Buying a
Buisness: Tips on Buying a Small Buisness
Basics
of Buying a Going Business
Sometimes the best way to become the owner of a business is to buy a
going concern. If you are considering this option, most of the factors
already discussed should be considered plus these additional points.
Advantages
Certain advantages may be gained by purchasing a going business.
- You may be able to buy the business at a bargain price, if, for
personal reasons, an owner is sufficiently eager to sell.
- Buying a business as it stands will save time and effort in
equipping and stocking it.
- You gain customers accustomed to trading with the establishment.
- Key personnel with customer following may be willing to stay.
- The "good will' created by the previous owner may be a valuable
asset.
Disadvantages
- You may pay too much for
the business because of your inaccurate appraisal or the former owner's
misrepresentation.
- If the owner had a bad
reputation you would inherit prejudices of former customers and,
perhaps, of merchandise and equipment suppliers.
- The location may be
going sour.
- Fixtures and equipment
may be outmoded or in bad condition. Check carefully.
- Too much of the
merchandise or materials on hand may be old or
poorly selected.
In deciding how much to pay for a going business, consider its profit
potential. Tangible assets such as equipment and inventory may be
important to you, but only to the extent that they contribute to future
profits. If the seller is asking a large sum for the intangible asset of
good will, estimate carefully how much - if anything - it will add to your
future profits. Also, determine and assess precisely the cost of any
liabilities you will be expected to assume. Get it in writing!
Profit Potential
You must be concerned with the future profitability of the business.
Most businesses have a natural cycle. Retail stores usually have a cycle
of one year. That is, each year follows the same pattern and several years
indicate a trend. Certain types of heavy manufacturing companies may have
up to a 7-year cycle. Try to estimate several (at least three) cycles.
Thus, in some businesses you will be estimating three to five years while
in another you may be estimating future sales and profits over a 25-year
period. Obviously your estimate for the next two years will be more
precise than your estimate for 25 years in the future. This doesn't mean
you should be careless in your long range planning. It does mean your long
range estimates will be more general and subject to change.
To estimate future profits, begin by analyzing the present owner's
balance sheets and profit and loss statements for at least 5 years back.
Going back 10 years would be even better. Many businesses have inadequate
or no records, but all should have copies of their income tax returns.
Sometimes even these are lacking or, more likely, very suspicious. Some
businesses have been known to prepare inaccurate tax returns. Insist on
seeing accurate records. If you are serious about purchasing a particular
business, consider making a deposit subject to receiving accurate business
records.
You want to look at many factors and ratios from this financial data.
What has been the rate of return on investment? Does it compare favorably
with the rate you can obtain from other investment opportunities? How does
it compare with averages for other businesses of the same kind? Have sales
over the years been increasing or decreasing?
What share of the market is the business obtaining within its market
area? To find out requires an analysis of the local market for the
particular firm in which you are interested. What is the competition in
the area, the population, the purchasing power? What are the trends? What
is the outlook for increasing sales?
Are the profits satisfactory? If not, what are the chances of
increasing them? Have profits been consistent over a period of years? If
the last year's profit was unusually high in comparison with previous
years, why was it? What is the profit trend? Have profits been increasing
consistently? Have they leveled off? Started to decrease? What are the
reasons for the profit trend, whatever it may be? Be sure such questions
are answered to your satisfaction before you buy.
Study the expense ratios. How does the percentage for each expense
classification compare with the average for the trade? The availability of
average operating ratios for certain trades has already been mentioned.
Comparison of the figures of the business offered for sale with standard
ratios will bring out any discrepancies. In discussing these discrepancies
with the seller you may become aware of operating problems which will help
in making up your mind how much to pay for the business, or whether to buy
it at all.
You need not necessarily be discouraged from buying the business if
past profit records are not favorable. Very often the reason the business
is for sale is because of recent poor earnings. Examination may reveal
that these have been brought about by poor management; and you may be
convinced that your management will improve the situation. By the same
token, an excellent past earnings' record, in itself, should not persuade
you to pay a large amount for the business without further investigation.
Ask the seller to prepare a projected statement of profit and loss for
the next 12 months. Such an estimate will probably be very optimistic and
should be compared with your own estimate. With a detailed estimate of the
next 12 months' operation, you can compute working-capital requirements
for each month. Next, estimate the value of assets and liabilities as of
the end of that period. Find the estimated return on investment by
dividing the projected net profit by the price asked for the business. If
you believe additional investment will be needed immediately to make the
business run profitably, add this to the price in your computations. The
highest price for the firm which brings you a return with which you are
satisfied is the maximum price you should pay for the business. Thus, an
estimate of future profitability will give you the basis of a logical
offer for the business.
If you are not familiar with accounting and income tax records so that
you may verify records of past operations and make a reasonable forecast
of future operations, have an experienced accountant or management
consultant work with you to help you understand the records and assist you
in your evaluation.
Tangible Assets
The most commonly purchased tangible assets are merchandise inventory,
equipment and fixtures, and supplies. If the business you plan to purchase
sells on credit you probably will take over accounts receivable.
What is the condition of the inventory you are purchasing? Is the stock
current, clean, well-balanced, in good condition? How much of it will have
to be disposed of at a loss or given away? Make a careful appraisal of the
stock. Each item should be separately priced and given a reasonable value.
If at all possible, the inventory should be "aged"; that is, the length of
time each group of items has been in stock over 18 months old,1 year to 18
months, 6 months to 1 year, and less than 6 months should be calculated.
Usually, the older the inventory, the less its value.
Examine equipment and fixtures carefully. Remember you are buying
second-hand furnishings with only a percentage of their original value. Be
sure equipment is in working order. Find out its age. Obtain evaluations
of similar equipment, new or second hand, from dealers. Not only should
you know how much equipment and fixtures have depreciated, but how
obsolete they may be. Office equipment may be in working order, but so
obsolete that to use it would be inefficient and costly. Also, it may be
difficult to obtain repair parts for old equipment in case of a breakdown.
Store fixtures quickly become out of date. New, modern fixtures attract
customers. Machines used in factories may have been superseded by far more
efficient equipment. To pay an exorbitant price for old machinery, no
matter how good its condition, is most unwise.
Make certain how much of the asking price is for furniture, fixtures
and equipment. The business may not warrant the investment which the owner
made. And, finally, find out if there is a mortgage on any of the fixtures
or equipment, or if they even have been completely paid for.
If you are taking over the assets such as accounts receivable, credit
records, sales records, mailing lists, or leases, investigate them
closely. Accounts receivable should be aged to determine how many of them
may be so old collection will be difficult or impossible. On the other
hand, records and contracts involving favorable leases have real value.
Make certain these are included in the sale.
Goodwill
Over and above the total appraisal of inventories, fixtures, equipment,
and other assets, there will usually be an amount asked for goodwill. Do
not confuse it with "net worth", which is the difference between the
dollar values of the assets and liabilities of the business. Rather it is
the ability of the business to realize a higher rate of return on the
investment than ordinarily in the particular type of business because of
the favorable public attitude created by the owner. When goodwill exists,
it is a valuable asset. Be realistic in determining how much you should
pay for goodwill.
No fixed formula can substitute for good judgment. Since you are paying
for favorable public attitude, make an effort to check it. Question
customers, bankers and others whom you feel have unbiased opinions. Who
will have the goodwill after the business changes hands? Does it go with
the business, or is it personally attached to and will it remain with the
seller?
Consider also that there may be "ill will" attached to a business.
customers may be unhappy with the business. You will have to overcome
these ill feelings to become successful.
The term "goodwill" is in some ways an accountant's fiction designed to
explain the difference between the real price and the net worth.
Accountants usually favor writing off this "goodwill" in a short period of
time. A test of the amount asked is to compare it with past profits of the
business. How many months or years will it take before the "goodwill" can
be paid for out of profits? During that period you will, in effect, be
working for the seller rather than for yourself. Another way to judge the
value of this intangible asset is to estimate how much more income you
will receive by buying the going business than by starting a new one.
Or compare the price asked for goodwill with that asked for goodwill in
similar businesses. In other words, if you are shopping around for a
business, compare not only the total prices asked, but the amounts asked
over and above the reasonable value of the net tangible assets.
Liabilities
Be sure the seller pays off accumulated debts before you pay the money
agreed upon in the terms of the sale, so the business is 'clear'. Find out
if there are mortgages, back taxes, liens upon the assets, or other
creditors' claims. Obtain full information about any undelivered purchases
for which you will be liable. Although it is generally not desirable to
assume any liabilities, it may be necessary in some instances. If
liabilities are assumed, be sure their value is subtracted from the
agreed-upon value of the assets.
The Price
After you have determined what you believe to be net value you will
still not have reached the final price to be paid for the business. Value
relates to what the business is worth. Other factors which affect the
final price must be considered. Only then can you begin to determine the
final price through negotiation and bargaining.
What has the seller's reputation been among employees and suppliers?
Poor relationships may require extra effort on your part to establish a
smoothly running organization. Make sure suppliers will deal with you. If
a franchise is involved, obtain satisfactory insurance from the supplier
that it will not be withdrawn.
Why does the owner wish to sell? This should be one of your first
questions. Is the reason given -a death in the family, poor health, or a
needed change in climate - the really decisive factor? Or does the seller
know the neighborhood is changing so his specific type of business will no
longer be needed; or that a new civic development, or zoning law, will
affect the business unfavorably? Search for his true reasons for selling
by questioning not only him but others whom you know to be reliable.
Some business owners have sold out only to start a new business in
competition with the buyer. Careful consideration should be given to
placing limitations upon the seller's right to compete with you for a
specific period of time and within a specified area.
As a safeguard against costly errors, obtain legal advice before any
agreement is made. The agreement should be drawn up by a lawyer to ensure
that it covers all essential points and is clearly understood by both
parties. Among the items covered in a typical contract for the sale of a
small business are:
- A description of what is being sold.
- The purchase price.
- The method of payment.
- A statement of how adjustments are to be handled at the time of
closing (for example, adjustments for inventory sold, rent, payroll and
insurance premiums).
- Buyer's assumption of contracts and liabilities.
- Seller's warranties (for example, warranty protection for the buyer
against false statements of the seller, inaccurate financial data,
undisclosed liabilities).
- Seller's obligation and assumption of risk pending closing.
- Covenant of seller not to compete.
- Time, place and procedures of closing.
As soon as possible after signing the contract, take possession.
Otherwise, the seller may deplete the inventory and, in some cases, create
ill will for you.
Food For Thought
Expect the best of yourself. Your expectations determine
your attitude, and your attitude determines your actions. Your
actions, in turn, determine your results. When you expect to be a
winner, you act like a winner. When you act like a winner, you are a
winner.
Expect the best of others. What you expect of other people will
determine how you relate to them. And the way you relate to them will
determine how they relate to you. When people know what you expect of
them, they rarely let you down. So make sure you communicate your
sincere, positive expectations.
Expect the best of every situation. Ask yourself, "What's good about
this? What can I learn? How can this help me to grow? How can I use
this to add value to my own life and the lives of others?" When you
look for the positive, you'll find it.
Expect the best every day. Look at each day as an opportunity to
improve yourself and the world around you. Expect to prosper. Expect
opportunity. Expect fulfillment. Expect the best that life has to
offer, and then delight in living your expectations.
Today you will face countless choices. They may each seem
insignificant, but they're not. Most of them, you probably won't even
think about -- you'll make these choices by habit. Others, you'll
consider briefly, perhaps, and then move on to something else.
We tend to focus on the "big" choices: where to go to college, what
house to buy, who to marry, what career to choose. And these are
important decisions. Yet the little choices -- the ones you make every
day without even thinking -- add up over the months and years to have
a huge impact on your life. The cumulative effect of these little
choices is powerful indeed.
Let's say you choose at lunch to have a double-meat cheesburger, large
order of onion rings and a piece of cheesecake, instead of having a
green salad and a bowl of fresh fruit. It won't make much difference
today which you choose. However, over the course of a year, your daily
choice of food can make a tremendous difference in your health and
fitness.
Other choices that you make every day: To spend 10 minutes circling
and fighting for a parking space next to the building, or to park out
where there are plenty of spaces and spend 3 minutes walking across
the parking lot. To call a friend or to watch another re-run of
"Coach". To assign blame or to solve the problem. To do something the
way it's always been done, or to look for a new approach. To pay
someone a compliment, or to mind your own business. To take off early,
or to work a few minutes late. These choices combine to form your
life. In what direction are your choices taking you?
The life you live right now is a result of the choices you have made
in the past. Be aware of your choices every day. Take control of your
life with the choices you make, especially the "little" ones.
Too often, we define our lives by what's wrong with us. That limits
us, and keeps us negatively focused.
Stop for a moment and consider all the things that are right with your
life. Look for the positive things and be sincerely thankful for them.
Gratitude is the cornerstone of abundance. When someone gives you a
gift, and you neglect to thank them for it, will they ever give you
another? It's not likely. Life is the same way. In order to attract
more of the blessings that life has to offer, you must truly
appreciate what you already have.
You have, within yourself, all the wealth and abundance that you'll
ever need. All you have to do is recognize it and put it to use. And
that starts with focusing on the positive.
What do you enjoy about life? When are you the happiest? What do you
do better than anyone else you know? What gives you a sense of
satisfaction? What is your passion? What would you do if your
resources were unlimited?
Answer these questions, and you'll find the things that are right with
your life. Get in touch with them and appreciate them. Find a way to
make them a part of your daily life and your work. Help them to grow,
and they will bring you fulfillment.
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