What’s the business worth?
Sellers frequently have an inflated idea about what their business is worth. So, don’t assume the asking price is reasonable.
There are "rules of thumb" for business valuations. Tom West’s "Business Reference Guide" is an excellent source of information about the valuation of different types of businesses (for more information go to Business Brokerage Press).
Why is the business for sale?
Understanding why the business is for sale gives you insight into the market and the business potential.
Reasons for sale vary greatly. The implications are quite different if the seller has health problems or if the seller wants out because of declining business conditions.
Should you work with a business broker?
A knowledgeable and professional business broker can be an effective intermediary and assist in negotiating the deal. Remember, the business broker usually represents the seller, not the buyer.
Making an offer - with contingencies.
Once you’re decided on a price and you’re ready to make an offer, you need to be sure to make the offer contingent upon certain issues such as:
- verification of books and records;
- transferability of licenses, if any;
- an acceptable lease;
- training and transition period;
- non-compete by seller;
- obtaining financing;
- no liens or encumbrances;
- retention of key employees; and
- verification of inventory.
Usually the initial offer is not accepted, and the seller makes a "counter offer." Buyer and seller need to talk candidly about what’s important to each to make the transaction work.
Negotiating the deal - use a "term sheet."
Using a one page "term sheet" or simply answering the questions: Who? What? Where? and How much? helps to focus the negotiations on what’s important to the parties.
Lawyers, accountants and other advisers can then review the term sheet and discuss the issues.
Be wary of professional advisers who use lots of boilerplate, take extreme positions, or use tactics that are adversarial.
Strive always to keep the negotiations "win-win."
Key terms:
Beware of purchasing stock!
Most deals are structured as asset purchases so that the buyer is protected from any undisclosed liabilities of the seller.
For the buyer, the asset purchase is advantageous from a tax point of view because the buyer gets a "stepped up basis" (basis is the cost for tax purposes and gives the buyer a more rapid write off of depreciable assets).
For the seller, a stock sale is more desirable from a tax point of view.
- Allocation of Purchase Price.
In negotiating the terms, buyer and seller need to be flexible and get professional tax advice.
It’s important to agree on how to allocate the purchase price between tangible (equipment) and intangible (goodwill) assets since the allocation impacts how the items are handled for tax purposes.
The allocation of the purchase price, and the resulting tax treatment, must be mutually agreed upon and reported to the IRS.
It’s customary for the seller to agree not to operate or be involved in a competing business for a period of years in the geographic area of the business.
- Conducting "due diligence."
Once the offer is accepted, you enter the "due diligence phase."
This is kind of like a home inspection. You wouldn’t buy a house without checking out the systems (e.g., heating, plumbing, septic) and the liabilities (title search). The same kind of systems and liability analysis (e.g., accounting systems, computer systems, payroll tax liabilities, liens) is important in buying a business.
Conducting due diligence usually requires professional experience. Unless you really understand business books and financial records, it’s wise to get professional help.
If the due diligence process turns up some problems or a history of poor financial performance, it’s important to think through how you will operate the business. (e.g., what will you do differently to improve the financial results of the practice?) This process leads to thoughtful business planning, which is critical to the future success of the business.
The results of due diligence can result in canceling the deal or renegotiating the purchase price.
The closing (official transfer of ownership) occurs after due diligence is completed and all the contingencies have been resolved.
The final purchase and sale documents, including the Bill of Sale and Promissory Notes, should be clear and understandable (without gobs of boilerplate or jargon and terms you do not understand.)
Managing the Ownership Transition - Communication and Cooperation!
A smooth transition is critical to retaining customers. Sellers usually provide some training or assistance in transitioning the business to the new owner. A plan should be detailed for how the ownership transfer will be communicated to employees, customers, suppliers and the public. A joint announcement, press release or other means of communications should be agreed upon. Mutual cooperation is essential to a smooth transition of ownership.
Bottom Line
Buying a business is a complex transaction. To avoid the pitfalls, it’s important to get good advice along the way.
NOTE: Information provided is intended as a broad, general overview and is not legal advice.
© Copyright, 2009, Jean Sifleet. All rights reserved. Used with permission.
------------------------------
About This Author:
Jean D. Sifleet, Esq. CPA, is the head of the Business Practice Group of Worcester-based law firm Hassett & Donnelly, PC. For practical information, check out Jean's articles and books which are featured on SmartFast.com.
