The First Steps After You Buy a Business 02/18/2011
By Richard Parker, President of The Business For Sale Buyer Resource Center™ and author of How To Buy A Good Business At A Great Price©
It's One Thing to Buy A Business, Now You Have To Run It! The first 90 days after you close on a business purchase will prove to be the most critical time in you new venture's short-term future. There are several key factors that if done right, will set the foundation for your success. It is very important for you to lay out your plan for post-closing before you take over so as to ensure the smoothest transition possible.
Don't Change Anything…. Yet!
Unless you have an intimate knowledge of the business and the industry, much, if not everything will be new to you. While it is normal for you to jump in full-steam ahead and implement many changes that you've thought about, the best thing that you can do is nothing, at least at the very beginning. That's right, no major changes at all, at least for now. Most businesses experience a downturn in the first three to six months after a new owner takes over. Don't panic, it can happen. However, if you avoid any substantial changes, things should rollover effectively.
Since so much is new, it would be impossible for you to set forth any policies or procedures that make sense. What you want to do is to first learn the business: who are the customers, what do they want and expect, understand the employees and determine their role and contribution to the business. Avoid drastic changes. The old saying that you've got to learn before you can earn is most applicable in this situation.
Get in, get comfortable, get smart and then get going.
A good friend of mine has a great line: “you've got to know it before you can grow it”.
The Seller's Role
Typically, there will be a period immediately after the acquisition where the former owner will be around for a transition period. This varies from deal to deal. In some cases, it can be as short as a couple of weeks while others may involve a long-term training period and even an ongoing consultation/employment relationship. This can be a difficult time. Regardless of the length of the relationship, keep in mind that the seller will still have a very strong attachment to the business and the employees will take some time getting used to a new boss.
Interestingly enough, no seller has ever made it through the entire training period for any business I've acquired. Sure, they have a role to offer some insights, but I've always found them to be more of a hindrance than an asset. Of course, if it's a complicated business, then this may not always hold true. If the business is far too difficult for you to take over, or, if it relies on them completely to succeed, you probably shouldn't buy it.
Pick their brains as best you can. Always keep the relationship friendly; you never know when you'll need them and they can remain a good source for brainstorming down the road. However, this is now your business, you're the new boss, it's your show, and it's time to get the show on the road.
Prepare a comprehensive list of everything that you want them to cover during training. This includes everything from how to operate the alarm systems down to providing you with their evaluation of the employees. One subject that should be covered at length is to ask them what they would do in your situation. Ask them to outline what their business plan would like and what things they feel you should explore as the new owner.
For the first couple of weeks, let them keep their office as-is. Set yourself up alongside them as watch what it is that they do each day. Observe the flow of communication with clients, employees, etc. Continually ask questions. Do not simply allow them to do their job as they did before; you need answers, so question everything.
Meeting with Employees
Set up a meeting the first day with all the employees. These people are naturally going to be nervous about you, their job and their future. Most people abhor change so be sympathetic to their situation. No matter what plans you have, let them know:
End the meeting by asking each one of them to prepare a report, due within one week, that outlines: what they believe can be done to make them more effective at their job, and second, if they were the new owner, what suggestions they would have for the overall business. Tell them that all reports will be kept confidential, that you will review it with them individually and that you expect everyone to have it submitted on a timely manner (a note here: if any of them are late, you can expect that person to be a trouble employee and chances are they will not last).
It's Time To Get Busy!
So you've got the transition period completed, you're feeling comfortable with the business, the employees are feeling positive, you've reviewed their reports, it's now time to get down to business.
Step One: Make the Place Your Own.
Get the place cleaned up. Throw on a new coat of bright paint, have everyone clean up their work areas, remove old files and throw out unwanted furniture, old posters, etc. Give the place a new look. You do not have to spend much money at all. Set the standard by keeping your work area spotless. There's no need to be a mess, no matter what your prior work habits were. You cannot expect any employee to do anything different than you so if you want to run a well-oiled, organized business, it all starts with you.
Step Two: Learn the Business and What Oils the Engine.
Perhaps the most critical thing you can do in your initial tenure is to really learn the guts of the business. The answers are readily available but you have to ask the questions. Make it your goal to speak with customers, suppliers, employees, competitors and anyone else associated with the business to get a true picture about the business and the industry and where you fit in. Generally, the customers have the answers, and quite often businesses do an awful job of satisfying the clients. They may think they do, but the truth is that most don't. As such, dig into your customers' wants so that you position the business as a place where they want to do business.
Your employees are a pivotal link in this process. Get them involved. They will be far more effective carrying out plans they have helped develop than they will executing strategies that have been dumped on them.
Based upon employee reports and fact-finding, compile a detailed listing of everything you want to do in the business… eventually. You can't do it overnight. However, by noting these potential items, your business plan will begin to marinate. Work at organizing your list by the area within the business (sales, marketing, accounting, operations, etc.) and keep it up to date.
Develop a 30/60/90-day plan for each specific area of the business. Follow up diligently to ensure timelines are respected. Change does not have to be monumental or drastic; it's improvement that you're striving to achieve.
Step Three: Sell Off Useless Assets if Applicable
If the business has acquired useless inventory, equipment, or any other obsolete asset, then get rid of it. There's no need to keep any assets around that take up space and do not produce revenue.
Step Four: The Marketing Plan
In concert with Step Two, assemble the marketing plan for the business. Keep in mind that marketing, is without a doubt the simplest thing to do in a business and something that is made overly complicated by most companies. Marketing is simply a matter of finding out what the customers want, and then giving it to them at terms that make sense to you and them. End of story. You may buy a business that excels at marketing, which is great. However, marketing also requires continuous testing and measuring. So even if they're great at it, make certain that you set forth additional strategies within this discipline.
Step Five: The Business Plan
Personally, I think most business plans stink and are completely unrealistic. Companies put them together to make themselves feel good and generally little of it ever gets executed. On the other hand, it can prove to be an invaluable document and a blue print for success, Therefore, it is needed, but must be done correctly. A business plan does not have to be a long document with unrelated information and useless pie-charts and graphs. On the contrary. Done right and it can be a bullet-point description of:
It's One Thing to Buy A Business, Now You Have To Run It! The first 90 days after you close on a business purchase will prove to be the most critical time in you new venture's short-term future. There are several key factors that if done right, will set the foundation for your success. It is very important for you to lay out your plan for post-closing before you take over so as to ensure the smoothest transition possible.
Don't Change Anything…. Yet!
Unless you have an intimate knowledge of the business and the industry, much, if not everything will be new to you. While it is normal for you to jump in full-steam ahead and implement many changes that you've thought about, the best thing that you can do is nothing, at least at the very beginning. That's right, no major changes at all, at least for now. Most businesses experience a downturn in the first three to six months after a new owner takes over. Don't panic, it can happen. However, if you avoid any substantial changes, things should rollover effectively.
Since so much is new, it would be impossible for you to set forth any policies or procedures that make sense. What you want to do is to first learn the business: who are the customers, what do they want and expect, understand the employees and determine their role and contribution to the business. Avoid drastic changes. The old saying that you've got to learn before you can earn is most applicable in this situation.
Get in, get comfortable, get smart and then get going.
A good friend of mine has a great line: “you've got to know it before you can grow it”.
The Seller's Role
Typically, there will be a period immediately after the acquisition where the former owner will be around for a transition period. This varies from deal to deal. In some cases, it can be as short as a couple of weeks while others may involve a long-term training period and even an ongoing consultation/employment relationship. This can be a difficult time. Regardless of the length of the relationship, keep in mind that the seller will still have a very strong attachment to the business and the employees will take some time getting used to a new boss.
Interestingly enough, no seller has ever made it through the entire training period for any business I've acquired. Sure, they have a role to offer some insights, but I've always found them to be more of a hindrance than an asset. Of course, if it's a complicated business, then this may not always hold true. If the business is far too difficult for you to take over, or, if it relies on them completely to succeed, you probably shouldn't buy it.
Pick their brains as best you can. Always keep the relationship friendly; you never know when you'll need them and they can remain a good source for brainstorming down the road. However, this is now your business, you're the new boss, it's your show, and it's time to get the show on the road.
Prepare a comprehensive list of everything that you want them to cover during training. This includes everything from how to operate the alarm systems down to providing you with their evaluation of the employees. One subject that should be covered at length is to ask them what they would do in your situation. Ask them to outline what their business plan would like and what things they feel you should explore as the new owner.
For the first couple of weeks, let them keep their office as-is. Set yourself up alongside them as watch what it is that they do each day. Observe the flow of communication with clients, employees, etc. Continually ask questions. Do not simply allow them to do their job as they did before; you need answers, so question everything.
Meeting with Employees
Set up a meeting the first day with all the employees. These people are naturally going to be nervous about you, their job and their future. Most people abhor change so be sympathetic to their situation. No matter what plans you have, let them know:
- There are no major changes planned.
- You are very optimistic about the business's future.
- Each one of them has a role to play.
- You're eager to build the business.
- You are available to speak to them at any time regarding any concerns they have
- They are expected to contribute to the success of the business.
- You're counting on their support to build the business.
- You realize that there will be a transition period and it may take some time for them to get used to you and vice-versa.
End the meeting by asking each one of them to prepare a report, due within one week, that outlines: what they believe can be done to make them more effective at their job, and second, if they were the new owner, what suggestions they would have for the overall business. Tell them that all reports will be kept confidential, that you will review it with them individually and that you expect everyone to have it submitted on a timely manner (a note here: if any of them are late, you can expect that person to be a trouble employee and chances are they will not last).
It's Time To Get Busy!
So you've got the transition period completed, you're feeling comfortable with the business, the employees are feeling positive, you've reviewed their reports, it's now time to get down to business.
Step One: Make the Place Your Own.
Get the place cleaned up. Throw on a new coat of bright paint, have everyone clean up their work areas, remove old files and throw out unwanted furniture, old posters, etc. Give the place a new look. You do not have to spend much money at all. Set the standard by keeping your work area spotless. There's no need to be a mess, no matter what your prior work habits were. You cannot expect any employee to do anything different than you so if you want to run a well-oiled, organized business, it all starts with you.
Step Two: Learn the Business and What Oils the Engine.
Perhaps the most critical thing you can do in your initial tenure is to really learn the guts of the business. The answers are readily available but you have to ask the questions. Make it your goal to speak with customers, suppliers, employees, competitors and anyone else associated with the business to get a true picture about the business and the industry and where you fit in. Generally, the customers have the answers, and quite often businesses do an awful job of satisfying the clients. They may think they do, but the truth is that most don't. As such, dig into your customers' wants so that you position the business as a place where they want to do business.
Your employees are a pivotal link in this process. Get them involved. They will be far more effective carrying out plans they have helped develop than they will executing strategies that have been dumped on them.
Based upon employee reports and fact-finding, compile a detailed listing of everything you want to do in the business… eventually. You can't do it overnight. However, by noting these potential items, your business plan will begin to marinate. Work at organizing your list by the area within the business (sales, marketing, accounting, operations, etc.) and keep it up to date.
Develop a 30/60/90-day plan for each specific area of the business. Follow up diligently to ensure timelines are respected. Change does not have to be monumental or drastic; it's improvement that you're striving to achieve.
Step Three: Sell Off Useless Assets if Applicable
If the business has acquired useless inventory, equipment, or any other obsolete asset, then get rid of it. There's no need to keep any assets around that take up space and do not produce revenue.
Step Four: The Marketing Plan
In concert with Step Two, assemble the marketing plan for the business. Keep in mind that marketing, is without a doubt the simplest thing to do in a business and something that is made overly complicated by most companies. Marketing is simply a matter of finding out what the customers want, and then giving it to them at terms that make sense to you and them. End of story. You may buy a business that excels at marketing, which is great. However, marketing also requires continuous testing and measuring. So even if they're great at it, make certain that you set forth additional strategies within this discipline.
Step Five: The Business Plan
Personally, I think most business plans stink and are completely unrealistic. Companies put them together to make themselves feel good and generally little of it ever gets executed. On the other hand, it can prove to be an invaluable document and a blue print for success, Therefore, it is needed, but must be done correctly. A business plan does not have to be a long document with unrelated information and useless pie-charts and graphs. On the contrary. Done right and it can be a bullet-point description of:
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Buying an Internet Business 02/18/2011
By Richard Parker, President of The Business For Sale Buyer Resource Center™ and author of How To Buy A Good Business At A Great Price©
Personally, I love the online business model. My company now does business in over 60 countries with no inventory, no receivables and a handful of employees; we outsource nearly every key function except customer service and support. I have absolutely no technical expertise. The entire business is automated and it's incredibly profitable. An ideal business model, isn't it?
Perhaps the best part about an online venture is that you can get into one quickly and inexpensively whether you buy an existing one or start one from scratch - although multiples for some successful online ventures are far greater than most bricks-and-mortar businesses because of many of the factors you'll read about here. Additionally, because an online business can be run from anywhere at anytime, it's an ideal business to have if you're not yet ready to take the full plunge into your own business or you like to travel, work remotely or casually (it's 3:00 pm now and I'm in Australia with my family on vacation looking at the famous Sydney Harbor and Opera House … and, even better, people are buying our program right now. Gotta love it!).
Don't be misled thinking it's all fun and games. But, it's the kind of business where, if you put in the effort up-front and automate every aspect of it, it will pay enormous ongoing dividends relative to the time expenditure. Right now, it takes me about 90 minutes maximum each day to operate the business, if at all.
If you want to buy an existing profitable venture, keep in mind that the multiples may be higher than traditional small business valuations since there are so many great benefits to them although they really should not be much greater than an offline business. You should also know that the financials of most pure Internet businesses are generally simpler to investigate because there are generally no cash sales, and almost all of the transactions are via credit card.
Likewise, if you decide to start one from scratch, you can build a website and begin marketing for just a few thousand dollars.
Here's what you need to be aware of when buying an existing online business:
It's been said that the best business is the world is everybody else's. However, an online venture, when set up and run properly, is, without question, the best business model around. The key, of course, is to provide a profitable product or service in a sustainable business model.
Personally, I love the online business model. My company now does business in over 60 countries with no inventory, no receivables and a handful of employees; we outsource nearly every key function except customer service and support. I have absolutely no technical expertise. The entire business is automated and it's incredibly profitable. An ideal business model, isn't it?
Perhaps the best part about an online venture is that you can get into one quickly and inexpensively whether you buy an existing one or start one from scratch - although multiples for some successful online ventures are far greater than most bricks-and-mortar businesses because of many of the factors you'll read about here. Additionally, because an online business can be run from anywhere at anytime, it's an ideal business to have if you're not yet ready to take the full plunge into your own business or you like to travel, work remotely or casually (it's 3:00 pm now and I'm in Australia with my family on vacation looking at the famous Sydney Harbor and Opera House … and, even better, people are buying our program right now. Gotta love it!).
Don't be misled thinking it's all fun and games. But, it's the kind of business where, if you put in the effort up-front and automate every aspect of it, it will pay enormous ongoing dividends relative to the time expenditure. Right now, it takes me about 90 minutes maximum each day to operate the business, if at all.
If you want to buy an existing profitable venture, keep in mind that the multiples may be higher than traditional small business valuations since there are so many great benefits to them although they really should not be much greater than an offline business. You should also know that the financials of most pure Internet businesses are generally simpler to investigate because there are generally no cash sales, and almost all of the transactions are via credit card.
Likewise, if you decide to start one from scratch, you can build a website and begin marketing for just a few thousand dollars.
Here's what you need to be aware of when buying an existing online business:
- Online businesses go far beyond building a website. It's not an: “if I build it they will come" business. Sure, you can have clients worldwide, but they have to find you before they can buy your goods and services. If not, it would be like Wal-Mart opening a new store with more products at deeper discounts, then locating it ten miles offshore in the ocean. Even if they offered 50% discount off every item, nobody would make the trip to the store. You need to figure out how to get people to the store (the website). In other words, you need to market the business and figure out how to get the store to the land where all the people are (translation – how to get people to your site).
- Niche products work great.
- You'll need to do extensive research to learn about the competition, the industry, products, competition, etc. It's not as easy as finding out about a local bricks-and-mortar businesses.
- You need a bullet-proof non-compete clause with the seller since it's so easy for them to open up a competing business in another name, country, etc. That is why you MUST have a large balance of sale as part of the deal.
- Make sure that any products or services being sold, if not proprietary, are going to be available to you from the various suppliers.
- If the business relies on email marketing campaigns, investigate how they get their lists and prospects. No matter how great email marketing is, spam is out of control. It will eventually become highly regulated with massive penalties for offenders.
- Stay away from fads, or any products that may become subject to government intervention or stricter controls, such as pharmaceuticals.
- Verify any potential liabilities, guarantees, etc., that may have been offered in the past. Get copies of old site versions from the owner. Some sites began by offering 1-2-or 5- year guarantees on their product. These claims can come back to haunt you. You'll need the seller to indemnify you from any future claims, or you need to have a mechanism to offset any claims against the balance of sale.
- Get detailed listings of all individuals who have access to the site's backend or passwords for accounts. In fact, make certain that you change all passwords once you take over.
- If the seller developed the site, bring in a tech-savvy individual to review the actual programming. Quite often the site evolved through the seller's design and he/she may have kept adding little bits of programming to it. While it may make sense to them, it may very well be a “plate of spaghetti” to someone else and can never be figured out.
- Get copies and ownership to all source code for the site.
- Meet with the webmaster and any other people who work on the site if you won't be doing the work yourself, and make certain that the relationship will continue.
- Investigate the credit card processing. You might have to put up significant personal guarantees with the merchant bank to process credit cards. In fact, you may want to check this out in the very early stages of your investigation.
It's been said that the best business is the world is everybody else's. However, an online venture, when set up and run properly, is, without question, the best business model around. The key, of course, is to provide a profitable product or service in a sustainable business model.
By Richard Parker, President of The Business For Sale Buyer Resource Center™ and author of How To Buy A Good Business At A Great Price©
Due diligence is probably the most critical stage in the buying process. Many prospective buyers incorrectly identify this period as strictly a financial review, but it goes far beyond that. Due diligence encompasses a far-greater project and that being the complete investigation and review of the business.
One of the keys to buying a good business, comes from your ability to learn the intimate details of the business. To identify the strengths, weaknesses, pluses, minuses, growth opportunities and areas of concern. If you do not do a flawless job of gathering information, you will not be able to pull the trigger and complete the transaction since you'll be uncertain about too many components of the business.
When To Start The Due Diligence?
The investigation process must begin the moment a business becomes of interest. Naturally, your goal is to make certain that you uncover everything about any business BEFORE you buy it. You don't have to meet the seller or even visit the business for your research to begin. The Internet is an incredible tool that will allow you to investigate the business, the industry, the competition, the marketing, the suppliers, and on and on.
The importance of beginning your investigation early on cannot be emphasized strongly enough. This way, you'll position yourself to ask the proper questions to the seller. Once you progress to the stage of an accepted offer, you will commence the inspection or financial due diligence. This period usually lasts 10-30 days. This is the time when you'll have access to all of the company's books and records.
Once you begin looking at a particular business, you'll find a thousand things crossing your mind regarding the acquisition. Keep a notepad handy at all times and log your thoughts. You'll have many thoughts about things “I need to check out.” Write these all in one place. Don't trust your memory; these little things are the ones that can come back to haunt you down the road. Begin to put together your checklist of what you need to investigate and how you're going to do it, along with the materials you may need from the seller to accomplish it.
A couple of things to keep in mind
Allow yourself enough time:
Many sellers and some brokers will press for a very short inspection period; sometimes just days. Don't get bullied into this - give yourself ample time to complete this part of the process. You should allow for, negotiate and not settle for less time than you comfortably need to complete a thorough inspection/due-diligence period. The financial review can usually be done in days but there is more to investigate and that is why a 20 business day period is not unreasonable for larger businesses, while a 15 day period is needed for smaller ones in order to complete the review and move the deal forward to closing.
Prepare properly
Since you'll have some time restrictions (you'll only have x number of days per the contract), provide the seller with a listing of all of the materials required for you and/or your CPA to complete this exercise. No matter what you're told, do not begin the process until they have provided what you/your CPA need to properly complete the review.
Dealing With Surprises
You'll probably find some surprises; don't panic, it's normal. Work through them. Get clarification. Build your case. Don't run to the seller or broker every time you find an inconsistency between what you've seen versus what you were told. No business is perfect. The rule to follow is do not treat any incidents as catastrophes or any catastrophes as incidents. If you find a major problem, get your facts in order and you can then decide the appropriate action to be taken with the seller (i.e. renegotiation, walking from the deal, etc.)
According to industry statistics, nine out of ten people who begin the search to buy a business never complete a transaction. While there are many reasons for this dismal figure, a lot has to do with the inability of people to “pull the trigger.” This gun-shy reaction is related specifically to uncertainty: if you have not gathered the right information or failed to investigate the business thoroughly, you will not be 100% certain of what to do. And so, you'll drop the project. Conversely, if you do a flawless job of investigating the business, and everything else adds up right, then making the final decision is simply one more step in the process!
Due diligence is probably the most critical stage in the buying process. Many prospective buyers incorrectly identify this period as strictly a financial review, but it goes far beyond that. Due diligence encompasses a far-greater project and that being the complete investigation and review of the business.
One of the keys to buying a good business, comes from your ability to learn the intimate details of the business. To identify the strengths, weaknesses, pluses, minuses, growth opportunities and areas of concern. If you do not do a flawless job of gathering information, you will not be able to pull the trigger and complete the transaction since you'll be uncertain about too many components of the business.
When To Start The Due Diligence?
The investigation process must begin the moment a business becomes of interest. Naturally, your goal is to make certain that you uncover everything about any business BEFORE you buy it. You don't have to meet the seller or even visit the business for your research to begin. The Internet is an incredible tool that will allow you to investigate the business, the industry, the competition, the marketing, the suppliers, and on and on.
The importance of beginning your investigation early on cannot be emphasized strongly enough. This way, you'll position yourself to ask the proper questions to the seller. Once you progress to the stage of an accepted offer, you will commence the inspection or financial due diligence. This period usually lasts 10-30 days. This is the time when you'll have access to all of the company's books and records.
Once you begin looking at a particular business, you'll find a thousand things crossing your mind regarding the acquisition. Keep a notepad handy at all times and log your thoughts. You'll have many thoughts about things “I need to check out.” Write these all in one place. Don't trust your memory; these little things are the ones that can come back to haunt you down the road. Begin to put together your checklist of what you need to investigate and how you're going to do it, along with the materials you may need from the seller to accomplish it.
A couple of things to keep in mind
Allow yourself enough time:
Many sellers and some brokers will press for a very short inspection period; sometimes just days. Don't get bullied into this - give yourself ample time to complete this part of the process. You should allow for, negotiate and not settle for less time than you comfortably need to complete a thorough inspection/due-diligence period. The financial review can usually be done in days but there is more to investigate and that is why a 20 business day period is not unreasonable for larger businesses, while a 15 day period is needed for smaller ones in order to complete the review and move the deal forward to closing.
Prepare properly
Since you'll have some time restrictions (you'll only have x number of days per the contract), provide the seller with a listing of all of the materials required for you and/or your CPA to complete this exercise. No matter what you're told, do not begin the process until they have provided what you/your CPA need to properly complete the review.
Dealing With Surprises
You'll probably find some surprises; don't panic, it's normal. Work through them. Get clarification. Build your case. Don't run to the seller or broker every time you find an inconsistency between what you've seen versus what you were told. No business is perfect. The rule to follow is do not treat any incidents as catastrophes or any catastrophes as incidents. If you find a major problem, get your facts in order and you can then decide the appropriate action to be taken with the seller (i.e. renegotiation, walking from the deal, etc.)
According to industry statistics, nine out of ten people who begin the search to buy a business never complete a transaction. While there are many reasons for this dismal figure, a lot has to do with the inability of people to “pull the trigger.” This gun-shy reaction is related specifically to uncertainty: if you have not gathered the right information or failed to investigate the business thoroughly, you will not be 100% certain of what to do. And so, you'll drop the project. Conversely, if you do a flawless job of investigating the business, and everything else adds up right, then making the final decision is simply one more step in the process!
By Richard Parker, President of The Business For Sale Buyer Resource Center™ and author of How To Buy A Good Business At A Great Price©
There's a popular saying regarding the asking price of any business for sale: “a business is overpriced the day it's listed for sale.” Experience shows, there's more truth than fiction to this statement.
The asking price has nothing to do with the purchase price. Good negotiating skills and creative deal-making is what gets a deal done! So, when looking at listings, don't get discouraged by what they're asking. After all, if you do this right, that's not what you're going to be paying... right?
It's easy to understand the seller's desire to price a business higher than what the market will bear.
Most Sellers Have an Emotional Attachment to Their Business
Sellers generally do not receive any professional input when establishing their selling price. They typically price the business based upon what they think it is "worth", or what they "need" to get out but this in no way reflects what the real value is.
Every seller wants to get the most money in his or her pocket from the sale.
The challenge for a potential buyer is to combat these issues with factual information in order to acquire the business and achieve the greatest possible return.
Both buyers and sellers must realize that business valuations are very subjective. It's an art, not a science. Both parties must also realize that appropriate formulas for that particular size and type business must be applied. Of equal importance is that both parties must recognize that it is only worth what a buyer is willing to pay and what a seller is willing to accept.
All of this sounds pretty basic and generic, doesn't it? The difficulty, of course, is to come to a common dollar figure. I've always felt that every seller's value is too high and every buyer's calculation is too low, and somewhere in the middle lays an accurate valuation.
This Is a Down Payment Driven Negotiation
Sellers usually have a fixed figure of what they want to walk away with in their pocket. That is why the down payment is quite often more important than the actual purchase price. I have been involved in countless transactions on behalf of buyers when we've offered to meet the down payment requirements in exchange for a massive reduction in the total purchase price or have received incredible concessions on the balance of sale note (zero interest for one year, extended terms, etc.).
When addressing the price in any negotiation, ask the seller to outline how they arrived at their price. If you do your research, you'll be able to demonstrate an abundance of reasons why they may be asking too much. Having said this, there are certain sellers, highly motivated ones, who price their business fairly. In these cases, work on getting other concessions in the deal in exchange for meeting their price.
Whenever you look at a business purchase, keep in mind that EVERYTHING is negotiable, especially the price. Use it as a barometer for the seller's thought process. Don't allow the asking price of any business within striking distance be a deterrent to you. If it's the right business for you, then solid negotiating skills can adjust any seller's thinking.
There are times during every deal when there are “deal breaker” issues on the table. Try not to adopt this hard-line attitude and be sensitive to conditions that the seller classifies and “deal breakers”. I have found that when the seller wants to sell, and the buyer wants to buy, and the parties trust each other then ANY issue can be resolved.
There's a popular saying regarding the asking price of any business for sale: “a business is overpriced the day it's listed for sale.” Experience shows, there's more truth than fiction to this statement.
The asking price has nothing to do with the purchase price. Good negotiating skills and creative deal-making is what gets a deal done! So, when looking at listings, don't get discouraged by what they're asking. After all, if you do this right, that's not what you're going to be paying... right?
It's easy to understand the seller's desire to price a business higher than what the market will bear.
Most Sellers Have an Emotional Attachment to Their Business
Sellers generally do not receive any professional input when establishing their selling price. They typically price the business based upon what they think it is "worth", or what they "need" to get out but this in no way reflects what the real value is.
Every seller wants to get the most money in his or her pocket from the sale.
The challenge for a potential buyer is to combat these issues with factual information in order to acquire the business and achieve the greatest possible return.
Both buyers and sellers must realize that business valuations are very subjective. It's an art, not a science. Both parties must also realize that appropriate formulas for that particular size and type business must be applied. Of equal importance is that both parties must recognize that it is only worth what a buyer is willing to pay and what a seller is willing to accept.
All of this sounds pretty basic and generic, doesn't it? The difficulty, of course, is to come to a common dollar figure. I've always felt that every seller's value is too high and every buyer's calculation is too low, and somewhere in the middle lays an accurate valuation.
This Is a Down Payment Driven Negotiation
Sellers usually have a fixed figure of what they want to walk away with in their pocket. That is why the down payment is quite often more important than the actual purchase price. I have been involved in countless transactions on behalf of buyers when we've offered to meet the down payment requirements in exchange for a massive reduction in the total purchase price or have received incredible concessions on the balance of sale note (zero interest for one year, extended terms, etc.).
When addressing the price in any negotiation, ask the seller to outline how they arrived at their price. If you do your research, you'll be able to demonstrate an abundance of reasons why they may be asking too much. Having said this, there are certain sellers, highly motivated ones, who price their business fairly. In these cases, work on getting other concessions in the deal in exchange for meeting their price.
Whenever you look at a business purchase, keep in mind that EVERYTHING is negotiable, especially the price. Use it as a barometer for the seller's thought process. Don't allow the asking price of any business within striking distance be a deterrent to you. If it's the right business for you, then solid negotiating skills can adjust any seller's thinking.
There are times during every deal when there are “deal breaker” issues on the table. Try not to adopt this hard-line attitude and be sensitive to conditions that the seller classifies and “deal breakers”. I have found that when the seller wants to sell, and the buyer wants to buy, and the parties trust each other then ANY issue can be resolved.
Financing The Deal 02/18/2011
By Richard Parker, President of The Business For Sale Buyer Resource Center™ and author of How To Buy A Good Business At A Great Price©
If you're thinking about buying a business, you'll be pleased to learn that financing the purchase is generally quite easy. In fact, it's far simpler to get the money you need to buy an existing business than it is for a start-up. Most people simply don't realize how to do it. Don't get the wrong idea: you're not going to buy a business, at least a good one, with no money down; that only happens in the infomercials.
Many prospective business buyers mistakenly believe that traditional lenders will welcome them with open arms when they present them with a business they're looking to acquire. Unfortunately, nothing can be further from the truth. It still amazes me how the banks have got most people fooled. They run these great ad campaigns promoting themselves as “business/client- friendly” but try to get them to lend you money to buy a business. It won't happen.
It doesn't matter how experienced you are, or what your relationship is with them, unless you're prepared to collateralize the loan 100% with non-business and personal liquid assets, they aren't going to give you a penny. So don't waste your time seeing them. With the terms they offer, it's just not worth it.
The landscape is pretty lopsided when it comes to how people buy small businesses. 80% of all transactions involve some financing. Only 10% are all-cash deals. Even if you're inclined to pay all cash, my advice is not to do so, unless you get a very hefty price reduction: at least 20%.
Seller Financing
The vast majority of small business acquisitions involve seller financing. In fact, it's estimated that over 80% include some form of seller financing. While the percentages vary, it's generally 30% to 50% of the total purchase price. When you think about the situation, it makes perfect sense. First of all, by providing financing, the seller validates the viability of the business itself. Also, the seller is able to get the highest price possible by funding part of the acquisition.
From a buyer's perspective, it serves to reinforce that the seller is also at risk in the transaction. It's a perfect mechanism to help ensure that what you've been told by the seller is true and accurate. It also serves as a mechanism to deal with situations that may arise later on that come about as a result of their actions where you may need the ability to offset their financing.
The Small Business Administration does NOT lend money for people to buy businesses. The SBA guarantees loans made by lenders (up to a certain amount) for small business acquisitions. There are both good and bad points to an SBA loan.
So What's Your Best Bet?
Unless you're buying a business for under $100,000 or getting an enormous price concession, don't pay cash. As for SBA approval, while their rigid guidelines will help to confirm the viability of a business, unless you're making an acquisition where you cannot finance the down payment, I tend to place this as my second choice.
I am a huge believer in seller financing. It's like buying a used car with an extended warranty paid for by the prior owner. There's no substitute for the flexibility you can achieve, or the favorable terms. Plus, more than anything else, it really forces the seller to share in the risk. If you're going to buy someone else's business, you want to be darn sure that they've got a stake (or risk) in your success as well.
If you're thinking about buying a business, you'll be pleased to learn that financing the purchase is generally quite easy. In fact, it's far simpler to get the money you need to buy an existing business than it is for a start-up. Most people simply don't realize how to do it. Don't get the wrong idea: you're not going to buy a business, at least a good one, with no money down; that only happens in the infomercials.
Many prospective business buyers mistakenly believe that traditional lenders will welcome them with open arms when they present them with a business they're looking to acquire. Unfortunately, nothing can be further from the truth. It still amazes me how the banks have got most people fooled. They run these great ad campaigns promoting themselves as “business/client- friendly” but try to get them to lend you money to buy a business. It won't happen.
It doesn't matter how experienced you are, or what your relationship is with them, unless you're prepared to collateralize the loan 100% with non-business and personal liquid assets, they aren't going to give you a penny. So don't waste your time seeing them. With the terms they offer, it's just not worth it.
The landscape is pretty lopsided when it comes to how people buy small businesses. 80% of all transactions involve some financing. Only 10% are all-cash deals. Even if you're inclined to pay all cash, my advice is not to do so, unless you get a very hefty price reduction: at least 20%.
Seller Financing
The vast majority of small business acquisitions involve seller financing. In fact, it's estimated that over 80% include some form of seller financing. While the percentages vary, it's generally 30% to 50% of the total purchase price. When you think about the situation, it makes perfect sense. First of all, by providing financing, the seller validates the viability of the business itself. Also, the seller is able to get the highest price possible by funding part of the acquisition.
From a buyer's perspective, it serves to reinforce that the seller is also at risk in the transaction. It's a perfect mechanism to help ensure that what you've been told by the seller is true and accurate. It also serves as a mechanism to deal with situations that may arise later on that come about as a result of their actions where you may need the ability to offset their financing.
- While the terms vary for seller financing, you can expect to pay about 6-8% over four to five years. Plus, you have the ability to get far more creative with seller financing than any other:
- Negotiate a holiday from any payments for three-six months after closing
- Allow for the first year to be all principal
- Have the right to make lump-sum payments several times a year towards the principal
- No prepayment penalty
- You can arrange for lower payments throughout the loan with a balloon payment down the road
- While you will have to sign personally, you will not have to personally collateralize the loan. The seller's lien is against the assets of the business.
The Small Business Administration does NOT lend money for people to buy businesses. The SBA guarantees loans made by lenders (up to a certain amount) for small business acquisitions. There are both good and bad points to an SBA loan.
- The good news is that there is money available: up to $2,000,000 (as of this writing – but it does change) plus additional funding should it include real estate.
- The terms for repayment are favorable - up to 10 years and greater when real estate is involved.
- When a business passes the SBA qualifications, you can be fairly confident that it is a solid business.
- If you do not have a certain amount of equity in your home, you may not have to fully collateralize the loan.
- Typically, they will finance 70-90% of the deal.
- Most small businesses won't pass the SBA requirements.
- The financial review is generally based upon the weakest of the past two or three year's tax returns – not any “owner to prove” documentation.
- Most lenders require that you must have demonstrative business experience in a business or job function that is similar in scope to the one you are considering.
- Although each lender differs they will want your house, life insurance policy (possibly) and your first-born as collateral.
- It can take up to 90 days to complete the entire process.
So What's Your Best Bet?
Unless you're buying a business for under $100,000 or getting an enormous price concession, don't pay cash. As for SBA approval, while their rigid guidelines will help to confirm the viability of a business, unless you're making an acquisition where you cannot finance the down payment, I tend to place this as my second choice.
I am a huge believer in seller financing. It's like buying a used car with an extended warranty paid for by the prior owner. There's no substitute for the flexibility you can achieve, or the favorable terms. Plus, more than anything else, it really forces the seller to share in the risk. If you're going to buy someone else's business, you want to be darn sure that they've got a stake (or risk) in your success as well.
Negotiating Your Way To A Great Deal 02/18/2011
By Richard Parker, President of The Business For Sale Buyer Resource Center™ and author of How To Buy A Good Business At A Great Price©
When it comes to buying a business for sale, the most exciting and anxious moments can be experienced when the time arrives for you to enter into negotiations and make an offer. This part of the process completely handcuffs some individuals. There's really no need for this to happen. Just like every other aspect to the buying process, your preparation will determine your level of success.
Keep in mind that this should be an enjoyable and educational part of buying a business. There is much to be learned during this phase. You must also realize that negotiations will evolve, and so if you approach it with an open-minded strategy instead of a “take it or leave it” philosophy, you will ultimately perform much better and produce a stronger deal.
Likewise, you should also know this is the stage when many deals come apart and never recover. Most of the time this happens because of the inability of one or both parties to truly understand what it takes to get the other side to see their point. Or, a failure to address the other party's concerns in a way that protects your specific interests.
Negotiating involves many independent personality issues. When dealing with a seller you must bear in mind that this is a very emotional time for them. They are looking to sell a business that has benefited from their hard work and sweat. It can be quite a personal adjustment for many and they do become irrational. They often feel as though they are losing a part of themselves. Be sensitive to their emotions but never at the expense of fabricating a good deal for you.
Your personality traits will come to light as well. Do your best to understand yourself. If for example, you're not a patient individual, then you must train yourself to avoid giving in on a certain point simply because you're tired of discussing it. You're better off to move on to something else and come back to it with the seller.
Find Their “Pain,” Soothe It and YOU Win!
Everybody has their “hot buttons” in a deal. These are the points that, in the mind of the buyer or seller, will make or break the deal. Once you identify them and can find a way to ease their concerns, you'll win. It works all the time. As an example, if the seller wants to be certain that they walk away from the deal with a specific amount of money in their pocket after broker commissions, paying debt, etc., then the down payment amount of the deal is clearly their “hot button.” There are two ways to determine this: put in an offer and see where and how they counter or, ask them pointedly: “what's more important to you, the down payment amount or the purchase price?”
The former method is usually more effective only because you can read into a variety of issues once you see the structure of a counter-offer. However, asking them directly is a very accurate way to measure this as well.
Getting back to our example, if it's the down payment then it's your turn to leverage the deal. Get as close as you can to their figure but, in exchange, get reduced interest rates on the balance of sale, extend the first payment to 60, 90 or 180 days after closing, negotiate the first year without interest, include the ability to payoff the note at anytime without penalty or to make periodic lump-sum payments towards the principal. There are tons that you can do once you know their pain.
An associate of mine who is an excellent negotiator always says that you should make, and get, concessions. In other words, whenever you agree to something, get something in return. It always works.
Preparation is The Key To Successful Negotiating
The average purchase agreement has over fifty individual clauses to be negotiated. There is far more involved than simply agreeing upon the price, down payment and terms. You will have to deal with the specific assets to be included, non-compete clauses, lease assignments, inspection period, adjustments, employee issues, liabilities, and on and on it goes.
Play "What If"
Think about the specific point to be negotiated, what your position is and what your rebuttal will be to the seller's comments. Play the “what if” game prior to sitting down to the table.
Layout the various points, giving consideration to what the short-term and long-term impact will be of your decision. As an example, if you negotiate finance terms with the seller that call for one lump payment down the road (i.e. a “balloon payment”) you must also consider that the business MUST be able to make that payment at that time. What if there's a cash crunch? What if you'd like to use the funds for something else at that time? What if… you want to balance that with a straight-line finance program so that you'll know what your obligations are every month and you can budget accordingly. Every situation is different, but again, give consideration to the impact today and down the road.
Structuring The Offer – and Remember, It's YOUR Offer!
The offer will, in most cases, begin the ball rolling on a potential acquisition. At times, this is the most effective way to gain insight into the guts of the business. You may also be dismayed to learn that you may in fact have to make an offer without all of the data that you would like to have. As an example, you may only gain access to the true financials after an accepted offer has been put forth.
This is fine; no need to panic. You may be asking: “how can I formulate an offer without all of the information?.” A good question in theory, but this is not always reality. Consider the fact that sellers may be exposed to an onslaught of buyers and, not knowing which ones are serious, they may choose to hold back certain information.
The offer you present is YOUR offer. You should be comfortable tabling any terms that YOU are comfortable with. Whatever the seller is “asking” is simply a guideline. Remember, it's an “asking price,” not a purchase price. On the other hand, don't be ridiculous. Table something that forms the basis of a future meaningful conversation. Your offer is, to a certain extent, a tool to prod the seller into playing his or her hand and to get them to demonstrate their pain; the areas that are fundamental to the deal - from their perspective.
There's nothing wrong if they are insulted. They may or may not be, and you can always refine your offer as the case may be. Additionally, a buyer's value of the business will certainly differ from a seller. That's where negotiation comes into play. There are no hard rules for what the terms of your offer should be. Each situation is different. While it's not advisable to make unlimited offers expecting one to catch on, you MUST make offers. Don't-over engineer each potential acquisition. Once a business is of interest, you've done your homework and you determine that you would, under the right conditions, like to buy the business, get your offer in.
There are standard offer-to- purchase agreements available to use. Every business broker will have one and so too will most attorneys. It's generally fine to use the business broker's template as long as you add in the conditions/contingencies particular to the business. On this note, you always have the option to start the offer process with a Letter of Intent instead of a full blown Offer to Purchase Agreement BUT, unless there are extenuating circumstances, a full offer is a better way to go. The one thing that you want to be certain of is that the due diligence/inspection clause provides you with the right to rescind your offer at your "sole and absolute discretion" if you determine that the business is not what it was represented to be. However, you cannot have an unlimited time frame to do so after acceptance of the offer.
Generally, once an offer is accepted, you will have a certain number of days to perform the financial due diligence (often referred to as the “Inspection Period”). Allow yourself enough time to conduct this. The idea is that you must be able to retract the offer for any reason whatsoever right up to the last day of this due diligence period.
There are some offer contracts that stipulate that you cannot retract your offer and get a refund of your deposit if the financials are within 5% of what has been presented. This is a ridiculous clause. Never agree to it. You must be able to get any monies returned, for any reason, through the due diligence phase. Conversely, if you sign off after the due diligence and then decide you do not wish to go through with the purchase, the seller is, in all fairness, entitled to your deposit.
Lawyers and Accountants and Others - Everyone has an opinion
Let's understand one thing: lawyers cannot negotiate your deal for you. They can certainly help to ensure your protection from potential liabilities but when it comes to negotiating the actual business deal, they are definitely NOT the ones to act on your behalf. I am certain that any attorney reading this column will disagree. That's OK. However, I have yet to meet more than a handful of attorneys who demonstrated any proficiency whatsoever in the actual art of negotiating the deal points of a small business acquisition. Most have never bought a business before, so even though they may have been involved in deals it's not the same perspective. You'll want to hear their point, but their input should be reserved for the areas in which they are experts: the legal aspects of the deal.
As for accountants, they too have their role: the input from a financial point of view and tax consequences. Leverage their expertise as well, but do not let them influence the actual business deal.
The Last Word
Great negotiators are not born; they evolve. Your effectiveness will increase over time. Be creative. Be reasonable. Keep the end result of putting a good deal together in your mind. Don't lose patience. Don't be confrontational. If there is tough news to deliver, let your broker do it. After all, you will need the seller to provide you with training.
Learn from each experience. Understand that there will be setbacks; work through each. You cannot win every point. It's a give-and-take. Prioritize. Prepare. Win/win is not always realistic. A buyer is usually taking on more risk in these transactions and so if the balance is to tilt in any parties' favor, it should be the buyer's.
When it comes to buying a business for sale, the most exciting and anxious moments can be experienced when the time arrives for you to enter into negotiations and make an offer. This part of the process completely handcuffs some individuals. There's really no need for this to happen. Just like every other aspect to the buying process, your preparation will determine your level of success.
Keep in mind that this should be an enjoyable and educational part of buying a business. There is much to be learned during this phase. You must also realize that negotiations will evolve, and so if you approach it with an open-minded strategy instead of a “take it or leave it” philosophy, you will ultimately perform much better and produce a stronger deal.
Likewise, you should also know this is the stage when many deals come apart and never recover. Most of the time this happens because of the inability of one or both parties to truly understand what it takes to get the other side to see their point. Or, a failure to address the other party's concerns in a way that protects your specific interests.
Negotiating involves many independent personality issues. When dealing with a seller you must bear in mind that this is a very emotional time for them. They are looking to sell a business that has benefited from their hard work and sweat. It can be quite a personal adjustment for many and they do become irrational. They often feel as though they are losing a part of themselves. Be sensitive to their emotions but never at the expense of fabricating a good deal for you.
Your personality traits will come to light as well. Do your best to understand yourself. If for example, you're not a patient individual, then you must train yourself to avoid giving in on a certain point simply because you're tired of discussing it. You're better off to move on to something else and come back to it with the seller.
Find Their “Pain,” Soothe It and YOU Win!
Everybody has their “hot buttons” in a deal. These are the points that, in the mind of the buyer or seller, will make or break the deal. Once you identify them and can find a way to ease their concerns, you'll win. It works all the time. As an example, if the seller wants to be certain that they walk away from the deal with a specific amount of money in their pocket after broker commissions, paying debt, etc., then the down payment amount of the deal is clearly their “hot button.” There are two ways to determine this: put in an offer and see where and how they counter or, ask them pointedly: “what's more important to you, the down payment amount or the purchase price?”
The former method is usually more effective only because you can read into a variety of issues once you see the structure of a counter-offer. However, asking them directly is a very accurate way to measure this as well.
Getting back to our example, if it's the down payment then it's your turn to leverage the deal. Get as close as you can to their figure but, in exchange, get reduced interest rates on the balance of sale, extend the first payment to 60, 90 or 180 days after closing, negotiate the first year without interest, include the ability to payoff the note at anytime without penalty or to make periodic lump-sum payments towards the principal. There are tons that you can do once you know their pain.
An associate of mine who is an excellent negotiator always says that you should make, and get, concessions. In other words, whenever you agree to something, get something in return. It always works.
Preparation is The Key To Successful Negotiating
The average purchase agreement has over fifty individual clauses to be negotiated. There is far more involved than simply agreeing upon the price, down payment and terms. You will have to deal with the specific assets to be included, non-compete clauses, lease assignments, inspection period, adjustments, employee issues, liabilities, and on and on it goes.
Play "What If"
Think about the specific point to be negotiated, what your position is and what your rebuttal will be to the seller's comments. Play the “what if” game prior to sitting down to the table.
Layout the various points, giving consideration to what the short-term and long-term impact will be of your decision. As an example, if you negotiate finance terms with the seller that call for one lump payment down the road (i.e. a “balloon payment”) you must also consider that the business MUST be able to make that payment at that time. What if there's a cash crunch? What if you'd like to use the funds for something else at that time? What if… you want to balance that with a straight-line finance program so that you'll know what your obligations are every month and you can budget accordingly. Every situation is different, but again, give consideration to the impact today and down the road.
Structuring The Offer – and Remember, It's YOUR Offer!
The offer will, in most cases, begin the ball rolling on a potential acquisition. At times, this is the most effective way to gain insight into the guts of the business. You may also be dismayed to learn that you may in fact have to make an offer without all of the data that you would like to have. As an example, you may only gain access to the true financials after an accepted offer has been put forth.
This is fine; no need to panic. You may be asking: “how can I formulate an offer without all of the information?.” A good question in theory, but this is not always reality. Consider the fact that sellers may be exposed to an onslaught of buyers and, not knowing which ones are serious, they may choose to hold back certain information.
The offer you present is YOUR offer. You should be comfortable tabling any terms that YOU are comfortable with. Whatever the seller is “asking” is simply a guideline. Remember, it's an “asking price,” not a purchase price. On the other hand, don't be ridiculous. Table something that forms the basis of a future meaningful conversation. Your offer is, to a certain extent, a tool to prod the seller into playing his or her hand and to get them to demonstrate their pain; the areas that are fundamental to the deal - from their perspective.
There's nothing wrong if they are insulted. They may or may not be, and you can always refine your offer as the case may be. Additionally, a buyer's value of the business will certainly differ from a seller. That's where negotiation comes into play. There are no hard rules for what the terms of your offer should be. Each situation is different. While it's not advisable to make unlimited offers expecting one to catch on, you MUST make offers. Don't-over engineer each potential acquisition. Once a business is of interest, you've done your homework and you determine that you would, under the right conditions, like to buy the business, get your offer in.
There are standard offer-to- purchase agreements available to use. Every business broker will have one and so too will most attorneys. It's generally fine to use the business broker's template as long as you add in the conditions/contingencies particular to the business. On this note, you always have the option to start the offer process with a Letter of Intent instead of a full blown Offer to Purchase Agreement BUT, unless there are extenuating circumstances, a full offer is a better way to go. The one thing that you want to be certain of is that the due diligence/inspection clause provides you with the right to rescind your offer at your "sole and absolute discretion" if you determine that the business is not what it was represented to be. However, you cannot have an unlimited time frame to do so after acceptance of the offer.
Generally, once an offer is accepted, you will have a certain number of days to perform the financial due diligence (often referred to as the “Inspection Period”). Allow yourself enough time to conduct this. The idea is that you must be able to retract the offer for any reason whatsoever right up to the last day of this due diligence period.
There are some offer contracts that stipulate that you cannot retract your offer and get a refund of your deposit if the financials are within 5% of what has been presented. This is a ridiculous clause. Never agree to it. You must be able to get any monies returned, for any reason, through the due diligence phase. Conversely, if you sign off after the due diligence and then decide you do not wish to go through with the purchase, the seller is, in all fairness, entitled to your deposit.
Lawyers and Accountants and Others - Everyone has an opinion
Let's understand one thing: lawyers cannot negotiate your deal for you. They can certainly help to ensure your protection from potential liabilities but when it comes to negotiating the actual business deal, they are definitely NOT the ones to act on your behalf. I am certain that any attorney reading this column will disagree. That's OK. However, I have yet to meet more than a handful of attorneys who demonstrated any proficiency whatsoever in the actual art of negotiating the deal points of a small business acquisition. Most have never bought a business before, so even though they may have been involved in deals it's not the same perspective. You'll want to hear their point, but their input should be reserved for the areas in which they are experts: the legal aspects of the deal.
As for accountants, they too have their role: the input from a financial point of view and tax consequences. Leverage their expertise as well, but do not let them influence the actual business deal.
The Last Word
Great negotiators are not born; they evolve. Your effectiveness will increase over time. Be creative. Be reasonable. Keep the end result of putting a good deal together in your mind. Don't lose patience. Don't be confrontational. If there is tough news to deliver, let your broker do it. After all, you will need the seller to provide you with training.
Learn from each experience. Understand that there will be setbacks; work through each. You cannot win every point. It's a give-and-take. Prioritize. Prepare. Win/win is not always realistic. A buyer is usually taking on more risk in these transactions and so if the balance is to tilt in any parties' favor, it should be the buyer's.
Business Brokers – How They can Help You 02/18/2011
By Richard Parker, President of The Business For Sale Buyer Resource Center™ and author of How To Buy A Good Business At A Great Price©
One of the most frequent questions I am asked by prospective business buyers is whether or not they should hire a business broker. My initial response is always: “yes… but.” The "but" is that you should "use" one, not "hire" one. A business broker can have a very specific and important role in the buying process. The “but” is related to understanding what that role is.
Business brokers almost always represent the seller or the deal in a transactional role. The seller pays their commission and even if they are assisting you in the process, they may in fact have a fiduciary duty to the seller. This is not to say that they won't provide you with helpful advice. Why then, you may ask, should you use a broker?
Keep in mind that business brokers do not work like real estate agents in every sense. Often, they will not share listings within a certain area and only sell the business that they (or their own offices) have listed.
In the past fifteen years, I have personally purchased ten businesses and have sold nine of them. I have used a business broker in nearly every transaction. Even though I would consider myself a very savvy buyer, there are three things that a business broker can do that are very helpful.
Business-For-Sale Listings
They can provide you with access to business-for-sale listings and details about the business that you may not discover on your own. Although the majority of businesses sold in the U.S. are not done through brokers, some states have a multiple listing service of businesses for sale, similar to residential real estate. In states that do not offer this, brokers will often only show you their own listings. In those cases, you'd have to work with several brokers just to see a variety. You may want to search for your state's "business broker association" and see if such a service exists.
Always Good To Have A Buffer Between You and The Seller:
They can be a conduit to help deliver bad news to the seller. There may be instances where you have to retract or modify an offer and certainly times where you'll need to adopt an aggressive negotiating position. Since you'll most likely need the seller to train you after the purchase, it's not a good idea to aggravate them too severely. As such, let the business broker deliver the bad news.
The Paperwork Is Astounding
A business purchase, no matter how small, requires a tremendous amount of coordination and document chasing. The data you'll need from a seller to evaluate a business, the documentation required to close a deal and the overall chasing that must be done between buyer/seller and their professional advisors, can be astounding. A good broker will be an enormous help putting all of it together.
Using the Right One:
In addition to being frequently asked by readers of my book about brokers, I also receive the greatest number of complaints from readers, about brokers. While many of these complaints are justified, equal amounts are due to a basic misunderstanding of what a broker can or cannot do.
A business broker cannot help you buy the right business. They can assist you, but ultimately it is up to you to make that decision. A business broker cannot afford to spend countless unpaid hours searching for the right business for you. The search is something that you must do. They'll provide you with the tools to do it, but it's your responsibility to get the ball rolling. A business broker cannot conduct the investigation for you. They may suggest common things to look for, but they won't be your detective. A business broker cannot negotiate the best deal for you. Most will certainly attempt to bring all parties to a point of understanding, but if you want the best deal, then you must realize that nobody cares more about your investment than you do.
Meet with several until you find one who makes you feel comfortable. In my course, How To Buy A Good Business At A Great Price©, there is an entire chapter devoted to finding and using the right broker, however, here are a few questions you should ask them:
Don't just call or email a broker inquiring about a particular listing. The point of your contact is to first determine how effectively they communicate and to get the dialogue going.
In your first contact, don't ask for three years of financials or other confidential information. Simply express your interest and request that they send you a standard non-disclosure document to execute so they will be able to tell you more about the business.
Help Them to Help You
Once you begin to speak with a broker, if you feel good about their attitude, follow up and arrange to meet them. Keep in mind that you want them to keep an eye out for the hottest listings for you. To accomplish that you must convey several things to them:
Business brokers have a role to play. Use them effectively and they can be a solid asset to help you complete the deal. Likewise, if they do not demonstrate a serious commitment to follow up on your requests, then get another broker.
But remember, no matter how effective a broker is, when all is said and done, the task of buying the right business is ultimately, entirely, in your hands!
One of the most frequent questions I am asked by prospective business buyers is whether or not they should hire a business broker. My initial response is always: “yes… but.” The "but" is that you should "use" one, not "hire" one. A business broker can have a very specific and important role in the buying process. The “but” is related to understanding what that role is.
Business brokers almost always represent the seller or the deal in a transactional role. The seller pays their commission and even if they are assisting you in the process, they may in fact have a fiduciary duty to the seller. This is not to say that they won't provide you with helpful advice. Why then, you may ask, should you use a broker?
Keep in mind that business brokers do not work like real estate agents in every sense. Often, they will not share listings within a certain area and only sell the business that they (or their own offices) have listed.
In the past fifteen years, I have personally purchased ten businesses and have sold nine of them. I have used a business broker in nearly every transaction. Even though I would consider myself a very savvy buyer, there are three things that a business broker can do that are very helpful.
Business-For-Sale Listings
They can provide you with access to business-for-sale listings and details about the business that you may not discover on your own. Although the majority of businesses sold in the U.S. are not done through brokers, some states have a multiple listing service of businesses for sale, similar to residential real estate. In states that do not offer this, brokers will often only show you their own listings. In those cases, you'd have to work with several brokers just to see a variety. You may want to search for your state's "business broker association" and see if such a service exists.
Always Good To Have A Buffer Between You and The Seller:
They can be a conduit to help deliver bad news to the seller. There may be instances where you have to retract or modify an offer and certainly times where you'll need to adopt an aggressive negotiating position. Since you'll most likely need the seller to train you after the purchase, it's not a good idea to aggravate them too severely. As such, let the business broker deliver the bad news.
The Paperwork Is Astounding
A business purchase, no matter how small, requires a tremendous amount of coordination and document chasing. The data you'll need from a seller to evaluate a business, the documentation required to close a deal and the overall chasing that must be done between buyer/seller and their professional advisors, can be astounding. A good broker will be an enormous help putting all of it together.
Using the Right One:
In addition to being frequently asked by readers of my book about brokers, I also receive the greatest number of complaints from readers, about brokers. While many of these complaints are justified, equal amounts are due to a basic misunderstanding of what a broker can or cannot do.
A business broker cannot help you buy the right business. They can assist you, but ultimately it is up to you to make that decision. A business broker cannot afford to spend countless unpaid hours searching for the right business for you. The search is something that you must do. They'll provide you with the tools to do it, but it's your responsibility to get the ball rolling. A business broker cannot conduct the investigation for you. They may suggest common things to look for, but they won't be your detective. A business broker cannot negotiate the best deal for you. Most will certainly attempt to bring all parties to a point of understanding, but if you want the best deal, then you must realize that nobody cares more about your investment than you do.
Meet with several until you find one who makes you feel comfortable. In my course, How To Buy A Good Business At A Great Price©, there is an entire chapter devoted to finding and using the right broker, however, here are a few questions you should ask them:
- How experienced are they?
- How many transactions have they been involved with?
- Have they ever owned their own business?
- Do they specialize in a particular business type?
- What references can they provide?
- How many clients are they working with presently?
- How many agents work in their office?
- Do they share/co-broker listings with other offices? If yes, of the total number of businesses they've sold in the past year, how many were their own listings and how many belonged to other agents? (this will indicate their willingness to suggest businesses to you based upon your needs, not simply because it's their listing as long as there is sharing of listings between brokers).
Don't just call or email a broker inquiring about a particular listing. The point of your contact is to first determine how effectively they communicate and to get the dialogue going.
In your first contact, don't ask for three years of financials or other confidential information. Simply express your interest and request that they send you a standard non-disclosure document to execute so they will be able to tell you more about the business.
Help Them to Help You
Once you begin to speak with a broker, if you feel good about their attitude, follow up and arrange to meet them. Keep in mind that you want them to keep an eye out for the hottest listings for you. To accomplish that you must convey several things to them:
- Show them you're serious. A business broker wants to be sure that if the right opportunity comes along, you'll be ready to buy!
- Prepare a laundry list of the types of businesses you're interested in purchasing
- Present them with your personal financial statement
- Tell them precisely how much money you have to invest
- Ask them for suggestions as to how you should conduct your search
- Ask them to show you how to best navigate the Internet
- Call them regularly, at least once a week.
- For the first couple of businesses that you locate on your own, ask them to check them out. See how long it takes for them to give you data or follow up with you. If it's more than a couple of days, use someone else.
Business brokers have a role to play. Use them effectively and they can be a solid asset to help you complete the deal. Likewise, if they do not demonstrate a serious commitment to follow up on your requests, then get another broker.
But remember, no matter how effective a broker is, when all is said and done, the task of buying the right business is ultimately, entirely, in your hands!
By Richard Parker, President of The Business For Sale Buyer Resource Center™ and author of How To Buy A Good Business At A Great Price©
A study was done recently in the State of Florida to determine how small business purchase prices have evolved over the years, and it came as no surprise to me that, in the past twenty years, small businesses have typically sold for around two times the seller's discretionary income total. The same holds true today, yet a certain segment of the market commands an enormous multiple regardless of the business's size.
I've always said that there are certain fundamentals that any business can have which will increase its value when the time comes to sell. These include:
The businesses today that command these multiples include: marinas, alarm companies and storage businesses. There's also been an inflated market created by medical-related businesses, although this may be more so because buyers have a delusional view of this industry segment. Instead, let's focus upon why these other businesses sell for such high multiples:
Recurring Revenue:
Any business that has a built-in revenue base will command a higher selling price. It's a whole lot more enticing for a buyer to know that they will have and immediate and locked-in long-term revenue stream the day they get the keys to the business.
One of the most challenging aspects to business is when you have to “go into business everyday.” When you have a company whereby there are contracts in place, written or verbal, that provide you with a base income every month, it's a huge benefit. Marinas, storage companies, alarm-monitoring companies, service businesses such as water and coffee suppliers to offices, equipment maintenance companies with annual customer contracts, all fit this bill.
The concept of recurring revenue is not only attractive; it just makes good business sense. It's far easier to expand a business knowing that you have a base to work from everyday. It's also a lot easier to sell additional products or services to a customer who is already buying from you.
“Buy land - they're not building any more” – Will Rogers
Perhaps this statement explains the gold rush (a.k.a The real estate market) we've been experiencing in many parts of the U.S.. Investors and developers are making gobs of money throughout the State of Florida as an example, and have been for about fifteen years and there is no let-up in sight. Although, with so may purchase being by speculators, one has to conclude that it's a matter of “when” the bubble will burst and not “if” it will. Now, it's not an easy game to get into, but think about the offshoots to this concept-marinas are a perfect segment that is taking advantage of this scenario. Furthermore, there is a moratorium in some parts on building new marinas. These factors are pushing the prices up dramatically. A marina that owns the land is commanding up to ten times the Net Operating Income while ones on leased land, with a long-term lease, are still getting 4-6 times the NOI. These are insane numbers when compared to other businesses for sale.
Limited Specialized Knowledge
Any business where a new owner with general business skills can take over and run will improve the value versus ones where specialized knowledge, experience, licensing, etc. is required. Take a look at storage units. They are all over the place and they're building more of them. It has been an absolute explosion in the past several years (I've always wondered what people did with all this stuff before?). While no business is easy, you certainly do not need a ton of experience to take over a business such as these.
Of course, no business is easy; and I've always said that the best business in the world is everybody else's. However, one can easily adapt to this environment and quickly ramp up to the skills needed to successfully manage it, and better yet, to have it operate absentee. Think about it: you have a storage building with limited capacity, and once the space is filled, you can't really go out and market it more. You can increase the fees, improve client turnover, but once it's filled, it's filled. And, best of all, the checks come in every month.
It's A Beautiful Thing when it's Harder to Lose an Existing Customer
Than To Gain a New One
Nobody thinks about changing alarm companies unless they incur a break-in and the alarm doesn't go off. Likewise, if you have a water-supply business, or marina and you provide the services you're expected then, people don't change. Storage businesses are even better examples: people just keep their “stuff” there year after year and never move it. Actually, it's a beautiful thing when you own this kind of business. These are the ones where customers either don't give a second thought to paying the monthly fees, or they realize that it's simply not worth the hassle to change to a competitor. In other words, you'd have to really mess things up to lose a customer. The commercial ones are even better since the customers are always moving stuff in and out and you get paid anytime you handle the goods.
By the same token, getting new business is not easy for the same reason that it's hard for one business to lose a customer; it's difficult to gain one from the competition. But, the costs and time required to keep an existing accounts are infinitely less and easier than getting a new one. This is a very attractive concept for any prospective business buyer, especially ones with limited professional or entrepreneurial experience.
The question you must ask yourself if you're thinking about buying a business is what you want from the business. While some businesses command massive premiums, the potential growth may be limited. However, the downside risk is far less than other types.
Also, these lend themselves to absentee-run situations which make them even more attractive to some. On the other hand, if you have entrepreneurial blood running through you veins, you'll probably be bored with these particular types and so there are many other options available to you as well.
A study was done recently in the State of Florida to determine how small business purchase prices have evolved over the years, and it came as no surprise to me that, in the past twenty years, small businesses have typically sold for around two times the seller's discretionary income total. The same holds true today, yet a certain segment of the market commands an enormous multiple regardless of the business's size.
I've always said that there are certain fundamentals that any business can have which will increase its value when the time comes to sell. These include:
- Clean books and records
- A reasonable selling price
- Good terms, including seller financing
- A proper transition period to a new owner
- Non-specialized skills required to run the business
The businesses today that command these multiples include: marinas, alarm companies and storage businesses. There's also been an inflated market created by medical-related businesses, although this may be more so because buyers have a delusional view of this industry segment. Instead, let's focus upon why these other businesses sell for such high multiples:
Recurring Revenue:
Any business that has a built-in revenue base will command a higher selling price. It's a whole lot more enticing for a buyer to know that they will have and immediate and locked-in long-term revenue stream the day they get the keys to the business.
One of the most challenging aspects to business is when you have to “go into business everyday.” When you have a company whereby there are contracts in place, written or verbal, that provide you with a base income every month, it's a huge benefit. Marinas, storage companies, alarm-monitoring companies, service businesses such as water and coffee suppliers to offices, equipment maintenance companies with annual customer contracts, all fit this bill.
The concept of recurring revenue is not only attractive; it just makes good business sense. It's far easier to expand a business knowing that you have a base to work from everyday. It's also a lot easier to sell additional products or services to a customer who is already buying from you.
“Buy land - they're not building any more” – Will Rogers
Perhaps this statement explains the gold rush (a.k.a The real estate market) we've been experiencing in many parts of the U.S.. Investors and developers are making gobs of money throughout the State of Florida as an example, and have been for about fifteen years and there is no let-up in sight. Although, with so may purchase being by speculators, one has to conclude that it's a matter of “when” the bubble will burst and not “if” it will. Now, it's not an easy game to get into, but think about the offshoots to this concept-marinas are a perfect segment that is taking advantage of this scenario. Furthermore, there is a moratorium in some parts on building new marinas. These factors are pushing the prices up dramatically. A marina that owns the land is commanding up to ten times the Net Operating Income while ones on leased land, with a long-term lease, are still getting 4-6 times the NOI. These are insane numbers when compared to other businesses for sale.
Limited Specialized Knowledge
Any business where a new owner with general business skills can take over and run will improve the value versus ones where specialized knowledge, experience, licensing, etc. is required. Take a look at storage units. They are all over the place and they're building more of them. It has been an absolute explosion in the past several years (I've always wondered what people did with all this stuff before?). While no business is easy, you certainly do not need a ton of experience to take over a business such as these.
Of course, no business is easy; and I've always said that the best business in the world is everybody else's. However, one can easily adapt to this environment and quickly ramp up to the skills needed to successfully manage it, and better yet, to have it operate absentee. Think about it: you have a storage building with limited capacity, and once the space is filled, you can't really go out and market it more. You can increase the fees, improve client turnover, but once it's filled, it's filled. And, best of all, the checks come in every month.
It's A Beautiful Thing when it's Harder to Lose an Existing Customer
Than To Gain a New One
Nobody thinks about changing alarm companies unless they incur a break-in and the alarm doesn't go off. Likewise, if you have a water-supply business, or marina and you provide the services you're expected then, people don't change. Storage businesses are even better examples: people just keep their “stuff” there year after year and never move it. Actually, it's a beautiful thing when you own this kind of business. These are the ones where customers either don't give a second thought to paying the monthly fees, or they realize that it's simply not worth the hassle to change to a competitor. In other words, you'd have to really mess things up to lose a customer. The commercial ones are even better since the customers are always moving stuff in and out and you get paid anytime you handle the goods.
By the same token, getting new business is not easy for the same reason that it's hard for one business to lose a customer; it's difficult to gain one from the competition. But, the costs and time required to keep an existing accounts are infinitely less and easier than getting a new one. This is a very attractive concept for any prospective business buyer, especially ones with limited professional or entrepreneurial experience.
The question you must ask yourself if you're thinking about buying a business is what you want from the business. While some businesses command massive premiums, the potential growth may be limited. However, the downside risk is far less than other types.
Also, these lend themselves to absentee-run situations which make them even more attractive to some. On the other hand, if you have entrepreneurial blood running through you veins, you'll probably be bored with these particular types and so there are many other options available to you as well.
How To Value A Business 02/18/2011
By Richard Parker, President of The Business For Sale Buyer Resource Center™ and author of How To Buy A Good Business At A Great Price©
Accurately valuing a small business is often the most challenging part of the process for prospective business buyers. However, it doesn't have to be an overwhelming or difficult undertaking. Above all, you should realize that valuation is an art, not a science. As a buyer, always keep in mind that the “Asking Price” is NOT the purchase price. Quite often it does not even remotely represent what the business is truly worth.
Naturally, a buyer's valuation is usually quite different from what the seller believes their business is worth. Sellers are emotionally attached to their businesses. They usually factor their years of hard work into their calculation. Unfortunately, this has no business whatsoever being in the equation.
The challenge for you, the buyer, is to formulate a valuation that is accurate, and will prove to provide you with an acceptable return on your investment.
There are several ways to calculate the value of a business:
Asset-based valuations do not work for small business purchases. Assets are used to generate revenue and nothing more. If a business is "asset rich" but doesn't make much money, how valuable is the business altogether? Conversely, if a business has limited assets, such as computers and office equipment, but makes a ton of money, isn't it worth more?
Income Capitalization is generally applicable to large businesses and most often uses a factor that is far too arbitrary.
The “Rule of Thumb” method may be too general since it's hard to find any two businesses that are exactly the same. Valuation must be done based upon what you, as the buyer, can reasonably expect to generate in your pocket, so long as the business's future is representative of the past historical financial data. Notwithstanding this, the “Rules of Thumb” methodology is an good place to start but is a bit too broad to consider by itself.
The Multiple Method is clearly the way to go. You have probably heard of businesses selling at “x times earnings.” However, this can be quite subjective. When buying a small business, every buyer wants to know how much money he or she can expect to make from the business. Therefore, the most effective number to use as the basis of your calculation is what is known as the total “Owner Benefits.”
The Owner Benefits amount is the total dollars that you can expect to extract or have available from the business based upon what the business has generated in the past. The beauty is that unlike other methods (i.e. Income Cap), it does not attempt to predict the future. Nobody can do that. Owner Benefit is not cash flow! It is, however, sometimes referred to as Seller's Discretionary Cash Flow (SDCF).
The theory behind the Owner Benefit number is to take the business's profits plus the owner's salary and benefits and then to add back the non-cash expenses. History has shown that this methodology, while not bulletproof, is the most effective way to establish the valuation basis of a small business. Then, a multiple, based upon a variety of factors, is applied to this number and a valuation is established.
The Owner Benefit formula to use is:
Pre-Tax Profit + Owner's Salary + Additional Owner Perks
+ Interest + Depreciation less Allocation for Capital ExpendituresWhy Add Back Depreciation?
Depreciation is an expense that allows a business to deduct a certain amount of money each year from an asset so that its purchase value is reduced by its overall useful life. As an example: if the business buys a $25,000 truck and its useful life is estimated at 5 years, then each year the company can deduct $5000 off its income to lessen its tax burden. However, as you can see, it is not an actual cash transaction. No money is physically leaving the business or changing hands. Therefore, this amount is added back.
Why Add Back Interest?
Each business owner will have separate philosophies for borrowing for the business and how to best use borrowed funds, if necessary at all. Furthermore, in nearly all cases, the seller will pay off the business's loans from their proceeds at closing; therefore, you will have use of these additional funds.
A Note About Add-Backs
After completing any add-backs, it is critical that you take into consideration the future capital requirements of the business as well as debt-service expenses. As such, in capital intensive businesses where equipment needs replacing on a regular basis, you must deduct appropriate amounts from the Owner Benefit number in order to determine both the true value of the business as well as its ability fund future expenditures. Under this formula, you will arrive at a "net" Owner Benefit number or true Free Cash Flow figure.
What Multiple?
Typically, small businesses will sell in a one-to three-times multiple of this figure. Now, this is a wide range, so how do you determine what to apply? The best mechanism I have found is that a one-time multiple is for those businesses where the seller is “the business.” In other words: "as out the door goes the seller, so too can go the customers." Consulting businesses, professional practices, and one-man businesses come to mind.
Businesses that have a strong track record, repeat clients, historical pattern of growth, more than 3 years in business, perhaps some proprietary item, or an exclusive territory, a growing industry, etc., will sell in the 3-times ratio. The others fall somewhere in-between.
So now the big question: what number/multiple do you apply to the Owner's Benefit number? The answer is simple: nearly all small businesses will sell in the 1-to-3 times Owner Benefit window. Of course, this is a very wide range.
Also, the actual total Owner Benefit figure will impact the multiplier. As the Owner Benefit number increases, so too will the multiple. As an example, a business generating $200,000 in OB, may be worth a 3 times multiple, but one generating $500,000 or $1,000,000 can be worth a four or five times multiple.
The Rules to Apply To Establish A Multiple:
You also want to calculate the Return on Investment (ROI) that you can expect to achieve when buying a business. Let's say that you have $100,000 for a down payment. If you go to Las Vegas and let it rip on “17 black,” well you should be entitled to enormous odds. Wouldn't you agree? On the other hand, if you invest it in commercial real estate, which is a solid, stable investment, then 10% return on your money seems about right, doesn't it? In fact, when the real estate market heats up, the return can diminish to 5% or so, and still investors are satisfied.
Buying a business is clearly a greater “risk” but definitely far less than gambling it at a casino and so you should expect something in-between. I've always felt that a 25% return on your investment should be the minimum and you can, if negotiated well, get as high as 35% -50% ROI.
If You're New At This, Here's What To Do:
For most small businesses, hiring a professional to perform a valuation is not necessary. First of all it is expensive, and more often than not, it simply does not reflect reality. I read a valuation recently on a local company handling specialized telecom components in a very restricted marketplace doing $700,000 a year in sales and netting $100,000. The valuation started off: “The company is focused upon the specialized B2B telephony arena and operates within a broad industry which generates annual revenues of $42 billion in North America. Leading competitors include Nortel, Cisco…..” I threw out the entire report after reading that one sentence. Why? How on earth can you possibly compare a $42 billion dollar industry and a $700,000 local distributor of telephone systems? Don't waste time or money getting a professional valuation done for a small business acquisition. Let the seller do that if they so choose. If you want to look at a variety of scenarios, there are some very good, inexpensive software packages available that will do the same thing at a fraction of the cost.
The Key Points:
Accurately valuing a small business is often the most challenging part of the process for prospective business buyers. However, it doesn't have to be an overwhelming or difficult undertaking. Above all, you should realize that valuation is an art, not a science. As a buyer, always keep in mind that the “Asking Price” is NOT the purchase price. Quite often it does not even remotely represent what the business is truly worth.
Naturally, a buyer's valuation is usually quite different from what the seller believes their business is worth. Sellers are emotionally attached to their businesses. They usually factor their years of hard work into their calculation. Unfortunately, this has no business whatsoever being in the equation.
The challenge for you, the buyer, is to formulate a valuation that is accurate, and will prove to provide you with an acceptable return on your investment.
There are several ways to calculate the value of a business:
- Asset Valuations: Calculates the value of all of the assets of a business and arrives at the appropriate price.
- Liquidation Value: Determines the value of the company's assets if it were forced to sell all of them in a short period of time (usually less than 12 months).
- Income Capitalization: Future income is calculated based upon historical data and a variety of assumptions.
- Income Multiple: The net income (profit/owner's benefit/seller's cash flow) of a business is subject to a certain multiple to arrive at a selling price.
- Rules Of Thumb: The selling price of other “like” businesses is used as a multiple of cash flow or a percentage of revenue.
Asset-based valuations do not work for small business purchases. Assets are used to generate revenue and nothing more. If a business is "asset rich" but doesn't make much money, how valuable is the business altogether? Conversely, if a business has limited assets, such as computers and office equipment, but makes a ton of money, isn't it worth more?
Income Capitalization is generally applicable to large businesses and most often uses a factor that is far too arbitrary.
The “Rule of Thumb” method may be too general since it's hard to find any two businesses that are exactly the same. Valuation must be done based upon what you, as the buyer, can reasonably expect to generate in your pocket, so long as the business's future is representative of the past historical financial data. Notwithstanding this, the “Rules of Thumb” methodology is an good place to start but is a bit too broad to consider by itself.
The Multiple Method is clearly the way to go. You have probably heard of businesses selling at “x times earnings.” However, this can be quite subjective. When buying a small business, every buyer wants to know how much money he or she can expect to make from the business. Therefore, the most effective number to use as the basis of your calculation is what is known as the total “Owner Benefits.”
The Owner Benefits amount is the total dollars that you can expect to extract or have available from the business based upon what the business has generated in the past. The beauty is that unlike other methods (i.e. Income Cap), it does not attempt to predict the future. Nobody can do that. Owner Benefit is not cash flow! It is, however, sometimes referred to as Seller's Discretionary Cash Flow (SDCF).
The theory behind the Owner Benefit number is to take the business's profits plus the owner's salary and benefits and then to add back the non-cash expenses. History has shown that this methodology, while not bulletproof, is the most effective way to establish the valuation basis of a small business. Then, a multiple, based upon a variety of factors, is applied to this number and a valuation is established.
The Owner Benefit formula to use is:
Pre-Tax Profit + Owner's Salary + Additional Owner Perks
+ Interest + Depreciation less Allocation for Capital ExpendituresWhy Add Back Depreciation?
Depreciation is an expense that allows a business to deduct a certain amount of money each year from an asset so that its purchase value is reduced by its overall useful life. As an example: if the business buys a $25,000 truck and its useful life is estimated at 5 years, then each year the company can deduct $5000 off its income to lessen its tax burden. However, as you can see, it is not an actual cash transaction. No money is physically leaving the business or changing hands. Therefore, this amount is added back.
Why Add Back Interest?
Each business owner will have separate philosophies for borrowing for the business and how to best use borrowed funds, if necessary at all. Furthermore, in nearly all cases, the seller will pay off the business's loans from their proceeds at closing; therefore, you will have use of these additional funds.
A Note About Add-Backs
After completing any add-backs, it is critical that you take into consideration the future capital requirements of the business as well as debt-service expenses. As such, in capital intensive businesses where equipment needs replacing on a regular basis, you must deduct appropriate amounts from the Owner Benefit number in order to determine both the true value of the business as well as its ability fund future expenditures. Under this formula, you will arrive at a "net" Owner Benefit number or true Free Cash Flow figure.
What Multiple?
Typically, small businesses will sell in a one-to three-times multiple of this figure. Now, this is a wide range, so how do you determine what to apply? The best mechanism I have found is that a one-time multiple is for those businesses where the seller is “the business.” In other words: "as out the door goes the seller, so too can go the customers." Consulting businesses, professional practices, and one-man businesses come to mind.
Businesses that have a strong track record, repeat clients, historical pattern of growth, more than 3 years in business, perhaps some proprietary item, or an exclusive territory, a growing industry, etc., will sell in the 3-times ratio. The others fall somewhere in-between.
So now the big question: what number/multiple do you apply to the Owner's Benefit number? The answer is simple: nearly all small businesses will sell in the 1-to-3 times Owner Benefit window. Of course, this is a very wide range.
Also, the actual total Owner Benefit figure will impact the multiplier. As the Owner Benefit number increases, so too will the multiple. As an example, a business generating $200,000 in OB, may be worth a 3 times multiple, but one generating $500,000 or $1,000,000 can be worth a four or five times multiple.
The Rules to Apply To Establish A Multiple:
You also want to calculate the Return on Investment (ROI) that you can expect to achieve when buying a business. Let's say that you have $100,000 for a down payment. If you go to Las Vegas and let it rip on “17 black,” well you should be entitled to enormous odds. Wouldn't you agree? On the other hand, if you invest it in commercial real estate, which is a solid, stable investment, then 10% return on your money seems about right, doesn't it? In fact, when the real estate market heats up, the return can diminish to 5% or so, and still investors are satisfied.
Buying a business is clearly a greater “risk” but definitely far less than gambling it at a casino and so you should expect something in-between. I've always felt that a 25% return on your investment should be the minimum and you can, if negotiated well, get as high as 35% -50% ROI.
If You're New At This, Here's What To Do:
- If you don't know how to read an income statement, then learn. It's important for this process. It's simple, and can be done quickly. Work with your accountant, if necessary, to determine the true Owner Benefits of the business. Be careful about the add-backs. Make certain that any benefits being added back are not necessary expenses needed to run the business. You can only add back something that has been expensed. Calculate a multiple in the 1-3-times window based upon the business's strengths and weaknesses. Note that the multiple will increase along with the Owner benefit figure. Determine your investment level and an acceptable ROI. Understand that value is personal. If the business is right for you, it is all right to pay a slight premium, but not to drastically overpay.
- Consider applying other valuation formulas simply as a test to your figure.
For most small businesses, hiring a professional to perform a valuation is not necessary. First of all it is expensive, and more often than not, it simply does not reflect reality. I read a valuation recently on a local company handling specialized telecom components in a very restricted marketplace doing $700,000 a year in sales and netting $100,000. The valuation started off: “The company is focused upon the specialized B2B telephony arena and operates within a broad industry which generates annual revenues of $42 billion in North America. Leading competitors include Nortel, Cisco…..” I threw out the entire report after reading that one sentence. Why? How on earth can you possibly compare a $42 billion dollar industry and a $700,000 local distributor of telephone systems? Don't waste time or money getting a professional valuation done for a small business acquisition. Let the seller do that if they so choose. If you want to look at a variety of scenarios, there are some very good, inexpensive software packages available that will do the same thing at a fraction of the cost.
The Key Points:
- Remember that valuations are not scientifically based; they're subjective. Use a variety of methods. Owner Benefits is the number on which to base your multiple Uncover how the seller established the asking price Valuation is a personal formula - What's the business worth to YOU?
- Consider the potential return on your cash investment
By Richard Parker, President of The Business For Sale Buyer Resource Center™ and author of How To Buy A Good Business At A Great Price©
There's a reason why buying a business is referred to as a “buying process.” There are a substantial number of steps involved and much to consider, especially for anyone who has never bought one before.
This is a major decision and investment. With so much at stake, it is crucial that you prepare yourself properly and educate yourself for this journey and take the necessary steps to be certain that you make all of the right decisions along the way.
According to industry statistics, nine out of ten people who begin the search to buy a business, never complete a transaction. Perhaps the biggest reason for this dismal statistic is that most people simply do not realize how much is involved.
Part of the challenge is that most are first time buyers. Faced with having to make one crucial decision after another, they become overwhelmed and frustrated and soon they abort the project.
Your approach must be different.
As Thomas Edison once said: “There is always a way to do it better… find it!”
This Will Take Time - Just Don't Take Forever
You can easily turn this entire buying process into an endless search. The average buyer spends 18 months looking and then gives up. However, there's no reason why you shouldn't be able to complete the process in six months. If you're working full-time, you will have to be disciplined in your search efforts. If buying a business is a goal you've set for this year, then block off at least ten hours per week to devote to this project.
Starting Off Right
It is estimated that 70% of all searches by buyers are now conducted via the Internet. A short time looking at business-for-sale websites and you'll soon realize that the number of available businesses is incredible. In fact, there are hundreds of thousands of them out there. It would be very easy to turn this into a never-ending search instead of a buying process.
Instead of looking at endless business-for-sale listings trying to figure out which, if any, are right, you must first identify what type of business is right for you and then focus your search accordingly.
Take a good look at yourself. What are your strengths, weaknesses, likes and dislikes? Don't try to be something you're not. Most people simply don't know what's right for them and that's fine. If this is your predicament, sometimes it's best to start by ruling out all of the businesses you don't want.
Next, consider your finances and focus solely upon those that make sense from an investment perspective. With these two criteria alone, you'll be able to whittle down the choices.
Educate Yourself About This Process
Unless you have a wealth of experience buying businesses, it is critical that you acquire the necessary knowledge and information to make this decision. You are going to face an onslaught of decisions throughout this process. Having the knowledge will likely make the entire difference between buying the right business and the wrong one.
Don't fool yourself into thinking that your attorney or CPA can make these decisions for you, although it is extremely important to find quality professionals that specialize in business transactions of the size and type you are considering. It is incumbent upon you to take the time to learn what is involved and how to successfully navigate your way to your dream. Think of it this way: if you're going to invest your savings to buy a business; shouldn't you first invest the time to learn how to buy the right one?
It's been proven over and over again that well-informed, properly prepared buyers acquire good businesses; the rest get sold lemons!
This is one decision you must get right the first time!
Organize Your Finances
You will definitely be required to produce a personal financial statement at some point. Get the details together right away. List all of your assets and liabilities and outline your net worth. Check your credit rating and rectify any erroneous information. You can obtain a free copy at www.freecreditreport.com .
Make Sure Your Family Is On Board
If you have a spouse/partner, be certain that you discuss this project together. It's no use going down the road with this if your spouse is not on board. You both have to see the dream. Business ownership is a time-consuming commitment. The hours are long. You need their support. Keep them informed. Answer their questions. Get their input. Remember, even though this may be your business, they're in it too.
Determine Your Investment Level
Determine with absolute certainty how much of your own cash you are prepared to invest. Forget any relatives who may have promised that they'll “back you.” When the time comes to lay down the money, chances are they won't be around.
Don't bother looking at businesses that are unaffordable. Over 80% of small business purchases involve seller financing. Generally, this is 30% to 50% of the purchase price. If you have $100,000 to invest, don't look at businesses that will sell for $2,000,000. It's OK to dream, but be realistic.
Also, take the time to sit down with an SBA specialist to research all avenues for your financing. They provide all types of loans for entrepreneurs financing a business purchase. See www.sba.gov for further information.
Intermediaries - Do You Need One?
I am a firm believer in using a business broker to help you throughout the process. Keep in mind that the seller nearly always pays brokers and so their role from an advice point of view may be limited or even tainted. However, a good broker can, and will:
Commit to a deadline for buying a business (not just “looking” for one).
There's a reason why buying a business is referred to as a “buying process.” There are a substantial number of steps involved and much to consider, especially for anyone who has never bought one before.
This is a major decision and investment. With so much at stake, it is crucial that you prepare yourself properly and educate yourself for this journey and take the necessary steps to be certain that you make all of the right decisions along the way.
According to industry statistics, nine out of ten people who begin the search to buy a business, never complete a transaction. Perhaps the biggest reason for this dismal statistic is that most people simply do not realize how much is involved.
Part of the challenge is that most are first time buyers. Faced with having to make one crucial decision after another, they become overwhelmed and frustrated and soon they abort the project.
Your approach must be different.
As Thomas Edison once said: “There is always a way to do it better… find it!”
This Will Take Time - Just Don't Take Forever
You can easily turn this entire buying process into an endless search. The average buyer spends 18 months looking and then gives up. However, there's no reason why you shouldn't be able to complete the process in six months. If you're working full-time, you will have to be disciplined in your search efforts. If buying a business is a goal you've set for this year, then block off at least ten hours per week to devote to this project.
Starting Off Right
It is estimated that 70% of all searches by buyers are now conducted via the Internet. A short time looking at business-for-sale websites and you'll soon realize that the number of available businesses is incredible. In fact, there are hundreds of thousands of them out there. It would be very easy to turn this into a never-ending search instead of a buying process.
Instead of looking at endless business-for-sale listings trying to figure out which, if any, are right, you must first identify what type of business is right for you and then focus your search accordingly.
Take a good look at yourself. What are your strengths, weaknesses, likes and dislikes? Don't try to be something you're not. Most people simply don't know what's right for them and that's fine. If this is your predicament, sometimes it's best to start by ruling out all of the businesses you don't want.
Next, consider your finances and focus solely upon those that make sense from an investment perspective. With these two criteria alone, you'll be able to whittle down the choices.
Educate Yourself About This Process
Unless you have a wealth of experience buying businesses, it is critical that you acquire the necessary knowledge and information to make this decision. You are going to face an onslaught of decisions throughout this process. Having the knowledge will likely make the entire difference between buying the right business and the wrong one.
Don't fool yourself into thinking that your attorney or CPA can make these decisions for you, although it is extremely important to find quality professionals that specialize in business transactions of the size and type you are considering. It is incumbent upon you to take the time to learn what is involved and how to successfully navigate your way to your dream. Think of it this way: if you're going to invest your savings to buy a business; shouldn't you first invest the time to learn how to buy the right one?
It's been proven over and over again that well-informed, properly prepared buyers acquire good businesses; the rest get sold lemons!
This is one decision you must get right the first time!
Organize Your Finances
You will definitely be required to produce a personal financial statement at some point. Get the details together right away. List all of your assets and liabilities and outline your net worth. Check your credit rating and rectify any erroneous information. You can obtain a free copy at www.freecreditreport.com .
Make Sure Your Family Is On Board
If you have a spouse/partner, be certain that you discuss this project together. It's no use going down the road with this if your spouse is not on board. You both have to see the dream. Business ownership is a time-consuming commitment. The hours are long. You need their support. Keep them informed. Answer their questions. Get their input. Remember, even though this may be your business, they're in it too.
Determine Your Investment Level
Determine with absolute certainty how much of your own cash you are prepared to invest. Forget any relatives who may have promised that they'll “back you.” When the time comes to lay down the money, chances are they won't be around.
Don't bother looking at businesses that are unaffordable. Over 80% of small business purchases involve seller financing. Generally, this is 30% to 50% of the purchase price. If you have $100,000 to invest, don't look at businesses that will sell for $2,000,000. It's OK to dream, but be realistic.
Also, take the time to sit down with an SBA specialist to research all avenues for your financing. They provide all types of loans for entrepreneurs financing a business purchase. See www.sba.gov for further information.
Intermediaries - Do You Need One?
I am a firm believer in using a business broker to help you throughout the process. Keep in mind that the seller nearly always pays brokers and so their role from an advice point of view may be limited or even tainted. However, a good broker can, and will:
- provide you with access to a vast database of businesses for sale
- walk you through the valuation process
- provide you with comparable business valuations
- keep the deal moving along when obstacles are encountered
- be the bearer of bad news to the seller when necessary
- ensure all pertinent documents are assembled for the closing
Commit to a deadline for buying a business (not just “looking” for one).
- Set aside time every day to work on this project.
- Organize your finances.
- Work on determining what type of business will thrive from your strengths and not suffer from your weaknesses.
- Seek professional advice from a qualified accountant and attorney.
- Unless you have a wealth of experience buying businesses, then educate yourself about this process. Learn as much as you can. When it comes to investing in your future, you can never know too much!
