Buying a Business: Lesson 4 (PDF)

 Lesson4 Title: Buying a Business a. Establishing a purchase price b. Evaluating a franchise or other small business purchase c. Franchise agreement **Buying a Business is an alternative to starting a business from scratch or buying a business opportunity that involves...

 Lesson4 Title: Buying a Business a. Establishing a purchase price b. Evaluating a franchise or other small business purchase c. Franchise agreement **Buying a Business is an alternative to starting a business from scratch or buying a business opportunity that involves purchasing an existing business for sale.** **While starting a business from scratch sounds exciting, it\'s risky because it\'s the most difficult way to get into business. A better option for many entrepreneurs is to buy an established business. Buying a going concern shortens the learning curve, reduces the costs of \"on-the-job training\" and helps you avoid many of the errors you might make in developing your business from the ground up. In an already existing business, everything is in place, from customers to a credit line at the bank.** **Keep in mind that all businesses for sale are for sale for a reason. And it\'s up to you to discover what that reason is, whether it\'s financial or personal. Do your homework and investigate thoroughly before you even consider investing. The areas and documents you want to make sure you investigate include:** **Inventory** **Furniture, fixtures, equipment, and building status** **All contracts and legal documents** **Incorporation paperwork** **Tax returns** **Financial statements** **Sales records** **Complete list of liabilities** **Accounts receivable** **Accounts payable** **Debt disclosure** **Merchandise returns** **Customer patterns** **Marketing strategies** **Advertising costs** **Prices** **Industry and market history** **Location and market area** **The business\'s reputation** **Seller-customer ties** **Salaries** **List of current employees and an organizational chart** **Occupational Safety and Health Administration (OSHA) requirements** **Insurance** **Product liability** **Don\'t be too anxious when you\'re looking to buy a business. Take your time and recognize that businesses typically don\'t sell overnight. And make sure to avoid these practices:** **Buying on price. Buyers don\'t take into account ROI. If you\'re going to invest \$20,000 in a business that returns only a three-percent net, you\'re better off putting your money in a CD or municipal bond.** **Running out of cash. Some buyers use most of their cash for the down payment on the business and don\'t reserve enough for working capital. This is folly of the worst kind, putting the business\' future on the line. Cash is king and needs to be managed thoughtfully. As a rule of thumb, at least 10 percent of your cash should be considered contingency funds and at least three-months' worth of operating expenses should be set aside as working capital.** **Buying all the receivables. It generally makes good sense to buy the receivables, except when they\'re 90 days old or older. The older the account, the more difficult it will be to collect. You can protect yourself by having the seller warrant the receivables\--what\'s not collected can be charged back against the purchase price of the business. Receivables beyond 90 days belong to the seller for collection.** **Failure to verify all data. Most business buyers accept all the information the seller gives them without doing due diligence (preferably by a CPA who can audit financial statements). Heavy payment schedules. During the first year or so, it makes sense to have smaller payments, graduating to larger payments as the business grows and becomes successful. This can easily be negotiated with a seller.** **Buying a business is a complex and highly emotional transaction. To make the best decision and achieve the most favorable terms, be aware of your emotions at all times, as they reveal why you\'re passionate about a particular business. And don\'t forget to bounce your thoughts and feelings off your attorney, CPA, and other advisors.** The three components of a successful business are location, product/service, and management.  As a prospective buyer, you have a vision of being your own boss and calling your own shots.  People go into business for various reasons, including but not limited to, financial independence, job security, control of destiny, investments, tax advantage, lack of suitable job opportunities, and freedom.  It is important to find a business you like and with which you feel comfortable. The process of buying a business is as follows: - Evaluate the basic information on alternative businesses that sound interesting to you.  In addition to profitability, be sure to buy a business you like and would enjoy.  Look at the proximity to you and how far you are willing to travel each day.  Also, consider the longevity of the employees and their likelihood of remaining. - Request a marketing packet from the business broker.  This will give the basic information about the business, including a cash flow statement for the previous three years.  From this information, you can determine if you wish to take the next step. - Schedule an appointment through a business broker to meet with the seller, asking from general to probing questions on anything and everything, except actual price negotiations.  Offers are only in writing, after which negotiations may take place.  Make a list of questions before the meeting so you won't forget to ask anything.  This will enable you to see if it is a fit for you and improvements you think would be needed.  Do your evaluation, based on the information provided to you by the seller and business broker.  Other advisors with whom you may wish to consult are attorneys and accountants.  This would be a good time to prepare a business plan using the information from the seller to project the next three to five years.  The most successful businesses have good plans. - Make a written offer through the business broker, assuming all of the information you have been provided is correct, but include contingencies, which allow you to confirm such information.  If the seller is willing to finance the purchase, the terms will be included in the offer.  If outside financing is needed, the business broker can direct you to sources; and a contingency to receive financing by a certain date will be included in the offer.  That contingency will void the offer if the financing is not received by the specified date. - Once a sales price is agreed upon, make a closer investigation of the business through due diligence, confirming to your satisfaction the validity of your offer. No information should be withheld from you at this point.  Look for red flags in cash flow and any hidden problems. - For closing, it is usually advantageous to both the seller and buyer to have documents prepared by an escrow attorney, based upon the agreement signed by the buyer and seller.  Both parties may then have the documents reviewed by their own attorneys, if they desire.  You will decide on your legal entity before closing.  Your business broker can guide you through the entire process. - Close the transaction and begin your first day as the owner of your own business.  You walk into an ongoing business and start making money immediately.  You and the seller meet with the employees at the business to explain the sale and to assure them their jobs will remain the same.  The sale is not disclosed to the employees, customers, or anyone until after closing to prevent inaccurate information from getting out that could hurt the business.  As part of the purchase agreement, the seller will work with you and train you for a determined amount of time and assist in an orderly transition.  You are part of the American dream.  You and your family own your own business! - After closing, the seller will give you the keys to everything.  You must also notify your suppliers of the change of ownership and transfer all licenses and permits, as well as open a bank account, if you have not done so before closing. ESTABLISHING A PURCHASE PRICE **What Is the Purchase Price?** ------------------------------- The purchase price is the price an investor pays for an investment, and the price becomes the investor's [cost basis](https://www.investopedia.com/terms/c/costbasis.asp) for calculating gain or loss when selling the investment. The purchase price includes any [commission](https://www.investopedia.com/terms/c/commission.asp) or sales charges paid for the investment, and the weighted average cost is used for multiple purchases of the same security. **Understanding Purchase Price** -------------------------------- Assume, for example, an investor buys 100 shares of Ford common stock on three different dates over a five-year period, including 100 shares purchased at a market price of \$40, \$60 and \$80 per share. To determine the cost basis of the purchases, the investor needs to calculate the weighted average cost, which is the total dollar amount of the purchases divided by the number of shares purchased. At 100 shares each, the dollar amounts of Ford stock purchases are \$4,000, \$6,000 and \$8,000, or a total of \$18,000, and the purchase total is divided by 300 shares to equal \$60 per share. If the investor adds to the stock position, he or she can calculate a new weighted average price by adding the dollar amount of the new purchases and the additional shares to the calculation. The formula can also be adjusted for stock sales if the investor only sells a portion of the holdings. With commission costs added, the investor's weighted average cost might approximate \$62 per share. Franchises are widely regarded as a safer way to enter the business world than going it alone. The problem is that a seemingly unending number of franchise opportunities are available in new and currently operating businesses. Picking a franchise that fits your skills, experience, interest and preference is importance since you will be operating the store until you sell it or it fails. You need to consider several important items before finalizing any franchise purchase agreement. **Evaluating a New Franchise** 1. Inventory your personal skills, experiences and interests. While you certainly do not need to have direct experience in the industry of the franchise you choose, it will make the job of learning and growing in the business much easier. You will also have a better understanding as to the day-to-day job if you have experience, although the job of an owner in the business will be much more comprehensive than your previous experience. 2. Research the category of business you are most interested in for franchise opportunities. The franchises with the most common small business default rates are readily available on the Internet. While failure statistics shouldn\'t be your biggest concern, it could indicate that more research is necessary. 3. Evaluate your finances. Franchises range in price. A service franchise can cost as little as a few hundred dollars while a restaurant can require liquid capital of more than \$100,000 and net worth of much more. Examine your liquidity and your borrowing power. Discuss your specifics with a lender who specializes in small business loans. 4. Seek references of existing franchisees in an area well out of your potential territory. Meet with him and get an insider\'s view of the opportunity. Come prepared with lots of questions and ensure that he does not think you will be competing with him so you can get more accurate answers. 5. Survey people in the area you are considering to determine whether your franchise will be in demand. Visit potential clients to discuss specific needs. Contact the local chamber of commerce to discuss similar inquiries and competition. **Evaluating an Existing Franchise** ------------------------------------ 1. Follow the applicable steps for selecting a new franchise to determine whether the existing opportunity is suited for your skills and experiences. -------------------------------------------------------------------------------------------------------------------------------------------------- 2. View the proposed franchise several times while it is operating, if possible. Look for traffic patterns and general trends in the operation of the business. Evaluate a \"typical day\" in the business. -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- 3. Contact the owner or listing agent. Sign the often-required confidentiality disclosure. Request three years of financial records including a sales history, balance sheet and profit and loss statement. Look for trends as to increased debt, declining sales or other reasons why the franchisee is selling the business. --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- 4. Contact the Better Business Bureau as well as the business references of the franchise. Informally discuss the business with business leaders and potential clients in the town to get a feel for its local reputation, if allowed by your agreement. Evaluate its history of community service and community involvement. -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- 5. Discuss the asking price with a lender specializing in small business loans. Her view of the business after examining its financial data will help you determine the asking price. ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- **The Franchise Agreement** You\'ve just finished attending Discovery Day and you like what you\'ve witnessed in this final installment of the franchise courting process. You\'ve decided this is the franchise for you. You sit down with the franchisor at the end of the day and he brings the franchise agreement to the table. There are a few things you should know. The franchise agreement is essentially a legal document between the franchisor and you (the franchisee). It is a legal binding agreement. It explains in detail what the franchisor expects from you, as a franchisee, in the way you operate every facet of the business. There is no standard form of franchise agreement because the terms, conditions, and the methods of operations of various franchises vary widely depending on the type of business. Every franchisee is required to sign the franchise agreement, and the franchisor will also sign the document. A word of caution, a franchise agreement is a binding legal document and you may want to have a franchise attorney review it on your behalf prior to signing. Now, more about what you will find in the pages of the franchise agreement. Here are 10 fundamental provisions outlined in some form or fashion in every franchise agreement: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. The franchise agreement will go into detail to explain more about the franchisee/franchisor relationship. It will include detailed information regarding proprietary statements and outline things like site maintenance and upgrade requirements.