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How Much Risk Are You Taking in Buying a Business?

Any seasoned business buyer will tell you that buying a business
can be very risky. The word, “risk” is most often quantified
monetarily in business purchase terms, however, before you
start your business purchase program you need to calculate ALL
your risks associated with buying a business.

Many business buyers unfortunately pay a heavy price for not
investing in appropriate business acquisition expertise and
counsel after they’ve bought a business. They clearing bought
the wrong business or the right business for the wrong purchase
terms and now they end up paying dearly financially and
personally. Some business buyers, without adequate contingency
funds, loose the business altogether!

Financial Risks and NON-Financial Risks to Buying a Business

Whether you are a veteran business buyer or someone who
purchases a company once in a lifetime, you need to take the
time upfront to think about what really is at stake in any
contemplated business purchase. It is most enlightening for
business buyers to evaluate an acquisition from a financial and
a non-financial perspective. Let’s take a deeper look at these
business buying risk elements:

Financial Risk Elements:

* The $ you personally invest in the business purchase

* The “$ finder’s fees” you pay to locate the business

* The seller’s $ business brokerage fee you indirectly pay

* The lost $ income while you are searching and evaluating a
business to buy

* The $ acquisition counsel fees paid, (CPA, Attorney, Market
research, Consultants)

* The $ cost of personal guarantees for acquisition debt and
asset leases

* The $ interest on acquisition debt

* The $ you overpaid for the business, (determined long after
closing)

* The capital needed post purchase for “business surprises”

NON-Financial Risk Elements:

* Your time away from other things important to you

* Your stress levels, negative health consequences

* Your additional marriage stress

* Your self confidence/ esteem damage

* Your reputation

* Your personal credit rating

* Your future employment prospects

Obviously it is much easier to put a monetary value on the
financial risk elements than the non-financial. For that
matter, putting a monetary value on your personal risk elements
may not be appropriate for this analysis. However, it may be
insightful to put some numbers next to the financial risk items
listed above to give you a better feel of what really is at
stake.

Concepts to Consider to Reduce Your Own “Business Buyer Risk”

There are many noteworthy tactics you can consider and implement
to reduce your risk levels in buying a business. Some of these
concepts listed below may warrant further consideration:

A 3rd party business appraisal that comes in significantly below
the seller’s asking price should be leveraged in any way
possible to reduce the company purchase price, buyer down
payment levels, seller financing interest, buyer debt payment
time frames … whatever you can RE-negotiate!

Do what you can to eliminate personal guarantee’s. This is best
accomplished within the business purchase terms. The business
buyer will undoubtedly appreciate this concept if the business
has to close its doors later.

If you hire the “right” business acquisition advisor you can
eliminate over half of your common business acquisition “sunk
costs”, even legal and accounting fees!

If you can utilize low or no cost means to find viable
businesses for sale that do not include a seller intermediary
cost augmentation to the purchase price, you can save thousands
of dollars and/ or significantly expand the seller’s ability to
negotiate.

If you can maintain your current source of income AND search,
qualify and negotiate a business purchase you can realize
substantial financial risk reduction.

If possible, structure acquisition advisor compensation formats
based on actual first year, post closing business results. This
concept will intensify advisor involvement and almost guarantee
continued support during the most challenging first months of
ownership.

Make a conscious effort not to try to do everything yourself.
Allocate funds to utilize high value expertise and reduce the
time required to either finalize or kill the deal.

Lastly, and probably most important, if you are heavily
leveraging personal assets and you are married, communicate all
the risks and all potential positive and negative consequences
of buying a business to your spouse. The personal risks of
buying a business are truly the most important!

This article is not intended to demotivate business buyers but
to give them another viable perspective about business merger
and acquisition risk and reward relationships before limited
human and financial resources are further invested in a pending
business purchase. As you can see, the risk of buying a
business starts at the moment you invest any of your time to
pursue a business.

If you correctly purchase a profitable business or obtain “a
deal” on an undervalued viable business, you should expect your
company’s annual profits and your owner’s compensation to total
at least 5% of total net revenues. Remember, best of all, that
your personal net worth will increase as you retain your
business profits, consistently pay off debt while your
company’s market value increases over time … this is the
“reward” part of the risk / reward perspective!

Develop a Business Purchase Plan!

Businesses are bought and sold everyday. Each transaction is
unique, yet there are fundamental elements to the purchase
process that are common. The purpose of this article is to
highlight the sequential components of a typical business
purchase plan. Whether you are a first time business buyer, or
a veteran business acquisition specialist, it is imperative to
understand the evolution and eventual structure of a business
purchase transaction.

Purchasing a business is an iterative process. There are logical
and cost effective steps that need to sequentially followed to
maximize eventual purchase success and minimize cost. For the
business buyer the ultimate goal is to find and purchase a
viable business for a fair market price, acquired via most
favorable purchase terms. Following these sequential steps will
get you there:

1) DEVELOP YOUR PURCHASE CRITERIA:

Define all relevant criteria to qualify a business for purchase

2) ESTABLISH YOUR “BUYING TEAM”:

A variety of skill sets and expertise will be needed to cost
effectively locate, evaluate, structure, valuate, fund and
negotiate an equitable purchase agreement

3) DOCUMENT YOUR PROFESSIONAL “CREDITABILITY”:

Providing a written summary of your professional skills,
experiences and successes of your entire buying team will
fortify your image with any business seller you approach

4) FINALIZE AND DOCUMENT YOUR FINANCIAL RESOURCES:

Every business seller will want to quickly qualify your
financial wherewithal early on in the mutual evaluation
process. Secure your finances and document your capabilities.

5) EDUCATE YOURSELF ON BUSINESS PURCHASE TERMS AND CONDITIONS:

Take the time prior to your first business pursuit to educate
yourself on as many common business purchase terms and
conditions as possible. Understanding your purchase deal
structure alternatives will maximize your negotiation
effectiveness.

6) DEVELOP A COST EFFECTIVE MEANS TO LOCATE VIABLE BUSINESSES
FOR SALE:

Decide if you are only going after businesses that are “for
sale” or those that can be bought. Establish a variety of means
to define these businesses.

7) UTILIZE NON-BINDING LETTERS OF INTENT:

If you find a viable business you like, document your
intentions, intended deal structure and what exact information
you need to start your purchase due diligence.

8) EFFECTIVELY ANALYZE ALL DOCUMENTATION PROVIDED BY THE SELLER:

Analyze all financial and non-financial documentation provided
as a response to your Letter of Intent. For subjects that are
beyond your level of expertise, acquire appropriate
professional assistance.

9) IMPLEMENT A STRUCTURED DUE DILIGENCE PROGRAM:

Validate provided information, research appropriate target
markets, gather data on key customers, employees, patents,
legal encumbrances, leases, purchase contracts, pending
legislation, key suppliers and technology trends.

10) UTILIZE PROFESSIONAL, 3RD PARTY BUSINESS VALUATION SERVICES:

Contract with a certified business valuation consultant to
define a fair market value, and equitable purchase term
structure for the business you seek to buy.

11) INVESTIGATE ALTERNATIVE FINANCING ALTERNATIVES:

Based on a valid business value determination, seek and define
as many ways you can to purchase a controlling interest of the
business with as much of other people’s money as is reasonable.

12) PRESENT YOUR FINDINGS TO THE SELLER AND NEGOTIATE A DEAL:

After your due diligence is completed, document your key
findings, organize your information and present your case to
the business seller. Hire a credible 3rd party negotiator or do
it yourself.

13) DOCUMENT THE AGREED UPON PURCHASE TERMS AND CONDITIONS, SET
A DATE:

Put everything agreed to in writing. Finalize the purchase
agreement, have your legal counsel review it. Both buyer and
seller sign a Letter of Intent, committing both to the agreed
upon purchase terms and to set a date and time to close the
deal.

14) SIGNATURE OF FINAL PURCHASE DOCUMENTS:

If the deal is an equitable one and both parties have conducted
themselves in a constructive and honest manner, this should be
a “joyous” occasion for both parties and their representatives.

Today’s successful business buyer is a disciplined person using
a definitive process to find, qualify, value and negotiate for
purchase viable business acquisitions. If a business buyer has
a written purchase plan, any number of other supportive people
can effectively participate, understand their role and
contribute to the buyer’s overall business purchase process and
objectives.

If you understand the fundamental steps involved in a typical
business purchase process you are well on your way to being
able to effectively write a plan you can use to meet your
personal business acquisition goals.

Key Steps to a Sound Business Purchase Structure

If you have just decided to start the process of buying your
first company or if you are a seasoned mergers and acquisitions
professional, you as a business buyer, need to utilize a
disciplined, structured approach to purchase the best business
acquisition possible. This article will give you a shortcut to
incorporating most of the elements you must have to
systematically qualify and “bias” the business purchase
negotiations in your favor with the business seller.

Buying a business is a “one off”, iterative process in that each
purchase opportunity is unique and different with regard to its
sense of urgency from the seller’s perspective. However, as
each purchase situation is different, if you do many business
acquisitions over time you quickly see that there are
fundamental elements to the location, qualification and
negotiation processes of buying a business, that once learned,
can be leveraged repeatedly from one business purchase
opportunity to another.

Four Steps to Business Valuation and Purchase/ Sale Analysis

With the intent to be brief yet adequately cover all the
important elements of the business appraisal and deal structure
steps of buying a business, we will only focus on these
elements within the typical business purchase process:

1) Company Analysis Steps:

Review all information obtained from the seller as solicited
in the buyer’s Letter of Intent or “LOI”:
All financials, leases, insurance policies, tax returns,
contracts, environmental reports, legal documents,
retirement programs, inventory counts, patents, licenses,
policies, customer lists

Adjust historical financial statements provided by the seller
to represent profits that reflect actual business
performance and exhibit correct asset and liability values

Compare adjusted financials to key, like industry,
performance metrics

Evaluate all non-financial elements of the company Customer
sales mix, customer retention rates, customer locations,
employee counts and performance metrics, landlord contracts
and lease provisions, bank/financing relationships, key
suppliers and critical product or service content and
warranty issues…to name a few

Prepare a “zero-based” budget for the next 3 financial terms,
including anticipated monthly cash flows for the business
including acquisition debt service requirements

2) Business Valuation Steps:

Calculate an asset based approach to business value
determination

Calculate a profit based approach to business value
determination: This will require use of capitalization and a
wide variety of Discount rate elements based on: Projected
real returns with inflation assumptions Industry growth
factors and risk influences Management additions or
deletions and compensation changes A wide variety of non-
financial factors and assumptions

Calculate a cost to replace company assets approach to
business value Determination

Weight each of the business valuation methods for relevancy
based on historical business performance, future performance
assumptions, various non-financial aspects of the business,
the anticipated final terms of business purchase, the
financial and human resources that will be available to take
the company where you want it to go

3) Business Purchase and Sale Analysis:

Select specific assets and liabilities to be purchased

Identify a $ allocation to each asset and liability you
select

Analyze various means to purchase current debt obligations,
consider seller contingencies

Rank each means to purchase current debt obligations and
select the best for your constraints

“Run the numbers”: put together a monthly and annual post
sale cash flow analysis for both the business buyer and the
seller. Emphasize positive cash flows for eventual seller
presentation.

Test your proforma financials for possible seller “numerical
exaggerations” or mistakes

4) Communicate Findings and Analysis to Seller:

Your primary objective is to justify your desired company
purchase terms in a professional manner, to maximize your
credibility and foster constructive dialog with the seller

All findings and analysis should be proof read before
presented to the seller

All documentation should be organized in a professional,
somewhat formal Format

The information should be introduced as a “starting point”, a
basis of further discussion

Your data should include numeric analysis responses to
anticipated seller Positions

Consideration should be made to have a professional, “non-
buyer” present the findings

All documentation should be also used for future lender, key
supplier, landlord and employee presentations.

Each presentation customized or fortified for the targeted
audience.

(This step is where all your purchase “weapons”
are shown, but not necessarily used)

Purchasing a viable business can be a complex and emotional
experience for both the business buyer and the seller. The
business seller often has much of their life and money wrapped
up in the enterprise and is looking for the long awaited “pay
day”, while the buyer typically has an intense “opportunistic”
disposition fueled by a “seek and conquer” methodology.

The more a business buyer can take the emotion out of the
purchase negotiation with effective development and
professional presentation of key financial and non-financial
justification content, the greater his probability of reaching
HIS desired business purchase terms with the business seller.
The business analysis and valuation steps in the business
buying process are key components to reaching this ultimate
objective.