Business Buyout Chapter 12

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Questions and Answers

What distinguishes the concepts of price and value in a business negotiation?

Price is determined by computational methods, whereas value is set by the market. (correct)

Value is purely based on the seller's financial needs, while price reflects market conditions.

Price is what the seller demands while value is what the buyer agrees to pay.

Price and value are synonymous and used interchangeably in business transactions.

Which of the following represents a source of power for a buyer during negotiations?

The timing of the buyer's offer. (correct)

The size of the seller's company.

The seller's desperation for a quick sale. (correct)

The buyer's secure financial position.

What is a potential trap to avoid when buying an existing business?

Underestimating hidden operational costs. (correct)

Focusing solely on the initial purchase price.

Assessing the size and status of the business. (correct)

Being overly patient during negotiations.

Which of the following is NOT a legal consideration when buying a business?

Assessing the potential opportunity costs. Signup and view all the answers

Which financial analysis technique is essential for evaluating a business's worth?

Discounted cash flow analysis. Signup and view all the answers

Which aspect does the asset-based method of business valuation primarily assess?

Total assets minus liabilities Signup and view all the answers

What does the earnings-based approach focus on when valuing a business?

Future income potential Signup and view all the answers

In business valuation, what does the discounted future earnings approach account for?

The risk associated with future earnings Signup and view all the answers

Which method combines existing assets with an estimate of future earnings for business valuation?

Excess earnings method Signup and view all the answers

When determining a business's value, which legal factor might be critical?

Employment contracts and their terms Signup and view all the answers

Which valuation method relies on the prices of similar businesses in the financial markets?

Market-based method Signup and view all the answers

What is a potential drawback of using the capitalised earnings approach?

It relies heavily on historical data. Signup and view all the answers

What should be primarily considered when assessing the legal aspects of a business?

Potential liabilities and compliance matters Signup and view all the answers

What is a characteristic of businesses found in the hidden market?

They typically represent high-quality opportunities. Signup and view all the answers

Which of the following is NOT a suggested question to evaluate a business for purchase?

Is the business located in a high-traffic area? Signup and view all the answers

What common problem might a buyer face when purchasing a business that was never profitable?

Creative accounting techniques disguising true financial health. Signup and view all the answers

What is a significant factor a buyer should consider regarding employees when acquiring a business?

Some inherited employees may not be suitable for the job. Signup and view all the answers

Which of the following could be a reason for a business to be operating under a poor reputation?

Previous financial mismanagement. Signup and view all the answers

When searching for a suitable business to buy, which source is typically not included?

Public advertisements. Signup and view all the answers

Which issue might arise from outdated equipment or inventory when buying a business?

Potential operational inefficiencies. Signup and view all the answers

Why might a business be considered overpriced?

The owner has inflated its market value. Signup and view all the answers

Study Notes

Chapter 12: The Business Buyout

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.