EC 5

Key Questions Before Buying a Business

• Is the business type suitable for your intended market?
• What is your experience in the particular business and industry? How crucial is experience for success?
• What is the business's potential for future success?
• What changes are necessary, and how extensive will they need to be, to fully leverage the business's potential?
• Is the price and payment method reasonable for both parties?
• Will the business generate sufficient cash flow to cover itself and provide a satisfactory return on investment?
• Should you start a new business from the ground up, or is buying an existing business a better option?

Types of Business Buyers

• Main Street Buyers: Seek manageable businesses, easy to run solo or with a small team. Revenue range up to $1 million. Low risk tolerance. Focus on current and past earnings, often wanting the seller to stay on to assist with transition. (Examples: Car washes, dry cleaners, cafes)
• Corporate Refugees: Prefer service businesses with commercial clients and existing revenue streams. Revenue below $5 million. Low to medium risk tolerance. Focus on building on corporate experience. (Examples: consulting firms, landscaping, advertising)
• Serial Entrepreneurs: Focus on profitable companies with established management. Revenue below $10 million. Medium to high risk tolerance. Focus on building a portfolio of companies in varied industries or sectors. Want businesses they can run themselves. (Examples: computer services, properties rentals)
• Financial Buyers: Seek profitable companies with ready-to-grow products/services. Revenue $10 million to $100 million (or more). Medium to high risk tolerance. Aim for highly profitable exits in 5-7 years. Often venture capitalists (VCs) or angel investors. (Examples: health care, communications, energy)

Advantages of Buying an Existing Business

• Potential for continued success.
• Established location.
• Existing employees and suppliers.
• Installed equipment.
• Inventory and trade credit in place.
• Existing business operations, facilitating quick start-up.
• Previous owner's experience, potentially valuable for guidance.
• Easier financing options compared to starting a new business.

Disadvantages of Buying an Existing Business

• Potential for bargain price, possibly indicating underlying problems.
• Possible obsolete or inefficient equipment.
• Difficulty in adapting to changing market demands.
• Stale inventory or problematic receivables.
• Overpriced valuation that may not reflect the business's true worth.
• Financial costs associated with the purchase.
• Previous owner's negative legacy, potentially affecting employee morale or customer relations.
• Unsuitable inherited employees.
• Location that has become unsatisfactory, affecting the business's performance.

Valuing Accounts Receivable

• Age of accounts (days) is correlated to the probability of collection.
• Accounts with shorter durations have higher collection probabilities.
• The present value of accounts receivable, weighted by factors like age and likely collection rates, estimates the net worth of accounts receivable.

Steps in Acquiring a Business

• Analyze personal skills, abilities, and interests. Create a list of potential candidates in the "hidden market."
• Investigate and evaluate potential businesses. Select the best one.
• Explore financing options utilizing the seller as a potential source.
• Facilitate a smooth transition by engaging the seller as a consultant.

Evaluating an Existing Business: The Due Diligence Process

• Determine the owner's motivation for selling.
• Assess the physical condition of the business. (Plant, receivables, leases, records, assets, location)
• Determine the market potential for the business's products/services. (Freshness, customer demographics, market mix)

More Legal Aspects of Buying a Business

• Lien: Creditor's claim to an asset that is outstanding.
• Contract assignment: Buyer can potentially take over rights under an existing contract.
• Restrictive covenant: Seller agrees to not compete with the buyer in a defined region or market.
• Bulk transfer: Protects buyer from seller's unpaid creditors concerning transferred assets.

Valuation Techniques

• Balance Sheet Technique: Value = Total Assets - Total Liabilities
• Adjusted Balance Sheet Technique: Adjust book values for market worth (e.g., inventory, receivables, intangible assets).
• Earnings Approach: Valuing a business based on the estimated future earnings potential. Excess earnings approach factors in owner's salary and calculated opportunity costs. Capitalized earnings approach determines value based on annual earnings. Discounted future earnings approach uses discounted values for future earnings over several years.
• Market Approach: Value based on P/E ratios of similar businesses.

Reasons Why Business Owners Sell Their Companies

• Reducing risk to personal assets.
• Intense market competition and external pressures.
• Lifestyle changes, including age and health concerns.
• Lack of capital at the present time
• Management issues.
• Other motives.

Negotiating the Deal

• Go into negotiations prepared with prioritized objectives.
• Understand the seller's motivations and priorities.
• Build cooperative relationships based on honesty and trust.
• Avoid the "win-lose" mentality; instead, look for areas of mutual benefit.

Tips for Negotiating Effectively (The Five Ps)

• Preparation: Thoroughly assess the needs of all parties and external factors.
• Poise: Remain calm and composed throughout the negotiations.
• Patience: Avoid being rushed and focus on making informed decisions.
• Persistence: Don't give up easily, especially with issues considered essential.
• Persuasiveness: Articulate key positions effectively and support them with relevant information.

Conclusion

• Ensure comprehensive assessment of the advantages and disadvantages of buying an existing business.
• Follow the steps to increase the chances of success.
• Determine the business value from several perspectives.
• Understand the seller's motivations.
• Negotiate successfully by appreciating both the buyer and seller dimensions of the agreement.