Tips for buying a small business

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INTRODUCTION

Going into business for yourself is a big step, one that can be full of apprehension and even fear. Almost 90 percent of all those who purchase a small business have never owned a business. Most of them bought a business that was different than what they had been looking for. These buyers had the opportunity to explore the marketplace and subsequently found a business more to their liking. In most cases, the seller financed the sale.

As you begin your search, keep in mind that running your own business is more than a job; it is a lifestyle change. In most cases, it is a very big lifestyle change. Usually, you will be working longer hours, making all of the decisions, and, as the expression goes, "you will be the chief cook and bottle washer." In other words, you will be doing all of the work from running the business to, in many cases, sweeping the floor and changing the light bulbs.

Most buyers are looking for many of the following in considering the purchase of a business:

o Pride in the service or the product

o Flexibility

o Income

o Control of your own destiny

o Recognition

o Security

o Privacy

o Status

o Customer and employee contact

WHAT TO LOOK FOR

1. How long the business has been in business.

A business with a long track record means there are good reasons to be operating. It will be well known in the area, and people will be used to patronizing the business or using its services. The longer it has been in operation, generally, the better the business.

2. How long the present owner has owned the business.

The longer the present owner has been in business, the more likely he or she has been successful. People don't stay in business if they are not making money.

3. Why the present owner is selling.

If the owner has been in business for six months, is 37 years old, and wants to retire, you should be suspicious. The more valid the reason for sale, the more realistic the seller will be in considering your offer. However, keep in mind that after five or six years or more, people do get restless, "burn-out" sets in, and people look for new challenges. Why the seller is selling is an important question - get the answer.

4. Why books and records are important.

The financial records are a good indication of how well the business has been doing over the years. Keep in mind that tax records are not designed to show the business in the best light: no one likes to pay more taxes than they have to, and owners of businesses are no different. Generally, tax returns are a worst case scenario. You need to be able to look at the expenses and discover which ones are non-cash items, such as depreciation, and business use of home and vehicles. How important was the business trip to Las Vegas? A professional business broker can point these items out to you. When in doubt, however, seek outside assistance.

Keep in mind that financial records are only history. There are no guarantees that they will or can be duplicated or repeated. All of your profits are future. In the final analysis, the financial records of the business are an indicator of what the business has done; what you do with its future is up to you.

5. How to determine if the seller is reporting all income.

The simple answer is - that you can't! Not reporting income is against the law. You should consider only the income that the seller can show you. We all know, of course, especially in cash type businesses, that there is the possibility that the seller is not reporting all of his or her income for tax purposes. This "underground economy" has been well-documented and is in the billions of dollars. Many sellers will tell you about how much they are "skimming," but you should ignore their statements, since they have no way of proving these amounts. In determining whether a business is the right one for you, you should base the decision on the figures actually supplied to you by the seller.

The Bottom Line

Being in business for yourself can be a daunting prospect. There are no guarantees. At some point, after all of your investigation is completed, you will still have to make that "leap of faith" that is necessary to proceed with the purchase of the business. You will have to work hard, perhaps even "tighten your belt" a little and perform many different jobs to be successful in your own business. But, if running your own show, making your own decisions, not having to worry about job security (remember, no one can fire you from your own business), and just being on your own are important - then owning a business is for you. After taking this leap of faith, almost all business owners will tell you that they would never go back to being an employee.

LOOKING AT THE NUMBERS

What should you look for when considering a business to purchase?

Unfortunately, too many prospective buyers want to know the asking price first and then ask how much money they can make. These are the wrong questions to ask initially. You need to know how much cash the seller requires as a down payment. No matter how good the numbers are there is no point in looking at a business if the seller wants three times as much cash as you are willing to invest. Remember, the actual amount of money a business earns is usually much more than just the bottom line. A smart approach is to get more information on the business, and even make a visit, before ruling it out or getting too involved in the numbers. It's all part of the learning process.

THE BUYING PROCESS

One of the most common questions asked by those who have never purchased a business (which is incidentally about 90 percent of those looking to buy a business) is how do you actually buy a business. There is no right or wrong way to buy a business. However, it is important that you get answers to all of your questions and that you have all the information necessary to make an informed decision. Here are the steps to buying a business that over the years have become the most efficient and practical:

Get the Basic Facts

Get preliminary information on price, terms, income, cash flow, and general location. There is no point in continuing the buying process if the amount of cash necessary to buy the business is more than you are willing to invest. At this point, don't worry about the full price. It's important, but the key factor is the amount of cash that is necessary to buy the business. There is very little outside financing available such as banks, etc., for those who are purchasing businesses. The great majority of business purchases are financed by the seller. This is why the amount you are willing to invest is a key issue.

Also, the business has to be able to meet your basic financial needs. You always expect a business to improve under your ownership, but you have to be able to meet your living expenses as well as meet the debt service of the business. It is also important to remember that almost all purchase prices and down payments are negotiable. In fact, businesses generally sell for about 15 percent to 25 percent less than the original asking price. There is an old adage that says, "the more cash you are willing to invest in a business purchase, the lower the full price; the less cash you are able to invest the higher the full price.

Visit the Business

Visit the business to see if you like the location and the looks of the business itself - both inside and outside. This is a visual inspection. Pretend you are a customer. It's not time yet to talk to the owner. If the business is the type that does not lend itself to a visit, make an appointment with the seller to inspect the business, or have the seller's representative schedule a visit. There is no point in going any further if you don't like the physical location of the business or the appearance of it.

Get Questions Answered

If you like the business so far, it's time to get your questions answered. For example: What is the rent? How long is the lease? What have been the sales for the past few years? Can the seller support the figures you have been told? Now is not the time to have the seller's books and records completely checked. There will be plenty of time to do that and review other important issues during the due diligence phase. This is the time to get those questions answered that have a bearing on whether you may want to own and operate this particular business.It is also the time to visit with the seller to get your questions answered about the business itself.

Make an Offer

If you now have your basic questions answered and you want to proceed with purchasing this business, it is time to make an offer, subject, of course, to verification of all the information you have received. The main purpose in making an offer is to see if the seller will accept your terms, price, and structure of the sale itself. Remember, you will have the offer subject to your verification of the important information. It doesn't make sense to employ outside advisors and go through the time and expense of due diligence unless you can come to financial terms with the seller.

Due Diligence

At this point, you hopefully have arrived at a meeting of minds with the seller, and you are ready to begin removing the contingencies, performing what is commonly called due diligence.

*Insider Tip

Unless you are completely familiar with the type of business purchased, it is beneficial to include as part of the agreement that the seller will stay with you (30 days is fair, with perhaps another 30 to 60 days of telephone consultation) a sufficient length of time to teach you the business - at no charge. If you want the seller to stay longer, it may be best to offer to pay him or her a consulting fee of some type.

IS BUYING RIGHT FOR YOU

The next step to buying your own business is to make sure it is the right move for you and your family. Owning one's own business is still very much "the great American dream," but it's not for everybody. Here are some questions that you should ask yourself before taking the next step. How long have you been thinking about buying a business? Many people are interested in buying their own business, but are not willing to make the commitment necessary to move forward. They continue to look just like those who continue to look at new and expensive automobiles, but will never spend the money necessary to buy. One veteran observer has said that the longer you look the less likely you are to buy.

What is your time-frame to find a business?

If you're thinking of buying a business in two years, it's good to start your education. BizBuySell is a good place to start. Keep in mind that it really doesn't make much sense to start your search now, since any business you find now will have been sold by the time you are ready to buy. It's important, however, to arm yourself with all of the information and education available before you begin the search.

What is your primary reason for buying a business?

If you are not motivated to buy a business, you won't. You must go into business for yourself and for the right reasons. If you're tired of the corporate world, just have a "job-job," or perhaps even a dead-end job, then business ownership may be right for you. Certainly if you're unemployed or being transferred to a place where you don't want to go - buying your own business can be a viable solution.

Are you willing to invest a majority of your liquid assets in a business?

Buying your own business requires a serious financial investment. If you're the type who does not want risk, you might want to rethink owning your own business. It is not for the faint-hearted.

Are you independent enough to make your own decisions and be in control?

Operating a small business requires continual decision making. You're the boss, and you are in control. All of the decisions are yours - right or wrong. And, you will make a lot of wrong ones. The question is, can you recover and keep going forward? If you brood about poor decisions or they keep you awake at night, owning your own business may not be for you.

Is your family supportive of your owning a business?

If your family, especially a spouse, is not behind you 100 percent, then you should think twice about business ownership. It's very important that you have the support of your spouse. He or she has to understand that running a business can be time-consuming. On the plus side, however, many businesses do allow for flexibility so you can attend the afternoon little league game.

Are you open-minded about different opportunities, or are you looking for a specific type or business?

It's best if you are open-minded, especially if you are a first-time buyer. There are many types of businesses available, and you don't want to limit your choices. You should be looking for a business that will provide the income you need (or ability to do so), that you can afford,that has numbers that work, and, most importantly, that you can see yourself running.

Do you have reasonable expectations?

Do you think that you can buy a business with lots of cash flow for $100? It's important that you have realistic expectations about what your money will buy. Many sellers are willing to assist in financing the sale of their business, but remember, they're not going to give it away. Keep in mind that many business owners have spent years building their business, and it may represent the biggest financial asset they have. They're not going to just hand it over to you.

Can you make the "leap of faith" necessary to buy a business?

Many prospective business owners do their homework, do everything necessary to begin the purchase process, and then back out of the transaction. They just don't have the courage to go forward. There is nothing wrong with that; not everyone should buy and own their own business. However, if you don't think you can part with your money and take over operating the business on your own, you may want to take a second look at business ownership.

Do you need a guarantee?

If you are looking for a guarantee or a sure thing, then business ownership is not for you. You can and should look at all of the financials, tax returns, and all of the books and records. Remember, however, that they all represent history. You can't buy anyone else's history. A new owner makes changes, no matter how subtle. Their management style is different, and times change. You have to look at the business with the attitude of how you can improve things. The financial history of the business is certainly important, but it does not guarantee the future of the business - you do.

COMMON BUYER QUESTIONS

Why should I buy a business rather than start one?

An existing business has a track record. The failure rate in small business is largely in the start-up phase. The existing business has demonstrated that there is a need for that product or service in a particular locale. Financial records are available along with other information on the business. Most sellers will stay and train a new owner and most will also supply financing. Finding someone who will teach you the intricacies of running a business and who is also willing to finance the sale can make all the difference.

What is the real reason people go into business for themselves?

There have been many surveys taken in an attempt to answer this question. Most surveys reveal the same responses, in almost the same identical order of priority. Here are the results of a typical survey, listed in order of importance:

To do my own thing, control my own destiny.

Don't want to work for someone else.

To better utilize my skills and abilities.

To make money.

*It is interesting to note that money is not at the top of the list, but comes in fourth.

How are businesses priced?

Generally, at the outset, a prospective seller will ask the business broker what he or she thinks the business will sell for. The business broker usually explains that a review of the financial information will be necessary before a price or a range of prices can be suggested for the business.

Most sellers have some idea about what they feel their business should sell for - and this is certainly taken into consideration. However, the business broker is familiar with market considerations and, by reviewing the financial records of the business, can make a recommendation of what he or she feels is what the market will dictate. A range is normally set with a low and high price. The more cash demanded by the seller, the lower the selling price; the smaller the cash requirements of the seller, the higher the price.

Since most business sales are seller-financed, the down payment and terms of the sale are very important. In many cases, how the sale of the business is structured is more important than the actual selling price of the business. Too many buyers make the mistake of being overly-concerned about the full price when the terms of the sale can make the difference between success and failure.

An oft-quoted anecdote may better illustrate this point: If you could buy a business that would provide you with more net profit than you thought possible even after subtracting the debt service to the seller, and you could purchase this business with a very small down payment, would you really care what the full price of the business was?

What should I iook for?

Obviously, you want to consider only those businesses that you would feel comfortable owning and operating. "Pride of Ownership" is an important ingredient for success. You also want to consider only those businesses that you can afford with the cash you have available. In addition the business you buy must be able to supply you with enough income - after making payments on it - to pay your bills. However, you should look at a business with an eye toward what you can do with it - how you can improve it and make it more productive and profitable. There is an old adage advising that you shouldn't buy a business unless you feel you can do better than the present owner. Everyone has seen examples of a business that needs improvement in order to thrive, and a new owner comes in and does just that. Conversely, there are also cases where a new owner takes over a very successful business and not soon after, it either closes or is sold. It all depends on you!

CEO of Africabrokers. Silvan a BSc & MBA graduate is a dynamic, results and systems driven business management professional with an outstanding track record of success in delivering critical leadership, strategic plans, and sustainable results in operating efficiency and productivity improvement, technology advancement, cost reduction, sales and revenue performance. Distinguished career focused on innovating new strategic directions, creating revenue opportunities, spearheading policy development, and driving organisational growth and success across broad disciplines. Key Expertise: Business & Strategic Planning, Financial Planning and Capital Raising, Managing Complex Mergers, Acquisitions, Management Buy-ins, Buy-outs and BEE transactions. Article by: www.africabrokers.com

The basics of buying a small business

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A Small Business Is Bought and Sold

Is there a small-business owner who has never considered selling his business? Probably not. Is there an individual with some money, talent, or an urge for independence (often only the last) who hasn't thought about owning his own business?

The number of small businesses actually bought and sold, however, represents only a small fraction of those who have felt these urges. To many people, the desire to buy or sell is only a passing thought. Others find various ways to solve their problems or satisfy their ambitions. But sometimes an individual doesn't follow through because he finds the prospect of buying or selling a business too baffling.

The Flow of Decisions in a Buy-Sell Transaction

BUYERS AND SELLERS both seek answers to the same question: "What is this business worth?" Most people see the worth of a business as the total value of equipment and fixtures, inventory, and buildings and land. Important, certainly, but the sum of these values does not equal the value of the business.

For both buyer and seller finding the answer to this question is the most difficult and at the same time the most important step in the buy-sell process. But this final decision reflects many other decisions made while the transaction is being considered. In other words, the buy-sell process is a flow of decisions. It would be impossible to point out every decision that must be made, but the basic ones are as follows:

o Motivation: a decision to attempt the sale or purchase of a business.

o Contact: a decision on how to find a buyer (or seller) for a business with specified characteristics.

o Information: a decision on what information must be gathered or given to buy or sell a business.

o Sources: a decision on how, where, and at what cost the needed information can be obtained.

o Analysis: a decision on the meaning, importance, and reliability of the information gathered.

o Value: a decision on what the business is worth. Price: a decision on how much money to take or give for the business.

o Financing: a decision on how to pay or receive the purchase price.

o Contract: a decision on the form and content of the contractual relation.

o Implementation: a decision on how and when to effect transfer of ownership.

How important is management ability in this business?

Occasionally, a business that is unique and very simple almost manages itself. But if the business is in a competitive field, management ability is probably the most important requirement for success.

Does the prospective owner have the ability to manage successfully?

Effectiveness with people (customers and employees), eagerness to tackle difficult problems and make decisions, and intelligence about general business operations are key ingredients in management ability.

Can he/she learn how to manage this business?

Most people can learn to manage if they recognize the need. This requires room to make mistakes, however, and the self-discipline to undertake self-improvement programs.

Value

A business has a purpose. That purpose is to provide a satisfactory return on the owner's investment. Consequently, determining value involves measuring the future profit of the business being sold.

A seller often thinks of value as representing the money he has invested through his years of ownership. A buyer is tempted to consider value as a fair price for tangible items such as equipment and inventory. These factors are important, but they have value only to the extent that they contribute to future profits. An owner may have invested $40,000, the tangible assets may have a current worth of $20,000, but it is the profit potential that establishes the value of the total business.

Assuming that a reliable estimate of future profit is made, how much is to be paid for each dollar of profit potential?

What am I buying (or selling)? Is it a business or a building full of equipment and inventory?

What return would I get if I invested my money elsewhere--in stocks, bonds, or other business opportunities?

What return should I get from an investment in this business?

Price

It might seem that the price to be paid or received for a business would simply be equal to the value. However, value refers to what a business is worth; price refers to the amount of money for which ownership is transferred. There is usually a difference between price and value because the buyer and seller differ as to how much the business is worth. The price will represent negotiation and compromise.

Here are two suggestions for fruitful negotiation:

o Discussion between buyer and seller should focus on the future profit performance of the firm. Since expected profit is basic to determining value, it can be a valuable point for negotiation.

o Every profit projection includes some assumptions and risks. Generally, the less firmly based the assumption and the more apparent the risk, the less value an expected profit can support. Consequently, identifying and analyzing risks involved in future operations can make discussions between buyer and seller more significant.

These two points will help bring negotiations about value toward a mutually acceptable price.

Sources of Financial Information

BOTH BUYER AND SELLER are interested in financial information, affecting the buy-sell transaction. However, since the seller already has this information, it is a major requirement for the buyer to get and make use of as much of it as possible.

The buyer can usually find financial information in the following places: (1) financial statements, (2) income-tax returns, (3) other internal records, and (4) other external sources.

Financial Statements

The results of the financial transactions of every company should be reflected in its periodic financial statements. These statements are extremely important in buying or selling a small business. They were prepared for the seller, of course, and their contents are available to him. But the buyer, too, should be aware during the early stages of a buy-sell transaction of the information contained in financial statements.

Balance sheet and income statement. The balance sheet is a statement of the financial position of the business at a given moment in time. The income statement is a summary of the revenue and expenses of the business during a specified period of time. These financial statements show only the past results of the company's transactions. The results of future operations may or may not be similar.

Balance sheets and income statements in themselves contain important information, but they are most useful when a professional accountant makes a detailed analysis of them. A complete analysis includes a review of the manner in which the statements were prepared, and perhaps also a review of the records and control features of the accounting system. This is especially important in a small business buy-sell transaction because the financial statements of smaller companies are not usually as professionally prepared as the statements for larger companies.

Audited statements. In many buy-sell transactions, the statements are supplied by the seller, but the buyer reserves the right to conduct an audit of the seller's records. Or the buyer insists that the seller "warrant" his financial statements. Warranty of financial statements by the seller should be accepted with caution, however, because there does not seem to be any uniform definition of the term warranty.

If the seller's financial statements are prepared by an independent accountant, the statements should show whether they were (1) prepared after an audit of the seller's accounts, or (2) prepared from the seller's records without verification by audit. If they were prepared without verification by audit, they may be quite similar or even identical to statements that would have been prepared by the seller's own bookkeeper. If they were prepared after an audit, they should include a statement of the accountant's opinion.

Financial statements prepared without such an audit may or may not reflect the financial position or results of operation of the company. Most small companies do not have their records audited annually, but without an audit it is impossible to tell how accurate the statements really are.

Another point the buyer should consider is the cutoff period for the financial statements. The statements may have been cut off during the low period of the sales cycle or during the high period. This has some bearing on the financial position reflected in the statements.

Risk and Return on Investment

If a buyer wants to invest money in a business that is being sold, he should be concerned about receiving a fair return on his investment. Many businesses can make a profit for a short time (1 to 5 years); not so many operate profitably over a longer period of time.

From the buyer's point of view, what is a fair rate of return from an investment in a small business? The rate of return is usually related to the risk factor--the higher the risk, the higher the return should be. United States Government bonds are the safest investment--the rate of return ranges from 5-1/2 to 6 percent. Blue-chip stocks and corporate bonds usually give the investor a return of 4 to 10 percent if both dividends or interest and increase in market value are considered. Speculative stocks may have a higher return, but they also have a higher risk factor.

The buyer of a small business should try to determine the risk factor of the new business, though this is difficult at best and in many cases impossible. In attempting to assess the risk factor, the buyer should project the profits of the business as far into the future as possible. He should ask himself how high the risk should be normally and look for conditions that would be likely to affect the sales and profit-making capability of the business.

Financing and Implementing the Transaction

THE BUYER AND SELLER have a number of important matters to attend to before the transaction can be closed. The seller will be thinking about instruments of transfer that must be delivered at the closing, about compliance with the bulk sale act, and possibly about making financial arrangements if the buyer can't raise the purchase price. The buyer's attention will be focused on financing arrangements, organizing his business-to-be, overseeing the seller's operation of the business in the meantime, and becoming familiar with the details of the business operation.

Compliance With the Bulk Sale Act

Most States require the seller of a business to furnish a sworn list of his creditors to the buyer and the buyer to give notice to the creditors of the pending sale. The purpose of such a "bulk sale" act is to make certain that the seller doesn't sell out his stock in trade and fixtures, pocket the proceeds, and disappear, leaving his creditors unpaid. Compliance with the statute gives creditors an opportunity to impound the proceeds of the sale if they think it necessary.

Noncompliance or inadequate compliance may result in attachment of the property after the sale by creditors of the seller and voiding of the buy-sell transaction. The buyer should not close the transaction until he has made sure that all statutory requirements have been met.

Financing the Buy-Sell Transaction

In general, the buyer has two options regarding the financing of the business. The first basic method of financing is person investment of the future owner or owners of the business. The buyer may pay cash for the business out of personal resources, establish a partnership, or sell stock. These forms of financing are commonly referred to as the use of equity or investment capital.

The other basic form of financing is through borrowing or the establishment of credit. This method of financing may or may not require the payment of interest, but it does require the borrower to repay the principal, usually over a stipulated period of time or on a specific date. This method of financing is commonly referred to as the use of debt capital. Often the purchase is made through a combination of equity and debt capital.

Equity capital. In the simplest form of purchase, the buyer pays the full purchase price in cash. The buyer's investment in the business, at least initially, is full and complete. Whether the funds come from one person or more than one, the financial nature of the transaction does not change.

The sources of equity capital are many and varied. Generally, they are in the form of bank savings. Or cash may be obtained from liquidating certain assets the buyer may own, such as surrendering life insurance policies for cash value or selling real estate, stocks and bonds, or other assets.

Before disposing of assets, however, the buyer should ask himself this question: "Do I want to buy the business more than I want to keep these assets, considering both present and future values?" For instance, if the buyer cases $16,000 worth of government bonds, there may be a possibility of his making a higher profit, but the risk of losing his investment entirely will be greater. He should be as certain as possible that the expected return is worth the risk.

An equally important question is how much the buyer should invest in the business. In general, the more he invests himself, the better chance he will have of borrowing at least part of the purchase price.

A buyer may not have the capital, however, nor perhaps the inclination, to purchase the business outright with his own personal funds. How far he goes in this respect depends on his own cash resources, his confidence in the business, and his ability to borrow money or establish credit with others.

Debt capital. In most cases, the buyer of a small business will have to borrow money or establish credit to purchase the business. Several factors will affect the use of debt capital for this purpose: the source of capital, the amount that can be borrowed, and the length of time for which the capital can be borrowed.

Commercial lending institutions are the sources to which the buyer will probably turn first. The availability of financing through these sources depends on the security that can be pledged to the loan, the profit potential of the business, the prospect of repayment of principal and interest, and the general availability of credit.

One of the major difficulties facing the buyer at this point concerns the collateral that can be pledged as security. The physical assets of the business--particularly fixtures, equipment, and land and buildings--will not be available for security unless they are free of other financial obligations. The buyer may be forced to look to his own personal assets, such as cash value of life insurance, stocks and bonds, mortgages on real property, and so on.

Less formal sources of debt capital may be open to the buyer, such as loans from friends, relatives, business associates, and the like. Many small businesses have been financed through such means.

The seller as lender. A common source of debt capital is that supplied by the seller when he lets the buyer pay for the business over time. Why should the seller finance the buyer? Probably because the desire to sell is strong enough so that the seller is willing to assume part of the risk.

As in financing from other sources, the seller usually demands that the buyer pay interest on the amount being financed and repay the principal and interest at stipulated periods. The seller usually establishes his security on the more certain assets, such as fixtures and equipment. However, he may also assume the inventory as acceptable security without placing it in a bonded warehouse.

The seller's philosophy toward financing the buyer seems to be that if the buyer should fail, the seller can take back the business. The major problem in this form of financing is that it is harder for the buyer to get additional financing from other sources when the seller has first claim on the assets of the business.

How much to borrow. As the first step toward financing the purchase of a business, the buyer has to find answers to two questions:

1) How much do I need to borrow?"

2) "How much can I afford to borrow?"

The answer to the first question depends partly on how much money the buyer has and how much he is willing to invest in the business himself. The less equity capital he has, the more debt capital he needs.

How much he can afford to borrow depends on his ability to keep up principal and interest payments. If a buyer borrows from a number of sources, he may find himself committed to a repayment schedule that the profits from the business will not support. His borrowing plans should be related to the projected income statement prepared during his study of the business under consideration.

Operating capital. In addition to funds for purchasing the business, the buyer must have enough working capital to cover the cost of operation until the business itself produces enough cash. In other words, the buyer must think in terms of cash requirements and cash flow for weeks and months ahead. A common mistake in buying a business is failure to provide adequate working capital.

If sales and business costs after purchase of the business are expected to follow the pattern of the immediate past, the need for short term working capital should not be hard to estimate.

Putting a Value on Goodwill

Goodwill, when it exists, is a valuable asset. It may result from a good reputation, a convenient location, efficient and courteous treatment of customers, or other causes. However, because it is intangible and difficult to measure, goodwill is sometimes recorded when it does not exist.

From the accountants' standpoint, goodwill should be recorded only when it is purchased. It should not be recorded otherwise, they believe, because of the difficulty of placing a fair value on it.

As a practical matter, above-average earnings are normally considered the best evidence of the existence of goodwill, and the value placed on the goodwill at the time of its sale is often determined by capitalizing these extra earnings. Take, for example, a business in a field in which the normal return on investment is 10 percent. Suppose the business has a capital investment of $200,000 and an annual return of about $24,000. The average return on $200,000 for this type of business would be $20,000 a year. Therefore, the business has above-average earnings of $4,000 yearly.

Capitalizing these above-average earnings at 10 percent ($4,000 div. by .10) gives $40,000 as the investment needed to earn the $4,000. Therefore $40,000 may be taken as the value of the goodwill of this firm.

Many people feel that unless a business has above-average earnings, it does not have goodwill. Thus, a business might appear to have an excellent location, enlightened customer policies, and a superb product; yet this business will not have goodwill attaching to it unless its earnings exceed the normal earnings for that type of business.

The measurement of goodwill has many pitfalls. To begin with, a decision must be made as to what normal earnings are. (Industry averages will probably be available, but average earnings for the industry aren't necessarily normal earnings.) And once this decision has been made, the percent at which the above-normal earnings will be capitalized must be decided. In the example given, 10 percent was used. This means that the buyer should recover his investment in 10 years. If he wants to recover his investment more quickly, he will want to use a higher percent, which will give a lower capitalized value. If he is willing to wait longer, he will accept a lower percent, which will raise the capitalized value.

Goodwill is simply a bookkeeping device to represent the value of one part of a business when that business is valued as a whole. In most cases, the total value of the business is decided without a detailed calculation of the goodwill figure--in many cases, without even detailed consideration of the value of the other assets.

In the ensuing chapters, we will develop an in-dept strategy to find, value and acquire a business using as little of our cash as possible. This is not a book that you read and put down. This is a workbook, a work-in-progress type manual. We recommend that the reader takes action as he/she goes through the information enclosed. That is the only way to successfully become a small business owner. And by duplicating your efforts, you can repeat the process outlined in this book to build a small empire.

For more information on how to buy and flip small businesses for profit, visit http://www.whiteoakpartnersinc.com/buyflipbiz You can also visit our blog at http://whiteoakpartnersinc.com/wordpress

Buying a business

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Start thinking about buying an established business if you want to avoid the immense risks involved in starting one. Not everyone wants to start a business from scratch, and buying a business with the infrastructure in place lets you focus on building it up, as opposed to getting a new business off the ground. This is not to say that it's easy to buy an existing business; it's a fairly complicated process throughout which you need to know exactly what you're doing.

First off, decide that you do want to buy before you begin your research. This way you will look at options more carefully. A particular business may not be exactly what you're looking for, but if you're sure that you do want to buy, then you won't brush it off immediately, without first considering how you might grow with it. Vested Business Broker's deals with a wide range of businesses and will surely help you make up your mind quickly.

Talk to the people in your life who are likely to be affected by the venture. Let them know the hours that you are likely to have to work and the risks involved. You might need their support if you initially go through a rough patch.

Using a Broker

It would be more prudent to use the services of a broker in buying your business. All the important groundwork in terms of research would already have been done. And, you can focus on finalizing the deal.

A broker will handle all those complicated negotiations which you may just find too much to handle. And, when things turn unpleasant you can leave it all to your broker.

Brokers are supposed to have systems in place to take care of deals. The sale is usually a time of some stress for both the buyer and the seller, so having someone to put everything together and take care of the paperwork is very helpful. You will appreciate a broker's services as it will allow you to concentrate on getting a worthwhile deal, and not have to worry about whether all the documents -and there are a lot of them- are in order.

Of course, your broker will charge you a substantial commission, but it will all be worthwhile if you get the deal you want. Vested Business Brokers can be counted on to take care of the nitty-gritty that ensures a successful deal.

Business Essentials

Once you figure out your particular area of interest, think about the size of the business that you want to buy, the location of prospective sellers etc. Know your financial resources so that you don't waste time looking at businesses that are beyond your reach, even if you have always fantasized about being a ship-builder.

Identify your strengths. Are you good at sales? Operations? Look out for a business that is in a position to benefit from your particular strengths.

Once you've identified a business that you want to buy, make contact with the seller but hire professionals i.e. accountants, attorneys, etc. to take care of different aspects of the purchase. Using Vested Business Brokers services would surely help you narrow down your search and identify all the expertise you might need to close the deal successfully.

Allow yourself a gut instinct about the seller and the business. Feel free to ask why they want to sell the business, and evaluate your decision based on their reasons. It might just reassure you that you should go ahead with the deal.

Company Valuation

There are many methods of valuing a company, and it is up to the seller to decide how to go about it. Make sure the price is a fair representation of how valuable the company is likely to be to you. It is obviously disadvantageous to you if a non-performing company that is heavy in assets is priced based on the net value of its assets.

The asking price is negotiable. Even in a situation where the seller is firm on her price, enquire as to the method of valuation and challenge it if you think it leaves you with an unfair deal. While negotiating, be prepared to challenge the seller with facts and statistics.

Find out what specific concerns the seller has about the deal, and address them. Be sensitive to the fact that selling a business can be an emotional process but at the same time make sure that you don't end up paying for its sentimental value. With Vested Business Brokers you can be sure to get yourself a fair valuation of the business of your choice.

Financing the Deal

To finance the deal, seller financing is probably the best option available to you. You won't get a bank loan without offering a 100% collateral. The Small Business Administration does offer some financing but only for deals that meet a strict set of criteria.

The good thing about seller financing is that it shows that the seller is being serious and honest about the deal, and is not trying to offload an ailing business onto you. It shows that he has enough faith in the business he is selling to share the risk involved in running it with you. There's no better way to be sure that a business is really worth buying. Seller financing also allows for far greater flexibility than any other kind of financing.

Most people who start looking for a business to buy never actually end up buying. If your first deal doesn't come through, don't let it deter you from looking for other businesses. Learn from the experience and use it to sharpen your skills so that the next time around, you know exactly what you want and how to go about getting it. Vested Business Brokers can offer you a range of financial options.

Services

Vested Business Brokers offers all services required in buying a business:

1. Initial Consultation - You will have a one-on-one via phone or in person with a broker in your area to discuss all of your questions and concerns regarding the business buying process. Our brokers are trained to help you with business concerns as well as personal concerns. We realize that this is not only a financial decision, but a lifestyle decision as well.

2. Buyer Profile - Once all of your concerns have been addressed and you have signed a buyer registration agreement, your Vested Business Broker will create a buyer profile by which he/she can search for the exact type of business you are looking for.

3. Viewing Listings - Once we have entered your criteria into our database, our computer will generate matches. Your Vested professional will then go with you to take a look at the listing and address any questions you may have.

4. Offer To Purchase - If one of these businesses fits what you are looking for and you have had a chance to think about making an offer (sometimes you may have to make several visits to the business to be certain), your broker will help you fill out an offer sheet. This sheet details the price and terms at which you would like to purchase the business. Here the experience of your broker will help you in making the best offer. In addition, Vested offers financial services that can help make a deal happen, even if you are short of funds.

5. Due Diligence - Once the offer has been accepted, the buyer conducts a period of research on the business. Basically, due diligence is the process by which you work with the seller to verify the financials of the business as well as a period in which you learn the inner workings of the business. This process typically takes two weeks. A buyer may want to bring in his/her attorney or CPA to help during this phase of the purchase. (We have many relationships with excellent professionals, if you need a referral). Your broker will be available to assist you in the due diligence process in every way.

6. Contract & Closing - Following a successful due diligence period in which all of your concerns have been addressed, a contract will be drawn up between yourself and the seller of the business. Typically this is done between your attorney and that of the seller. (Again, Vested has relationships with many attorneys if you need a referral). If the contract meets all contingencies you have set forth, it can be signed and a closing date set. At closing, the business will officially change hands and you will have completed the buying process. Keep in mind that our brokers are here for you every step of the way to ensure that you are making informed decisions.

The process doesn't end at closing. Vested has developed relationships with many business service providers to offer new business owners services that are vital to the success of their businesses.

At Vested Business Brokers we have enough experience in putting together successful deals. Our web page is http://www.vestedbb.com

We assist to buy a business, sell a business and to be a business broker. Get the deal you want with Vested Business Brokers.