Frequently Asked Questions (FAQs) About Buying A Business

What are the key motivators for people going into business for themselves?
Should I start my own business or buy an existing one?
What should I be looking for in a business?
Why is confidentiality so important to the seller?
How is the asking price of the business determined?
Should I hire an attorney?
What is due diligence?
During the due diligence process, what are some significant warning signals, and what should I do about them?
What are the main reasons for the failure of a business after it's bought?
How much cash do I need in order to purchase a business?
Where can I obtain financing to help me buy a business?

1. What are the key motivators for people going into business for themselves?
Before making a decision to purchase a business, a buyer should understand his or her objectives to make sure those objectives can be met by purchasing any or a particular business. Most relevant surveys reveal similar responses and, interestingly, making money is not at the top of the list. Here is a list of the typical answers, in the order of importance:

To control my own future.
To work for myself.
To take advantage of my skills and abilities.
To make money.

2. Should I start my own business or buy an existing one?
An existing business has a historical track record (good or bad) which can be used to evaluate the business. An existing business has usually shown there is demand for its products or services, and it should have, among other things, detailed financial records. Sometimes, a seller will agree to stay with the business and help to train a new owner and to provide seller financing. These are important factors because many small businesses tend to fail during the early stage of their development. On the other hand, there can also be disadvantages to buying an existing business. A buyer will be assuming an established corporate culture and infrastructure which may make implementing changes more difficult. Also buyers will generally have to pay a premium for an existing business.

3. What should I be looking for in a business?
A buyer should only consider a business he or she will feel comfortable owning and operating. The time and effort which will be required is an important consideration as is how much the buyer can afford to pay for the business. The amount of cash the buyer hopes or needs to regularly take out of the business is very important, especially if the business is to be the buyer's only source of income. Because many experts believe you should not purchase a business unless you can make it better, it is helpful if a buyer has some definite ideas on how to improve the purchased business.

4. Why is confidentiality so important to the seller?
Typically, confidentiality is very important to a seller. It can be damaging to a business if it is known that it is for sale. Customers may not be interested in buying from a business that is up for sale, competitors could use the information to their advantage, and employees generally experience anxiety and often leave.

5. How is the asking price of the business determined?
Sometimes the seller's business broker will review the financial records of the business and make a recommendation about the price. Other times, the seller will obtain a professional valuation of the business. Sometimes, the deal structure is more important than the financial status of a business in determining the actual selling price. As an example, the cash to be paid and the availability of seller financing are important determinants. All other things being equal, typically, a greater cash requirement and/or lack of seller financing will lead to a lower selling price.

6. Should I hire an attorney?
Yes, it is a good idea to retain an attorney to review the necessary legal documents. Although most businesses already use an attorney, it is important that the attorney you hire be familiar with business acquisitions to be as effective as possible during the process.

7. What is due diligence?
Due diligence is a systematic process for acquiring and analyzing information to help a buyer or seller to determine whether or not to proceed with a proposed business transaction. The information obtained relates to all aspects of the business to be purchased. Due diligence should include both quantitative information, such as sales and other financial data, and qualitative information, such as an assessment of the existing management, internal systems, existing licenses, location and other matters. Sometimes the information to be reviewed can be quite technical or industry specific. It is important that the person doing due diligence have a complete understanding of the information being reviewed. The Bizquest M&A Forms Center includes a Due Diligence List.

8. During the due diligence process, what are some significant warning signals, and what should I do about them?
The seller has:

Imposed an unrealistic time frame for the transaction.
Withheld key information.
Limited access to information and people.
Provided unclear or biased reasons for selling.
Presented information that is significantly misleading or false.
Displayed a lack of commitment to remain after the sale.

If these signals are present you should:

View them as real warnings of increased risk to the transaction.
Increase the amount and extent of due diligence procedures to ensure a realistic assessment of the business.
Determine whether to invest more time investigating the opportunity or to simply pass on the deal.

9. What are the main reasons for the failure of a business after it's bought?

The price paid was significantly over market value.
The due diligence procedures were not adequate.
A previously dependent asset was unable to function/survive without support (i.e. sales to related parties or below market debt).
A change in business environment created unexpected problems.

10. How much cash do I need in order to purchase a business?
In most cases, a portion of the total consideration paid for a business is paid in some sort of deferred payment - whether in the form of a seller note or payments contingent on the performance of the business. Third party lenders are also available to make acquisition loans. Therefore, a cash investment of 1/3 to 1/2 of the purchase price may be sufficient to complete a transaction, depending upon the financeability of the transaction.

11. Where can I obtain financing to help me buy a business?
There are a variety of sources available for purchase financing. These range from a typical commercial lending source to asset-based lenders and seller financing. The availability of outside financing will depend upon the asset base of the business, its operating history, collateral availability and projected cash flow - the same issues considered in all business lending. Seller financing is also an option. In this case, the seller of the business takes back a promissory note for part of the value of the company. Seller financing may be a good indication of the seller's faith in the continuing operations of the business. The SBA and the Bizquest Network of Financing Providers are helpful resources when trying to determine what type of financing is available.

"Good, is the enemy of Great"

John Tortorella

Are you Ready to Sell Your Business?

Selling your business is a major decision! You have committed your time, money and energy to building this company; it may represent your life’s work and your single greatest asset. You have decided to sell, what should you do next. Before you do anything, please consider this information in this outline!

Here are some national statistics from 2002 compiled by the Business Reference Guide, the odds of selling your business are: Sales < $750,000 are 1:5.5=18% Sales $ 750,000 to $2 million 1:4 = 25% Sales $2 to $6 million 1:3.5=35% Sales $30 million > 1:3=33%...As you can see these numbers are not very good, what can you do to increase your chances? First, you need the very best professional guidance you can get. You will want a team of professionals to assist you. This should include your Accountant, Attorney, a Tax Expert and a Professional Business Broker. The right team can mean the difference between getting rid of your company and selling it for the very best price and terms. The following are some of the most common questions sellers ask. The responses are based on experience and knowledge.

How Do I Select the Right Business Broker?

Ask Questions like: “What is the majority of the sales in your office-sale of homes? Businesses / commercial real estate?” If the answer is, selling homes- move on quickly to another office until you find one that just specializes in the sale of businesses and commercial real estate. Other questions to ask are: “How long has your office specialized in the sale of businesses?” “How many exclusive business listings does your office currently have?” “How many businesses does your office typically sell each year?” “Can you provide references?” “Are you members of a Business Brokers multiple listing service?” “Can you assist in getting a Small Business Administration loan?” Once you have selected a qualified Broker stick with them- loyalty has its awards!

What To Expect From A Business Brokers.

Business Brokers are the professionals who will facilitate the successful sale of your business. As your Business Broker they can help you decide how to price your business and how to structure the sale so it makes sense to everyone-you and the buyer. A good qualified Broker can find the right buyer; work with you and the buyer in the negotiation, and coordinating every step of the way until the transition is successfully closed.

Business Brokers do not, however, set the price of your business. Only the marketplace can do that. Most businesses will sell if priced right and structured properly. The down payment you require as well as the other terms of the sale can have a significant impact on the price and ultimate success of the transaction.

How Long Will It Take TO Sell My Business?

The national average is seven months to sell your business. This is only an average that will be influenced by many factors. Buyers want facts. A good Broker cannot professionally present the business without this information. It is equally important that the business be priced correctly from the beginning. Some sellers want to overprice the business in the belief that they can always come down. The fact is many qualified buyers will refuse to look at the business that is over priced. They simply do not want to enter into negotiations with a person that they believe has unreasonable expections,70% of businesses that do not sell are due to the price being too high.

Often, the down payment required may be the key ingredient to a quick sale. If the down payment is low, the quicker the sale. Many businesses sell with down payments equal to one third or one half of the total price and the owner carrying the balance over a negotiated term and rate. A reasonable down payment also tells the buyer that the seller has confidence in the business’s ability to make the payments.

Why IS Seller Financing Important?

Surveys have shown that a seller who asks for all cash receives on average only 70% of their asking price. Sellers who accept terms receive over 85% on average. In many cases, businesses listed for all cash simply do not sell. With reasonable terms, the chances of a sale increase dramatically. Seller financing may be the only way to sell the company. You will also receive interest from the note, which can greatly increase the total amount received. Seller financing tells the buyer emphatically that the seller believes the company can make the payments. Ask your Broker about the protections that can be built in to a seller note. Some businesses may be pre-qualified for a SBA loan, thereby giving a buyer the ability to purchase with a small down payment (about 20%) and the seller ability to cash out. Ask you Broker if your business will qualify for government backed SBA loan.

What Happens When There Is A Buyer For My Business?

When a buyer is sufficiently interested, a qualified Broker should assist in the preparation of an offer. The Asset Purchase Contract will spell out the buyer’s offer in detail. The offer may contain several contingencies and will spell out the type of due diligence the buyer perform. You can expect to be asked for Tax Returns, Bank Statements, Sales Tax Reports and any other documents necessary to prove the financial performance of the business, usually for at least the past three years. Additionally, the buyer will want to review the lease, franchise agreement or other contracts that will affect the business after the sale. A broker should present all offers to you for your consideration. You always have the right to accept an offer, issue a counter proposal or reject the offer. It is important to know that if you do not accept the offer, a buyer can withdraw at anytime. Be prepared to do some work at this point in the process. People from all over the world are seeking business opportunities in your area. Different nationalities and cultures approach negotiations in far different ways. You should take the time to consider all offers carefully and seriously. There may be some definite positives in the offer and the negatives may be offset with careful negotiations. Often, the first buyer turns out to be the best.

How Can I Help To Sell My Business?

First and foremost, continue to run the business in an aggressive, growth-oriented way. Do not let up on business operations during the marketing period. You should make most decisions in the best interest of the long-term objectives of the company.

Maintain up to date financial information. Work with your accountant to provide monthly statements with year to date numbers. Real buyers want real data, usually no more than 60 days old.

Understand the tax implications before listing your business. This may very well require the assistance of a specialist in the field. Your company accountant is an expert at keeping the records of the company; buy may not be completely up to date on some of the latest structures that can be employed to reduce your total tax burden. An effective tax plan can allow you to price the business much more attractively without sacrificing your total return. This is a critical step in developing a win-win transition.

You too should be prepared to close quickly. Once an agreement is reached between buyer and seller, buyers generally want to close as soon as possible. It is a fact that businesses rarely improve between the times a seller signs a contract and a closing. Customers, competitors and key employees may react in different ways when they here of the sale. The sooner the new owner takes over, the sooner some of those fears and anxieties will go away. If there are actions that you have deferred, such as maintenance or repairs, you should take care of them at once. There will be lots to do as the closing approaches so everything that can be done in advance of an offer should be done. Only thought the close cooperation of all parties can a qualified Business Broker do his or her best to help you through this most important transition?

Why should I use a Business Broker?

A Business Broker is an individual who works with either buyers or sellers of businesses to help them realize their goals.

The business broker determines the value of a business, determines whether or not a sale makes sense, and recommends the proper terms and structure for the sale. The business broker can handle the various aspects of a transaction including developing a marketing plan, executing the plan, locating and screening potential buyers, negotiating the price and the terms of the sale, and assisting buyers in obtaining proper financing.

Business Brokers can help a buyer to determine exactly what type of business he/she is looking for, based on the buyer’s goals and financial picture. The business broker can then locate and evaluate businesses that meet the buyer’s criteria. A Business Broker can handle all aspects of the transaction, including negotiating the price and the terms of the acquisition and assistance in securing financing. Finally, the broker maintains a network of contacts in the business community that provide information about confidential situations that are not available through public channels.

BUYER'S GUIDE

Business Financing - Where to get it and why you would want a SBA Loan and Seller Financing

Business financing can come in the form of conventional loans, SBA (Small Business Administration) loans, and seller financing. A combination of the three forms may be used, but SBA loans are by far the most popular. In fact, SBA loans are the primary source of capital injected into the small business community nationwide. Last year the SBA assisted small businesses with over $10 Billion Dollars of loan guaranties.

The Small Business Administration more commonly known as the SBA is a Federal Agency established in 1953 to protect and assist America's greatest resource... small businesses. SBA's mission is to stimulate and foster economic development through small businesses, because helping small businesses get started and become successful is great for the nation's economy. Briefly, the SBA loan guarantee program works in the following manner. The SBA will guarantee a portion of a business loan made by a lender enrolled in the program. By issuing a partial Federal Guarantee to the Bank, your loan, which might not be approved on conventional terms, can now be approved via a SBA guaranteed loan.

SBA Loan benefits include longer terms and larger loan amounts than you might be able to obtain through a conventional loan. They also include competitive interest rates and no balloon payments or annual reviews. Furthermore, SBA loans are fully amortized and loan terms typically range from 7 to 25 years depending on the purpose. To understand the benefits of full amortization, consider a loan that is used to purchase commercial real estate.

The conventional bank loan is normally amortized over 15 to 20 years and renewed every 3 or 5 years. So, when a small business owner faces the 3 year review of that conventional loan:

The bank may decide that its risk appetite no longer favors loans for those types of businesses and therefore requires full payment.
The bank may review and re-amortize the loan over another 15 to 20 year period, which would mean more interest over the term of the loan.
If the small business is doing well, the bank may renew the loan as is, but often the borrower has to pay thousands of dollars in costs associated with the renewed loan application.

All of that uncertainty and additional expense for refinancing or restructuring of the loan is eliminated with SBA financing.

SBA loans are also easier to secure because they are offered by private lenders, and are not restricted by regulatory constraints that make bankers hesitate to lend to small businesses. The typical private lender offers from $100,000 to $2,000,000 financing (more or less depending on the lender).

As a buyer, seller financing should not be overlooked. How much money is the seller looking for as a down payment? Will the seller finance some of the purchase price? Is there another lender involved (like a bank or a former owner)? Is there an assumable loan? What is the current balance of each loan the business has now? This is an essential area of inquiry if you are trying to save time. Most sellers are unrealistic in the early stages of selling their business, even if it is listed with a broker. Sellers usually hope for an all-cash buyer. Most buyer prospects are also unrealistic - buyers are often looking for 100% seller financing! In reality, the "average" deal is closer to 30-50% down in cash from the buyer with 50-70% financing from the seller, SBA, and banks.

Most first-time business buyers need seller financing. Sellers are much more likely to finance buyers they like, regardless of experience. But it can take time for sellers to warm-up to this idea and to a particular buyer prospect. Seller financing is great because it shows that the seller believes in the business, but most importantly he or she believes that you can run it profitably!

Business Valuation Rules of Thumb

Business brokers and other professional intermediaries use business valuation rules of thumb to help sellers price their businesses for sale. These "rules" are very useful for appraising nearly every small business, however they are gross simplifications and should only provide a general idea of a suitable price range for a particular business.

If a rule of thumb is used to value a business, some type of earnings multiplier makes the most sense to prospective buyers. It directly addresses the buyer's motive to make money to achieve a return on investment. Sales multiples mean nothing unless they can be translated into earnings.

Two areas of confusion are inappropriate comparisons to investment real estate or to stock market earnings multiples. Real estate is often priced at 8 to 10 times its net operating income. Stock market prices are often as much as, or even more than, 20 times earnings. These two comparisons do not work for small businesses primarily because the risk of owning a small, closely-held, privately owned business is thought to be much higher than owning either real estate or publicly held stock. A business has lower liquidity than real estate and stock, and running a small business is also a lot tougher than managing an office building or a stock portfolio.

To determine an appropriate earnings multiplier, the following questions must be taken into consideration:

How is the business doing in terms of earnings? What are the average earnings per year in the last three to five years? What are the future projected earnings?
How is earnings calculated? Should it include or exclude the owner's pay and perks, interest expenses, depreciation, and taxes? What about those one-time expenses that may be on the books?
How do you choose the right earnings multiplier to value the business? What is the multiplier based on? Most people can agree that the multiplier varies based on the risk of the business, but how can risk be measured?
What about the various tangible and intangible asset values? Do we include the real estate, equipment, vehicles, and inventory? Is there a separate value for a seller's agreement to consult with the new owner after the sale? What about non-compete agreements? What about patents, franchises and other extraordinary intangible assets? Is "value" defined as fair market value or a specific value for a specific circumstance?

As you can see, determining an appropriate earnings multiplier is fairly subjective. The reality is that it is very difficult to estimate the market value of a business because a marketplace of buyers and sellers cannot be easily observed. In fact, there are not many buyer prospects for a given small business and the result is that buyers pay prices that are unique to their circumstances, sometimes considerably above or below any so-called "fair market value".

A buyer must use common sense and remember that potential buyers create the market. Determining an earnings multiplier can be difficult, and the following six guidelines could be used to help calculate earnings:

Examine the most recent year's earnings on the seller's latest tax return. It would make sense to look at the last three years, but remember as a buyer you are buying the future and not the past. Use these figures to determine projected annual future earnings with you as the new owner. Do you have experience in this type of business? Can you perform the duties and responsibilities of the seller? Will you be able to maintain sales at their current levels?
Look at the tangible and intangible assets. They often seem to have a value separate from the business. Is there real estate and inventory for re-sale included in the sale? Real estate and inventory for re-sale is theoretically less risky than owning the other assets of a business because it is believed that real estate could be easily sold on the open market and inventory for re-sale could be easy to liquidate if the business failed. Generally, inventory is valued at cost. These assets may be valued separately from the business, and then added back to the multiple-derived value of the business. Aside from real estate and inventory for re-sale, other assets should already be included in the multiple-derived business value as they are needed to generate the projected future earnings.
If there is real estate involved but it is not for sale, a real estate rent expense must be subtracted from the earnings figure. The seller did not have to pay rent if he or she owned the property where the business is located, but this would not be the case for you as the buyer. You must take future rent expense into consideration.
Owner's salary, perks, and certain one-time expenses should be included in the earnings calculation. If these expenses were subtracted from profit on the tax returns, they should be added back in your earnings calculation. Businesses tend to maximize deductible expenses to minimize taxes.
Depreciation / amortization is a non-cash expense, meaning the owner does not have to pay out of pocket each year. If these expenses were subtracted from profit on the tax returns, they should be added back to your earnings calculation.
Earnings = Net Profit before taxes + Owner's Salary + Fringe Benefits + Depreciation / Amortization.
Generally, intangible assets such as an owner's agreement to not compete, or to consult during a transition period, are included in the value of the business derived by using a multiple of earnings, even though such assets may well be treated separately at a business closing for tax purposes.

Once you have calculated projected annual future earnings, also known as EBIT (Earnings Before Interest and Taxes) by accountants and is an understood norm, consider the risks involved in owning the business. How much are you willing to pay for the business given the risks involved? The right earnings multiple really depends. For most businesses, it's somewhere between 3 to 5 times EBIT. But, the multiple is less when there are few tangible assets and more when the business is uniquely attractive.

In summary, the rule of thumb to use to value a business is based on an earnings multiple. The right multiple is, in the eyes of buyers, a matter of assumed risk. Buyers feel better about buying tangible assets that they can appreciate with their five senses - things like real estate and equipment. On the other hand, buyers are also enticed when there is a clearly attractive opportunity to make money, regardless of the tangible assets included.

"Business Valuation Rules of Thumb Article" written by Jim Brown with excerpts by Glen Cooper.

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