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Questions and Answers
What distinguishes the concepts of price and value in a business negotiation?
Which of the following represents a source of power for a buyer during negotiations?
What is a potential trap to avoid when buying an existing business?
Which of the following is NOT a legal consideration when buying a business?
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Which financial analysis technique is essential for evaluating a business's worth?
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Which aspect does the asset-based method of business valuation primarily assess?
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What does the earnings-based approach focus on when valuing a business?
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In business valuation, what does the discounted future earnings approach account for?
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Which method combines existing assets with an estimate of future earnings for business valuation?
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When determining a business's value, which legal factor might be critical?
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Which valuation method relies on the prices of similar businesses in the financial markets?
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What is a potential drawback of using the capitalised earnings approach?
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What should be primarily considered when assessing the legal aspects of a business?
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What is a characteristic of businesses found in the hidden market?
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Which of the following is NOT a suggested question to evaluate a business for purchase?
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What common problem might a buyer face when purchasing a business that was never profitable?
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What is a significant factor a buyer should consider regarding employees when acquiring a business?
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Which of the following could be a reason for a business to be operating under a poor reputation?
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When searching for a suitable business to buy, which source is typically not included?
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Which issue might arise from outdated equipment or inventory when buying a business?
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Why might a business be considered overpriced?
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Study Notes
Chapter 12: The Business Buyout
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Learning Outcomes (LO):
- LO1: Evaluate buying an existing business (advantages and disadvantages)
- LO2: Conduct a self-audit for finding a business.
- LO3: Identify places to find businesses for sale.
- LO4: Evaluate available businesses before purchase.
- LO5: Apply valuation methods.
- LO6: Identify critical negotiation issues for final purchase price.
- LO7: Understand traps to avoid during purchase.
12.1 Introduction
- Buying an existing business (buyout) is an alternative to starting from scratch.
- Buyouts involve transferring ownership to a new individual, group, or entity.
- Buyouts can involve existing businesses or franchises.
12.2 Evaluating the Option of Buying an Existing Business
12.2.1 Advantages
- Going Concern: The business is already functioning.
- Easier Financing: Easier to secure funding for an operating business compared to a new start-up.
- Higher Success Probability: Existing businesses with a strong track record have a better chance of continued success.
- Established Location: A business with a desirable location gives an advantage.
- Experienced Employees: Existing employees provide continuity and reliability.
- Established Suppliers: Established supplier relationships save time and effort.
- Existing Inventory and Equipment: Available inventory and equipment reduce startup costs.
- Potential Bargain Price: An established business might be available at a lower price.
12.2.2 Disadvantages
- Hidden Problems: Businesses might have concealed financial problems.
- Low Sales Volume: Inadequate sales volume could be a concern.
- Poor Reputation: A negative reputation of the business could hinder success.
- Unsuitable Employees: Inherited employees might not align with the buyer's needs.
- Obsolete Equipment: Equipment, facilities, and inventory could be outdated.
- Overpriced Valuation: The business might be overvalued.
- Previous Owner Influence: Potential difficulties from dealing with the previous owner.
12.3 Finding a Business to Buy
12.3.1 The Search Process
- Businesses on the Market: Businesses actively listed for sale (advertised in newspapers or through brokers).
- Businesses Not on the Market: Some hidden gems can be found from various sources (property agents, financial institutions, business brokers, accountants, and auditors).
12.4 Evaluating Available Businesses
- Important considerations for evaluating businesses:
- Reasons for selling
- Profitability
- Necessary skills and competencies
- Business history, reputation
- Physical condition (facilities, assets)
- Competition
- Market size (existing and potential)
- Legal factors (e.g., contracts, liabilities)
12.5 Methods for Determining the Value of a Business
- Several methods can assess business value.
- Asset-based method (or balance sheet method): Total assets minus liabilities.
- Market-based method: Analyzing comparable sales of similar businesses in the marketplace.
- Price-to-earnings ratio = Market price/After-tax earnings
- Earnings-based approaches (use income statements):
- Excess earnings method: Combines asset value and projected future earnings to determine business value and goodwill.
- Capitalized earnings approach: Estimates future earnings and uses it alongside factors like interest rates to evaluate value.
- Discounted future earnings: Assumes future earnings are worth less than present value.
- Non-quantitative factors:
- Competition, market share, future community developments, legal commitments, employee contracts
12.6 The Negotiation Process
12.6.1 Stages of Negotiation
- Preparation: Clarifying objectives
- Discussion: Engaging the other side, sharing information, exploring options.
- Bargaining: Real face-to-face negotiations to reach a mutual win-win outcome.
- Conclude: Reaching a legally binding agreement.
- Execute: Implementing the agreed-upon terms.
12.6.2 Price vs Value
- Value determined in marketplace by willingness to pay (by the buyer).
- Sellers use computational methods to determine a price.
- Price is different from value.
12.6.3 Sources of Power
- Information (Complete and Reliable information is critical for the buyer)
- Timing (Desperate sellers are often a favorable situation for the buyer)
- Pressure (Multiple owners or partners can potentially complicate the process)
12.7 Traps to Avoid When Buying an Existing Business
- Legal Circumstance
- Attraction to status and size
- Unknown territory
- Opportunity cost
- Underestimation of other costs
- Greed
- Anxiousness and Impatience
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Description
Explore the intricacies of purchasing an existing business through Chapter 12. This quiz guides you in assessing the advantages, conducting self-audits, and applying valuation methods essential for a successful buyout. Understand negotiation tactics and common pitfalls to navigate in the business acquisition process.
