| A Small Business Is Bought and SoldIS THERE A | | | | the business in the meantime, and becoming familiar |
| SMALL-BUSINESS OWNER who has never considered | | | | with the details of the business operation.Compliance |
| selling his business? Probably not. Is there an individual | | | | With the Bulk Sale ActMost States require the seller |
| with some money, talent, or an urge for | | | | of a business to furnish a sworn list of his creditors |
| independence (often only the last) who hasn't | | | | to the buyer and the buyer to give notice to the |
| thought about owning his own business?The number | | | | creditors of the pending sale. The purpose of such a |
| of small businesses actually bought and sold, | | | | "bulk sale" act is to make certain that the seller |
| however, represents only a small fraction of those | | | | doesn't sell out his stock in trade and fixtures, pocket |
| who have felt these urges. To many people, the | | | | the proceeds, and disappear, leaving his creditors |
| desire to buy or sell is only a passing thought. Others | | | | unpaid. Compliance with the statute gives creditors an |
| find various ways to solve their problems or satisfy | | | | opportunity to impound the proceeds of the sale if |
| their ambitions. But sometimes an individual doesn't | | | | they think it necessary.Noncompliance or inadequate |
| follow through because he finds the prospect of | | | | compliance may result in attachment of the property |
| buying or selling a business too baffling.The Flow of | | | | after the sale by creditors of the seller and voiding |
| Decisions in a Buy-Sell TransactionBUYERS AND | | | | of the buy-sell transaction. The buyer should not |
| SELLERS both seek answers to the same question: | | | | close the transaction until he has made sure that all |
| "What is this business worth?" Most people see the | | | | statutory requirements have been met.Financing the |
| worth of a business as the total value of equipment | | | | Buy-Sell TransactionIn general, the buyer has two |
| and fixtures, inventory, and buildings and land. | | | | options regarding the financing of the business. The |
| Important, certainly, but the sum of these values | | | | first basic method of financing is person investment |
| does not equal the value of the business.For both | | | | of the future owner or owners of the business. The |
| buyer and seller finding the answer to this question is | | | | buyer may pay cash for the business out of personal |
| the most difficult and at the same time the most | | | | resources, establish a partnership, or sell stock. These |
| important step in the buy-sell process. But this final | | | | forms of financing are commonly referred to as the |
| decision reflects many other decisions made while the | | | | use of equity or investment capital.The other basic |
| transaction is being considered. In other words, the | | | | form of financing is through borrowing or the |
| buy-sell process is a flow of decisions. It would be | | | | establishment of credit. This method of financing may |
| impossible to point out every decision that must be | | | | or may not require the payment of interest, but it |
| made, but the basic ones are as follows:- Motivation: | | | | does require the borrower to repay the principal, |
| a decision to attempt the sale or purchase of a | | | | usually over a stipulated period of time or on a |
| business. | | | | specific date. This method of financing is commonly |
| - Contact: a decision on how to find a buyer (or | | | | referred to as the use of debt capital. Often the |
| seller) for a business with specified characteristics. | | | | purchase is made through a combination of equity |
| - Information: a decision on what information must | | | | and debt capital.Equity capital. In the simplest form of |
| be gathered or given to buy or sell a business. | | | | purchase, the buyer pays the full purchase price in |
| - Sources: a decision on how, where, and at what | | | | cash. The buyer's investment in the business, at least |
| cost the needed information can be obtained. | | | | initially, is full and complete. Whether the funds come |
| - Analysis: a decision on the meaning, importance, | | | | from one person or more than one, the financial |
| and reliability of the information gathered. | | | | nature of the transaction does not change.The |
| - Value: a decision on what the business is worth. | | | | sources of equity capital are many and varied. |
| Price: a decision on how much money to take or give | | | | Generally, they are in the form of bank savings. Or |
| for the business. | | | | cash may be obtained from liquidating certain assets |
| - Financing: a decision on how to pay or receive the | | | | the buyer may own, such as surrendering life |
| purchase price. | | | | insurance policies for cash value or selling real estate, |
| - Contract: a decision on the form and content of | | | | stocks and bonds, or other assets.Before disposing |
| the contractual relation. | | | | of assets, however, the buyer should ask himself this |
| - Implementation: a decision on how and when to | | | | question: "Do I want to buy the business more than I |
| effect transfer of ownership.How important is | | | | want to keep these assets, considering both present |
| management ability in this business?Occasionally, a | | | | and future values?" For instance, if the buyer cases |
| business that is unique and very simple almost | | | | $16,000 worth of government bonds, there may be |
| manages itself. But if the business is in a competitive | | | | a possibility of his making a higher profit, but the risk |
| field, management ability is probably the most | | | | of losing his investment entirely will be greater. He |
| important requirement for success.Does the | | | | should be as certain as possible that the expected |
| prospective owner have the ability to manage | | | | return is worth the risk.An equally important question |
| successfully?Effectiveness with people (customers | | | | is how much the buyer should invest in the business. |
| and employees), eagerness to tackle difficult | | | | In general, the more he invests himself, the better |
| problems and make decisions, and intelligence about | | | | chance he will have of borrowing at least part of the |
| general business operations are key ingredients in | | | | purchase price.A buyer may not have the capital, |
| management ability.Can he/she learn how to manage | | | | however, nor perhaps the inclination, to purchase the |
| this business?Most people can learn to manage if | | | | business outright with his own personal funds. How |
| they recognize the need. This requires room to make | | | | far he goes in this respect depends on his own cash |
| mistakes, however, and the self-discipline to | | | | resources, his confidence in the business, and his |
| undertake self-improvement programs.ValueA | | | | ability to borrow money or establish credit with |
| business has a purpose. That purpose is to provide a | | | | others.Debt capital. In most cases, the buyer of a |
| satisfactory return on the owner's investment. | | | | small business will have to borrow money or establish |
| Consequently, determining value involves measuring | | | | credit to purchase the business. Several factors will |
| the future profit of the business being sold.A seller | | | | affect the use of debt capital for this purpose: the |
| often thinks of value as representing the money he | | | | source of capital, the amount that can be borrowed, |
| has invested through his years of ownership. A buyer | | | | and the length of time for which the capital can be |
| is tempted to consider value as a fair price for | | | | borrowed.Commercial lending institutions are the |
| tangible items such as equipment and inventory. | | | | sources to which the buyer will probably turn first. |
| These factors are important, but they have value | | | | The availability of financing through these sources |
| only to the extent that they contribute to future | | | | depends on the security that can be pledged to the |
| profits. An owner may have invested $40,000, the | | | | loan, the profit potential of the business, the |
| tangible assets may have a current worth of | | | | prospect of repayment of principal and interest, and |
| $20,000, but it is the profit potential that establishes | | | | the general availability of credit.One of the major |
| the value of the total business.Assuming that a | | | | difficulties facing the buyer at this point concerns the |
| reliable estimate of future profit is made, how much | | | | collateral that can be pledged as security. The |
| is to be paid for each dollar of profit potential?What | | | | physical assets of the business--particularly fixtures, |
| am I buying (or selling)? Is it a business or a building | | | | equipment, and land and buildings--will not be available |
| full of equipment and inventory?What return would I | | | | for security unless they are free of other financial |
| get if I invested my money elsewhere--in stocks, | | | | obligations. The buyer may be forced to look to his |
| bonds, or other business opportunities?What return | | | | own personal assets, such as cash value of life |
| should I get from an investment in this | | | | insurance, stocks and bonds, mortgages on real |
| business?PriceIt might seem that the price to be paid | | | | property, and so on.Less formal sources of debt |
| or received for a business would simply be equal to | | | | capital may be open to the buyer, such as loans from |
| the value. However, value refers to what a business | | | | friends, relatives, business associates, and the like. |
| is worth; price refers to the amount of money for | | | | Many small businesses have been financed through |
| which ownership is transferred. There is usually a | | | | such means.The seller as lender. A common source of |
| difference between price and value because the | | | | debt capital is that supplied by the seller when he lets |
| buyer and seller differ as to how much the business | | | | the buyer pay for the business over time. Why |
| is worth. The price will represent negotiation and | | | | should the seller finance the buyer? Probably because |
| compromise.Here are two suggestions for fruitful | | | | the desire to sell is strong enough so that the seller is |
| negotiation:- Discussion between buyer and seller | | | | willing to assume part of the risk.As in financing from |
| should focus on the future profit performance of the | | | | other sources, the seller usually demands that the |
| firm. Since expected profit is basic to determining | | | | buyer pay interest on the amount being financed and |
| value, it can be a valuable point for negotiation. | | | | repay the principal and interest at stipulated periods. |
| - Every profit projection includes some assumptions | | | | The seller usually establishes his security on the more |
| and risks. Generally, the less firmly based the | | | | certain assets, such as fixtures and equipment. |
| assumption and the more apparent the risk, the less | | | | However, he may also assume the inventory as |
| value an expected profit can support. Consequently, | | | | acceptable security without placing it in a bonded |
| identifying and analyzing risks involved in future | | | | warehouse.The seller's philosophy toward financing |
| operations can make discussions between buyer and | | | | the buyer seems to be that if the buyer should fail, |
| seller more significant.These two points will help bring | | | | the seller can take back the business. The major |
| negotiations about value toward a mutually | | | | problem in this form of financing is that it is harder |
| acceptable price.Sources of Financial InformationBOTH | | | | for the buyer to get additional financing from other |
| BUYER AND SELLER are interested in financial | | | | sources when the seller has first claim on the assets |
| information, affecting the buy-sell transaction. | | | | of the business.How much to borrow. As the first |
| However, since the seller already has this information, | | | | step toward financing the purchase of a business, the |
| it is a major requirement for the buyer to get and | | | | buyer has to find answers to two questions:1) How |
| make use of as much of it as possible.The buyer can | | | | much do I need to borrow?" |
| usually find financial information in the following places: | | | | 2) "How much can I afford to borrow?"The answer |
| (1) financial statements, (2) income-tax returns, (3) | | | | to the first question depends partly on how much |
| other internal records, and (4) other external | | | | money the buyer has and how much he is willing to |
| sources.Financial StatementsThe results of the | | | | invest in the business himself. The less equity capital |
| financial transactions of every company should be | | | | he has, the more debt capital he needs.How much he |
| reflected in its periodic financial statements. These | | | | can afford to borrow depends on his ability to keep |
| statements are extremely important in buying or | | | | up principal and interest payments. If a buyer |
| selling a small business. They were prepared for the | | | | borrows from a number of sources, he may find |
| seller, of course, and their contents are available to | | | | himself committed to a repayment schedule that the |
| him. But the buyer, too, should be aware during the | | | | profits from the business will not support. His |
| early stages of a buy-sell transaction of the | | | | borrowing plans should be related to the projected |
| information contained in financial statements.Balance | | | | income statement prepared during his study of the |
| sheet and income statement. The balance sheet is a | | | | business under consideration.Operating capital. In |
| statement of the financial position of the business at | | | | addition to funds for purchasing the business, the |
| a given moment in time. The income statement is a | | | | buyer must have enough working capital to cover |
| summary of the revenue and expenses of the | | | | the cost of operation until the business itself |
| business during a specified period of time. These | | | | produces enough cash. In other words, the buyer |
| financial statements show only the past results of | | | | must think in terms of cash requirements and cash |
| the company's transactions. The results of future | | | | flow for weeks and months ahead. A common |
| operations may or may not be similar.Balance sheets | | | | mistake in buying a business is failure to provide |
| and income statements in themselves contain | | | | adequate working capital.If sales and business costs |
| important information, but they are most useful | | | | after purchase of the business are expected to |
| when a professional accountant makes a detailed | | | | follow the pattern of the immediate past, the need |
| analysis of them. A complete analysis includes a | | | | for short term working capital should not be hard to |
| review of the manner in which the statements were | | | | estimate.Putting a Value on GoodwillGoodwill, when it |
| prepared, and perhaps also a review of the records | | | | exists, is a valuable asset. It may result from a good |
| and control features of the accounting system. This | | | | reputation, a convenient location, efficient and |
| is especially important in a small business buy-sell | | | | courteous treatment of customers, or other causes. |
| transaction because the financial statements of | | | | However, because it is intangible and difficult to |
| smaller companies are not usually as professionally | | | | measure, goodwill is sometimes recorded when it |
| prepared as the statements for larger | | | | does not exist.From the accountants' standpoint, |
| companies.Audited statements. In many buy-sell | | | | goodwill should be recorded only when it is purchased. |
| transactions, the statements are supplied by the | | | | It should not be recorded otherwise, they believe, |
| seller, but the buyer reserves the right to conduct an | | | | because of the difficulty of placing a fair value on |
| audit of the seller's records. Or the buyer insists that | | | | it.As a practical matter, above-average earnings are |
| the seller "warrant" his financial statements. Warranty | | | | normally considered the best evidence of the |
| of financial statements by the seller should be | | | | existence of goodwill, and the value placed on the |
| accepted with caution, however, because there does | | | | goodwill at the time of its sale is often determined |
| not seem to be any uniform definition of the term | | | | by capitalizing these extra earnings. Take, for |
| warranty.If the seller's financial statements are | | | | example, a business in a field in which the normal |
| prepared by an independent accountant, the | | | | return on investment is 10 percent. Suppose the |
| statements should show whether they were (1) | | | | business has a capital investment of $200,000 and an |
| prepared after an audit of the seller's accounts, or | | | | annual return of about $24,000. The average return |
| (2) prepared from the seller's records without | | | | on $200,000 for this type of business would be |
| verification by audit. If they were prepared without | | | | $20,000 a year. Therefore, the business has |
| verification by audit, they may be quite similar or | | | | above-average earnings of $4,000 yearly.Capitalizing |
| even identical to statements that would have been | | | | these above-average earnings at 10 percent ($4,000 |
| prepared by the seller's own bookkeeper. If they | | | | div. by .10) gives $40,000 as the investment needed |
| were prepared after an audit, they should include a | | | | to earn the $4,000. Therefore $40,000 may be |
| statement of the accountant's opinion.Financial | | | | taken as the value of the goodwill of this firm.Many |
| statements prepared without such an audit may or | | | | people feel that unless a business has above-average |
| may not reflect the financial position or results of | | | | earnings, it does not have goodwill. Thus, a business |
| operation of the company. Most small companies do | | | | might appear to have an excellent location, |
| not have their records audited annually, but without | | | | enlightened customer policies, and a superb product; |
| an audit it is impossible to tell how accurate the | | | | yet this business will not have goodwill attaching to it |
| statements really are.Another point the buyer should | | | | unless its earnings exceed the normal earnings for |
| consider is the cutoff period for the financial | | | | that type of business.The measurement of goodwill |
| statements. The statements may have been cut off | | | | has many pitfalls. To begin with, a decision must be |
| during the low period of the sales cycle or during the | | | | made as to what normal earnings are. (Industry |
| high period. This has some bearing on the financial | | | | averages will probably be available, but average |
| position reflected in the statements.Risk and Return | | | | earnings for the industry aren't necessarily normal |
| on InvestmentIf a buyer wants to invest money in a | | | | earnings.) And once this decision has been made, the |
| business that is being sold, he should be concerned | | | | percent at which the above-normal earnings will be |
| about receiving a fair return on his investment. Many | | | | capitalized must be decided. In the example given, 10 |
| businesses can make a profit for a short time (1 to 5 | | | | percent was used. This means that the buyer should |
| years); not so many operate profitably over a longer | | | | recover his investment in 10 years. If he wants to |
| period of time.From the buyer's point of view, what | | | | recover his investment more quickly, he will want to |
| is a fair rate of return from an investment in a small | | | | use a higher percent, which will give a lower |
| business? The rate of return is usually related to the | | | | capitalized value. If he is willing to wait longer, he will |
| risk factor--the higher the risk, the higher the return | | | | accept a lower percent, which will raise the capitalized |
| should be. United States Government bonds are the | | | | value.Goodwill is simply a bookkeeping device to |
| safest investment--the rate of return ranges from | | | | represent the value of one part of a business when |
| 5-1/2 to 6 percent. Blue-chip stocks and corporate | | | | that business is valued as a whole. In most cases, |
| bonds usually give the investor a return of 4 to 10 | | | | the total value of the business is decided without a |
| percent if both dividends or interest and increase in | | | | detailed calculation of the goodwill figure--in many |
| market value are considered. Speculative stocks may | | | | cases, without even detailed consideration of the |
| have a higher return, but they also have a higher risk | | | | value of the other assets.In the ensuing chapters, we |
| factor.The buyer of a small business should try to | | | | will develop an in-dept strategy to find, value and |
| determine the risk factor of the new business, | | | | acquire a business using as little of our cash as |
| though this is difficult at best and in many cases | | | | possible. This is not a book that you read and put |
| impossible. In attempting to assess the risk factor, | | | | down. This is a workbook, a work-in-progress type |
| the buyer should project the profits of the business | | | | manual. We recommend that the reader takes action |
| as far into the future as possible. He should ask | | | | as he/she goes through the information enclosed. |
| himself how high the risk should be normally and look | | | | That is the only way to successfully become a small |
| for conditions that would be likely to affect the sales | | | | business owner. And by duplicating your efforts, you |
| and profit-making capability of the business.Financing | | | | can repeat the process outlined in this book to build a |
| and Implementing the TransactionTHE BUYER AND | | | | small empire.Rudy LeCorps and his wife are the |
| SELLER have a number of important matters to | | | | owners of various businesses, including a Car Rental |
| attend to before the transaction can be closed. The | | | | Franchise and a Publishing company. He also works |
| seller will be thinking about instruments of transfer | | | | full-time for a large Wall Street Investment Bank.On |
| that must be delivered at the closing, about | | | | the entrepreneurial front, his main focus is small |
| compliance with the bulk sale act, and possibly about | | | | business productivity. RGL Publishing, the publishing |
| making financial arrangements if the buyer can't raise | | | | company he founded, is a publisher and distributor of |
| the purchase price. The buyer's attention will be | | | | books, eBooks and application software, whose |
| focused on financing arrangements, organizing his | | | | purpose is to help increase small business |
| business-to-be, overseeing the seller's operation of | | | | productivity, efficiency and success. |