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