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