So, where does the money come from?  Second mortgages, credit cards, and family loans are the most common sources of start-up funds.  The Globe added that “over the past few years, more than 80 percent of Inc. Magazine’s Fast 1000 companies have been started with about $50,000 or less.”

The article concluded with a plea for “seed” capital and funding from both public and private sources.  Perhaps this article and similar ones will lead the way towards the recognition that those who own and operate their own businesses deserve a less arduous journey toward making the right start.

Small Companies Are Innovators

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Small companies are the innovators. The need for large companies to acquire small companies is necessary in order for the former to capture new products and services.  According to Fortune magazine, “Big companies almost never innovate. This is unfortunate because innovation is one of the few ways to gain proprietary advantage and stay profitable.  It’s not that innovation itself is rare – it’s occurring everywhere.  Which means, mostly, elsewhere.  And as engineers and inventiveness continue to flourish in China and India, elsewhere moves farther and farther from here.  A healthy business must therefore not only innovate more within its walls but leverage innovation elsewhere too.

“So why is innovation so hard for big companies?  The main reason is that innovative people tend to prefer working in smaller organizations that have more focus and less bureaucracy.  Even in small companies, adopting a large-company style can frustrate the innovators.
“The problem with large companies isn’t that they fail to do large and seemingly ambitious projects; it’s that they fail to do small, quirky, controversial projects  – that  have the potential to grow.  (If everyone thinks an idea is okay, how can it be innovative?)  A large organization – its missions threatened by new ideas – is often incredibly hostile to its own innovators; the antibodies to change are strong.”

Small Company Growth Trends

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The median sales of a company going public has gone from an average $15 million in 1999 and 2000 to $164 million in 2004.  Smaller companies have decided not to go public as often as in years past, and they reap the quick – and cheap – money as a result of that decision.  The question is “why?”

A company with only $15 million in annual revenues would most likely not want to have an IPO and absorb all of the attendant costs and the on-going fees related to going public.  They also would not want to have to spend the money necessary to comply with the Sarbanes-Oxley regulations.  Smaller companies have to pay a hefty price to go public – and remain public.  In fact, a recent Business Week article reported that “Bankers expect a record number of U.S. companies to go private this year, topping last year’s 86.”

Many CEOs, in order to rapidly grow their businesses, merge or acquire other companies.  However, many of these do not work out and the acquired entities eventually get sold off.  But as long as mergers and acquisitions are in vogue, large companies will acquire smaller ones in an effort to grow as rapidly as possible.  Therefore, many smaller companies that won’t go public because of the costs and subsequent compliance issues will be absorbed by larger companies.

The trend today, at least in manufacturing, is to provide complementary services.  For example, General Electric manufactures aircraft engines and medical equipment, but they also provide financing and maintenance services for the things that they manufacture.  These ancillary, but complementary, services are big profit makers.  Small service companies that provide these services may be excellent acquisition targets for manufacturers.  If smaller companies want to grow, adding complementary services such as GE does may be the best way.

On the flip side, many large companies are divesting themselves of companies that don’t fit into their core strategy.  For example, McDonald’s purchased Boston Market and several other food franchises in an effort to continue their growth. McDonald’s discovered that they were much better off focusing on their core business than they were trying to grow new concepts.  It is believed that these other franchises will be sold or they may already have been.  Smaller companies may want to divest themselves of products or services that aren’t complementary to their core business.

Some companies have almost reinvented themselves by adding new, more profitable, and “sexier” services or products.  This can increase the value of the company.  Smaller companies, because of their size and the fact that they usually have one manager, can shift quickly.  They can get rid of products or services that don’t generate commensurate profits, or add new products or services that can add to profits, much more quickly and efficiently than their larger counterparts.

Small companies, at least for the short term, will not be likely to go public, will be able to shift gears quickly to improve profits, but may also become acquisition targets by larger companies.

A Board of Advisors

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In most jurisdictions, a board of directors is not required for privately held companies.  However, many of these companies have appointed what might be termed advisory boards.  Although they may not have any legal authority, owners of these privately owned companies have discovered that this team of outside advisors can assist them in many ways.

One important way they can help is just by having their name and/or company affiliation attached to the company.  This can open doors to new customers and new relationships.  Appointing advisors from both the accounting and legal fields can help insure that the company maintains strong controls on these important areas.  This board can also assist in developing company strategy and systems.  A business-savvy board can also help in management succession and can help prepare the company for sale.

In order to create a strong and helpful advisory board, “cronies” should not be included. The advisory team can consist of two to four people. They should meet several times a year, or in emergency sessions when necessary, and be available by telephone.  They should also be compensated for their time just as any consultant would be.

Closing the Price Gap

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The deal is getting down to the wire, the price differential is close, but the parties are not yet in agreement. Following are some ideas that might get the ball rolling and help bring the parties together.

  • Let the seller retain the real estate and rent it to the buyer, thus reducing the price. The same could be done for major pieces of equipment. Let the seller lease them to the buyer reducing the price. The lease should, however, like most leases, provide for a buyout at the end.
  • Structure a royalty on sales rather than an earnout on gross margins or EBIT.
  • Have the parties create a subsidiary for the fastest growing part of the business in which the buyer and seller share 50/50.
  • Let the buyers acquire 70 percent of the business with the requirement that they purchase 10 percent more each year on the same multiple of EBIT as in the 70 percent sale.
  • Arrange a consulting agreement with the seller to provide additional compensation to be paid annually.

Certainly, any agreement or deal structure should be approved by the party’s professional advisors.

M&A Trends

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A  recent article in M&A Today offered some observations concerning current and future M&A trends.

“The business world is constantly changing.  For the first half of the 20th century, vertical integration was the objective in which, oil companies, for example, owned the entire process from drilling to retailing at the gas station.  From 1950 to 1980, diversification was in vogue.  Recently, the trend is to outsource everything except the core business.  One of the new business models known as the new profit imperative is to go downstream and get closer to the ultimate customer.”

Today’s M&A Climate

Many companies still look to acquisitions as the best way to increase both capability and market share.  Acquisitions generally add complementary products, new technology or increase geographic coverage.  Interestingly, today’s companies are investing in new ventures, while, at the same time; divesting themselves of some of their original businesses.  Since these “original” businesses now have low margins and slow growth, they are being sold off.  Quite a few of the large public companies have spun off some of their original core businesses.  One company – Perkin Elmer – sold off all of its businesses including its name and reinvented itself as PE Biosystems.

“The previous M&A drivers, such as the need to grow externally as well as internally; the pressure for industries to consolidate; and the ongoing globalization, are all prevalent.”

Tomorrow’s M&A Climate

1. “Strategic acquirers will not only be more particular and demanding about the fit of the target company, but they will continue to divest divisions with the least potential or with low returns.”  Edward C. Johnson of Fidelity Investments summed it up best: “My own rule of thumb is that a business has to be good for the customer (quality), good for the company (profitable), and good for the employees (rewarding).  If we only achieve two out of three, we have not succeeded.”

2. Gone are the high prices of the late 1990s.  “The structure of the transactions will have a higher cash component, but there will be an emphasis on more contingency factors or tighter representations and warranties in an attempt to minimize risks inherent in the deal.”

3. Intangibles will be more important than ever.  Areas such as “the brand” will be more important.  Branding represents a company’s “credibility, its true identity, its meaning, its uniqueness.”

4.  “The use of strategic alliances and joint ventures will be used more frequently as a forerunner or in lieu of acquisitions.”  Technology changes so quickly today that one company, especially in hi-tech, can’t do everything.  Alliances and joint ventures provide earnings without the dilution of acquisitions.

5. The requirements of the new Sarbanes-Olxey regulations will impede a lot of acquisitions, according to industry experts.  This increase in regulatory requirements due to this new law may not only slow down the process, but may actually kill a lot of deals. This is especially true when public companies acquire a privately held one.  Sellers of these companies are going to provide a lot more audited financial information.

6. Over the years, many mergers and acquisitions have been within the same industry.  There is a trend towards merging companies that can “piggy-back” ancillary services.  The recent attempt by Comcast to merge with Disney is a good example – distribution merging with content.  Another excellent example is General Electric.  They manufacture jet engines, turbines, medical equipment, finance it through a GE finance unit, and then service it through another GE division.  The trend seems to be that more manufacturing companies “will acquire relevant service companies as a way to capture more profitable businesses.”

More recently there has been a trend to outsource everything but the basic business.  One thing is sure in the world of mergers and acquisitions – change will always be taking place.  It is important that sellers and their advisors stay abreast of these constantly changing trends.

How Many Businesses Are There?

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We suspect that the answer to this question depends on who you ask! The Internal Revenue Service (IRS) reports that they received some 24.8 million business tax returns for the year 1999. We can hear the joyful sounds emanating from new business brokers and those considering the profession. Wow, almost 25 million businesses! We can hear them adding up the commission dollars. This is a very misleading figure. Many of these tax returns are for hobby-type businesses, one-person consultants, writers, artists and the like. In fact, one source reports that there are 18 million non-employee businesses, and they account for only 2 percent of total sales. INC, in their Small Business issue, reports that Sole Owners generate only 3.3 percent of all revenues and have annual sales of about $38,000.

Home-Based Businesses

According to INC magazine, 61 percent of the firms in their 500 fastest-growing companies list started out as home-based businesses. And, on average, 15 months after they started, they moved to outside space.

We dont want to take anything away from these non-employee businesses, many of which are home-based, as obviously some of them will grow to be large businesses. Quite a few of these businesses, rather than have actual employees, use independent contractors or outsource work needed. Many others are making an excellent living for the owner, and still other owners are quite content with the results of their business. However, they are not the kind of businesses that business brokers and intermediaries normally sell. Certainly, there are a few exceptions — some one-person businesses generate sufficient revenues that would be quite salable. And, it’s not really that business brokers couldn’t sell them or that people wouldn’t buy them.  Quite frankly, they are just not commissionable.

Most business brokers, out of necessity, have a minimum fee;  adding $10,000 to a selling price of $10,000 would price many small businesses out of the marketplace. There may be a way of handling them, but these small businesses can’t afford full-service brokerage services. This is coupled with the fact that obviously many, many of these non-employee businesses dont generate enough profit, if any, to make them salable. A total annual sales of $38,000 isn’t going to create a lot of excitement among prospective business buyers.

What Is A Real Business?

As we have discussed earlier, we are really only interested in those businesses that have at least one employee. When we are asked how many businesses there are, we assume the person is asking how many possible businesses are available for sale. The above figures give a false impression of the overall marketplace of businesses that might be for sale at some point. Certainly, many of the businesses that have no employees might be available for sale, but most will not.  Secondly, business brokers and intermediaries will most likely not be involved in a sale if one does occur. Since most people who call are interested in the business brokerage profession, very few of the businesses that file business income tax returns are really businesses that would sell, especially by business brokers.

Our feeling is that to qualify as a real business, it must have at least one employee. As we mentioned above, we suspect that some no-employee businesses use outsourcing rather than go through all of the red tape required by governmental agencies to have even one employee.

An article in the Boston Globe March 4, 2001 stated that there were 7.7 million small businesses with less than 100 employees. Last year’s Business Reference Guide reported that there were 5.5 million businesses with one employee or more. INC in their Small Business issue said that there were 5.8 million with at least one employee. One other source reported 7.2 million.

BizStats reported that there were 5.547 million businesses with at least one employee. We’re going with that figure.

Here Is A Further Breakdown:

4,467,900 represent 80.5% of the total and have sales under $1 million

790,600 represent 14.3% of the total and have sales of $1-5 million

265,600 represent 4.8% of the total and have sales of $5-100 million

23,311 represent 0.4% of the total and have sales of $100 million +

Total Businesses =5,547,400

*Courtesy: BizStats
Here’s A Breakdown By Type of Business:

Services – 40% (87.8% Of Those Have Revenues Under A Million)

Retail – 19.8% (80.3% Of Those Have Revenues Under A Million)

Wholesale – 7.5% (50.7% Of Those Have Revenues Under A Million)

Manufacturing – 6.0% (61% Of Those Have Revenues Under A Million)

Construction – 12% (81% Of Those Have Revenues Under A Million)

Finance, Insurance & Real Estate – 8.3% (83% Of Those Have Revenues Under A Million)

Transportation/Utilities – 3.9% (81.3% Of Those Have Revenues Under A Million)

Agriculture & Mining – 2.4% (89.8% Of Those Have Revenues Under A Million)

Size Breakdown of Businesses

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Here is a common and much-used breakdown by the federal government:

Small Business Administration (SBA):

Very Small Business = 19 or fewer employees

Small Business = 20 to 99 employees

Medium-Size Business = 100 to 499 employees

Large Business = 500+ employees

Checklist for Valuation

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1. Start with the business
– Value Drivers: Size, growth rate, management, niche, history
– Value Detractors: Customer concentration
Poor financials
Outdated M&E
Few assets
Lack of agreements with employees, customers, suppliers
Poor exit possibilities
Small market
Potential technology changes
Product or service very price sensitive

2. Financial analysis: Market Value – comparables
Multiple of Earnings – based on rate of return desired

3. Structure and terms: 100% cash at closing could reduce price 20%

4. Second opinion: Even professionals need a sounding board

5. Indications of high value:
– High sustainable cash flow
– Expected industry growth
– Good market share
– Competitive advantage – location/exclusive product line
– Undervalued assets – land/equipment
– Healthy working capital
– Low failure rate in industry
– Modern well-kept plant

6. Indications of low value:
– Poor outlook for industry –
foreign competition
price cutting
regulations
taxes
material costs
– Distressed circumstances
– History of problems – employees, customers, suppliers, litigation
– Heavy debt load

Checklist for Valuation

/in /by

1. Start with the business
– Value Drivers: Size, growth rate, management, niche, history
– Value Detractors: Customer concentration
Poor financials
Outdated M&E
Few assets
Lack of agreements with employees, customers, suppliers
Poor exit possibilities
Small market
Potential technology changes
Product or service very price sensitive

2. Financial analysis: Market Value – comparables
Multiple of Earnings – based on rate of return desired

3. Structure and terms: 100% cash at closing could reduce price 20%

4. Second opinion: Even professionals need a sounding board

5. Indications of high value:
– High sustainable cash flow
– Expected industry growth
– Good market share
– Competitive advantage – location/exclusive product line
– Undervalued assets – land/equipment
– Healthy working capital
– Low failure rate in industry
– Modern well-kept plant

6. Indications of low value:
– Poor outlook for industry –
foreign competition
price cutting
regulations
taxes
material costs
– Distressed circumstances
– History of problems – employees, customers, suppliers, litigation
– Heavy debt load

Checklist for Valuation

/in /by

1. Start with the business
–  Value Drivers:  Size, growth rate, management, niche, history
–  Value Detractors:  Customer concentration
Poor financials
Outdated M&E
Few assets
Lack of agreements with employees, customers, suppliers
Poor exit possibilities
Small market
Potential technology changes
Product or service very price sensitive

2. Financial analysis: Market Value – comparables
Multiple of Earnings – based on rate of return desired

3. Structure and terms: 100% cash at closing could reduce price 20%

4. Second opinion: Even professionals need a sounding board

5. Indications of high value:
– High sustainable cash flow
– Expected industry growth
– Good market share
– Competitive advantage – location/exclusive product line
– Undervalued assets – land/equipment
– Healthy working capital
– Low failure rate in industry
– Modern well-kept plant

6. Indications of low value:
– Poor outlook for industry –
foreign competition
price cutting
regulations
taxes
material costs
– Distressed circumstances
– History of problems – employees, customers, suppliers, litigation
– Heavy debt load

Simplifying the Valuation

/in /by

“There are many reasons for valuing an entity, and those circumstances can lead to different outcomes…For instance, a business’s value for sale on a going-concern basis will differ from its value for liquidation purposes. It similarly makes a difference if the valuation is for an orderly liquidation as opposed to a forced one. For example, the value of a company for estate-tax purposes (fair market value) likely will differ from its value for a sale to a specific purchaser (investment or strategic value). In some instances involving litigation, the courts or the law may dictate which standard of value to use.”

Source: Journal of Accountancy , August 2003

Introduction

The two variables – EBIT and DCF numbers – are affected by not only the financial aspects of the business but also the non-financial aspects, which can be both objective and subjective. For purposes of buying or selling a company, it is important for the seller to determine the floor price (the lowest acceptable price) and for the buyer to determine the walk-away price (the highest possible offer). Valuing companies may be more of an art than a science, but there are three basic factors that buyers focus on when trying to establish a price for a target company.

1. Quality of Eearnings

i.e., not a lot of “add-backs” or one-time events like the sale of real estate which does not reflect on the true earning power of the company’s operations. It is not unusual for companies to have some non-recurring expenses every year, whether it is a new roof on the plant, a hefty lawsuit, write-down of inventory, etc.

2. Sustainability of Earnings After the Acquisition.

The key question a buyer often asks is whether he is acquiring a company at the apex of its business cycle or whether the earnings will continue to grow at the previous rate.

3. Verification of Information

i.e., 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 uncollectible receivables? Is the seller above-board, or are there skeletons in the closet?

Measuring Earnings

When a seller talks about earnings, earnings really needs to be defined; e.g., EBIT or EBITDA; last year’s earnings or this year’s projected earnings; EBITDA – CAP X; restated without prerequisites but with add-backs, etc.

When a buyer is analyzing earnings, is it for one year, three years, interim earnings annualized, combination of reporting periods, projections, etc.? What is the timeframe for measuring earnings and what is the trend of earnings?

Another concern in measuring earnings in the future is related to what changes might affect earnings, such as increase in rent, family members off the payroll, loss of key customers and/or vendors, etc. Beware of companies that are locked into long-,term contracts in which they are unable to raise prices or companies in a commodity-type business in which there is unrealistic market pricing.

Key Considerations

The following questions are useful to understand the business and thereby value the company more prudently:

  • What’s for sale? What’s not for sale? Does it include real estate? Are some of the machines leased instead of owned?
  • What assets are not earning money? Should these assets be sold off?
  • What is proprietary? Formulations, patents, software, etc.
  • What is their competitive advantage? A certain niche, superior marketing or better manufacturing?
  • What is the barrier of entry? Capital, low labor, tight relationships?
  • What about employment agreements / non-competes? Has the seller failed to secure these agreements from key employees?
  • How does one grow the business? (Maybe it can’t be grown.)
  • How much working capital does one need to run the business?
  • What is the depth of management and how dependent is the business on the owner/manager?
  • How is the financial reporting undertaken and recorded and how does management adjust the business accordingly?

Conclusion

Much of the information above will influence the person’s perception of value. Valuation is often in the eyes of the beholder, whether the price is rational or not.

Simplifying the Valuation

/in /by

“There are many reasons for valuing an entity, and those circumstances can lead to different outcomes…For instance, a business’s value for sale on a going-concern basis will differ from its value for liquidation purposes. It similarly makes a difference if the valuation is for an orderly liquidation as opposed to a forced one. For example, the value of a company for estate-tax purposes (fair market value) likely will differ from its value for a sale to a specific purchaser (investment or strategic value). In some instances involving litigation, the courts or the law may dictate which standard of value to use.”

Source: Journal of Accountancy , August 2003

Introduction

The two variables – EBIT and DCF numbers – are affected by not only the financial aspects of the business but also the non-financial aspects, which can be both objective and subjective. For purposes of buying or selling a company, it is important for the seller to determine the floor price (the lowest acceptable price) and for the buyer to determine the walk-away price (the highest possible offer). Valuing companies may be more of an art than a science, but there are three basic factors that buyers focus on when trying to establish a price for a target company.

1. Quality of Eearnings

i.e., not a lot of “add-backs” or one-time events like the sale of real estate which does not reflect on the true earning power of the company’s operations. It is not unusual for companies to have some non-recurring expenses every year, whether it is a new roof on the plant, a hefty lawsuit, write-down of inventory, etc.

2. Sustainability of Earnings After the Acquisition.

The key question a buyer often asks is whether he is acquiring a company at the apex of its business cycle or whether the earnings will continue to grow at the previous rate.

3. Verification of Information

i.e., 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 uncollectible receivables? Is the seller above-board, or are there skeletons in the closet?

Measuring Earnings

When a seller talks about earnings, earnings really needs to be defined; e.g., EBIT or EBITDA; last year’s earnings or this year’s projected earnings; EBITDA – CAP X; restated without prerequisites but with add-backs, etc.

When a buyer is analyzing earnings, is it for one year, three years, interim earnings annualized, combination of reporting periods, projections, etc.? What is the timeframe for measuring earnings and what is the trend of earnings?

Another concern in measuring earnings in the future is related to what changes might affect earnings, such as increase in rent, family members off the payroll, loss of key customers and/or vendors, etc. Beware of companies that are locked into long-,term contracts in which they are unable to raise prices or companies in a commodity-type business in which there is unrealistic market pricing.

Key Considerations

The following questions are useful to understand the business and thereby value the company more prudently:

  • What’s for sale? What’s not for sale? Does it include real estate? Are some of the machines leased instead of owned?
  • What assets are not earning money? Should these assets be sold off?
  • What is proprietary? Formulations, patents, software, etc.
  • What is their competitive advantage? A certain niche, superior marketing or better manufacturing?
  • What is the barrier of entry? Capital, low labor, tight relationships?
  • What about employment agreements / non-competes? Has the seller failed to secure these agreements from key employees?
  • How does one grow the business? (Maybe it can’t be grown.)
  • How much working capital does one need to run the business?
  • What is the depth of management and how dependent is the business on the owner/manager?
  • How is the financial reporting undertaken and recorded and how does management adjust the business accordingly?

Conclusion

Much of the information above will influence the person’s perception of value. Valuation is often in the eyes of the beholder, whether the price is rational or not.

Simplifying the Valuation

/in /by

“There are many reasons for valuing an entity, and those circumstances can lead to different outcomes…For instance, a business’s value for sale on a going-concern basis will differ from its value for liquidation purposes.  It similarly makes a difference if the valuation is for an orderly liquidation as opposed to a forced one.  For example, the value of a company for estate-tax purposes (fair market value) likely will differ from its value for a sale to a specific purchaser (investment or strategic value).  In some instances involving litigation, the courts or the law may dictate which standard of value to use.”

     Source: Journal of Accountancy , August 2003

Introduction

The two variables – EBIT and DCF numbers – are affected by not only the financial aspects of the business but also the non-financial aspects, which can be both objective and subjective.  For purposes of buying or selling a company, it is important for the seller to determine the floor price (the lowest acceptable price) and for the buyer to determine the walk-away price (the highest possible offer).  Valuing companies may be more of an art than a science, but there are three basic factors that buyers focus on when trying to establish a price for a target company.

1.  Quality of Eearnings

i.e., not a lot of “add-backs” or one-time events like the sale of real estate which does not reflect on the true earning power of the company’s operations.  It is not unusual for companies to have some non-recurring expenses every year, whether it is a new roof on the plant, a hefty lawsuit, write-down of inventory, etc.

2.  Sustainability of Earnings After the Acquisition. 

The key question a buyer often asks is whether he is acquiring a company at the apex of its business cycle or whether the earnings will continue to grow at the previous rate.

3.  Verification of Information

i.e., 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 uncollectible receivables?  Is the seller above-board, or are there skeletons in the closet?

Measuring Earnings

When a seller talks about earnings, earnings really needs to be defined; e.g., EBIT or EBITDA; last year’s earnings or this year’s projected earnings; EBITDA – CAP X; restated without prerequisites but with add-backs, etc.

When a buyer is analyzing earnings, is it for one year, three years, interim earnings annualized, combination of reporting periods, projections, etc.?  What is the timeframe for measuring earnings and what is the trend of earnings?

Another concern in measuring earnings in the future is related to what changes might affect earnings, such as increase in rent, family members off the payroll, loss of key customers and/or vendors, etc.  Beware of companies that are locked into long-,term contracts in which they are unable to raise prices or companies in a commodity-type business in which there is unrealistic market pricing.

Key Considerations

The following questions are useful to understand the business and thereby value the company more prudently:

  • What’s for sale?  What’s not for sale?  Does it include real estate?  Are some of the machines leased instead of owned?
  • What assets are not earning money?  Should these assets be sold off?
  • What is proprietary?  Formulations, patents, software, etc.
  • What is their competitive advantage?  A certain niche, superior marketing or better manufacturing?
  • What is the barrier of entry?  Capital, low labor, tight relationships?
  • What about employment agreements / non-competes?  Has the seller failed to secure these agreements from key employees?
  • How does one grow the business?  (Maybe it can’t be grown.)
  • How much working capital does one need to run the business?
  • What is the depth of management and how dependent is the business on the owner/manager?
  • How is the financial reporting undertaken and recorded and how does management adjust the business accordingly?

Conclusion

Much of the information above will influence the person’s perception of value. Valuation is often in the eyes of the beholder, whether the price is rational or not.