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Business Purchases
To assist your client locate a suitable business, it helps to know some
specific things about your client. I have a range of questions I always
ask a buyer which assists me to locate a suitable business. For a person
(rather than a corporate buyer) these include:
What is their background/work history/skill base? Clearly it can make
good sense to use their existing skill base. If a client is not a "marketing
person", they may not be wise/comfortable to buy a business, which
relies heavily for its success on "selling/marketing skills".
- How much equity do they have? It is important to know how much a buyer
has of their own funds i.e. excluding borrowings against the business
assets they are buying. Given this figure, one can add what a lender
may advance against the assets of a business and therefore advise what
a realistic purchase price range might be for a buyer.
- What minimum net profit do they want to earn per annum? This will
drive the purchase price range of target businesses as all businesses
can be valued on a rate of return for risk formula (see later in this
article) so if one knows the net profit before tax sought by a client,
you can determine the approximate price range of the required business.
- Will the client seek 100% control or be happy to be a part owner (50/50
or perhaps 70/30)? There are obvious issues to contend with in a partnership
(compatibility, common goals etc) but partnerships can work and there
are advantages e.g. sharing of responsibilities, complementary skills,
cover for holidays etc).
- Where should the business be located? Some clients will not necessarily
be willing to drive 1 hour a day from home to work and then back again
at the end of a day, especially in big city peak traffic times.
- What do they rule out of their search? Many clients will know what
they are not interested in rather than what type of business they would
be happy with. Some may not wish to be involved in retail or importing
whilst others may not be comfortable with say manufacturing or perhaps
a service business.
You can narrow down the range of businesses by following this method
of questioning but the choice of businesses is still very wide.
With a corporate buyer, some of the same broad questions listed above
will still apply.
I always tell clients at the outset that it may take them many months
to locate a suitable business.
How to locate
a suitable business
There are many ways to locate a suitable business and these include:
reading the businesses for sale columns in local newspapers, business
and trade magazines (essentially a reactive approach), talking to Business
Brokers (a more proactive approach) or even approaching businesses directly
to see if they are for sale (assuming a client knows what they are seeking)
certainly the most proactive. Naturally I would always suggest that your
clients contact a reputable, professionally qualified business broker!
Due Diligence
Accountants obviously perform financial due diligence for clients including
proving key financial items: Sales, gross profits, wages, rents and other
major expenses as well as key balance sheet items (stocks, fixed assets).
They will review tax returns (income, GST, FBT etc) and perhaps even carry
out a competitor analysis etc.
However when it comes to other issues (e.g. legal matters -trademarks,
leases, sale and purchase agreements and employment contracts and regulatory
issues etc) I believe Accountants would be wise to consider leaving such
matters to other professional advisors. The issues can be complex and
we are becoming a more litigious society so perhaps Accountants should
be prudent!
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The sale of a business
Preparing a
business for sale
In a physical sense, the business should obviously ideally be presented
in a clean and tidy manner.
Ideally the financial track record should be sound, with increasing profits.
Non-necessary assets should be removed or preferably sold. Naturally annual
and monthly accounts should be processed right up to date and preferably
an information memorandum should be available (describing the business,
its history and including details of leases, staff, product/services,
strengths and weaknesses threats and opportunities).
Valuing the
business
To properly value a business, one must fully assess the risks involved
and a wide range of information about a business is needed to do this.
Obviously in a short article it is not possible to cover everything in
this regard but the key matters to really understand are the risks which
affect the ongoing earnings stream and this embraces matters like customers,
competitors, industry matters (all of which should be researched in the
due diligence process. Two simple examples of matters which may impact
on valuations are firstly, there may be special supplier arrangements
which may not continue with a new owner and secondly one needs to check
if there are going to be any major expenses needed soon e.g. bigger premises,
new machinery etc
The following is the basic key financial information I obtain to assist
me in valuing a business.
Up to date full sets of accounts i.e. profit and loss and balance sheets
(annual for the last 5 years and monthly for the current year along with
a budget for the current year if available) Monthly sales figures for
the last two completed financial years and the current year. This helps
to understand trends and seasonality.
Naturally one seeks explanations for all significant variations in revenues
and expenses, non-recurring items etc
The key figure we are trying to determine is the expected future maintainable
earnings.
I have developed a simple valuation technique, which very quickly allows
me to estimate a possible selling price range for a business. The purists
amongst you will, I know, find fault with it but my defence is that I
have successfully used it in the marketplace for many years! Here it is.
The most common business sale basis/method for businesses up to say $3,000,000
is an asset sale i.e. fixed assets, stock and goodwill (rather than a
share sale, due to the tax and other contingent liabilities which may
subsequently arise.)
To value the assets of a business being sold I calculate the EBIT (earnings
before interest and tax)-after ALL costs including market owners remuneration,
depreciation and interest on the net average monthly debtors less creditors
i.e. base working capital needed to operate the business. My logic is
that on top of buying the fixed assets and stock one needs in most businesses
to fund the net difference between debtors and creditors on an ongoing
basis, hence my allowance for interest on this working capital amount
needed. This adjusted EBIT is then capitalised by a factor ranging typically
from 25% to 30% on average depending on the type of business. The capitalisation
rate may be higher or sometimes lower depending on the risk factor. By
dividing the adjusted EBIT by the risk factor you get the value for the
sum of the assets (stock, fixed assets and goodwill) and so the goodwill
is effectively the balancing figure. A simple example will demonstrate
what I mean.
Assumed Adjusted EBIT $200,000
Value of stock $250,000
Value of fixed assets $250,000
Goodwill?
Total Price of assets $800,000 (EBIT $200,000/25%)
Clearly the goodwill is worth $300,000 in this example.
Marketing the
business
With an information memorandum and valuation prepared, one can then market
the business.
Buyers will be either existing competitors (who can grow their market
share and perhaps cut out overheads) or outsider's e.g. senior executives
or employees wishing to get into their own businesses.
My marketing will involve utilising my database and network along with
using the appropriate media advertising.
I am also involved in locating equity partners to allow shareholding changes
to be made or the introduction of funds to allow businesses to grow. Equity
partners may be passive or active.
As a full time business broker I obviously have a pool of business buyers
and businesses for sale at all times and hence can match parties easily.
I always welcome the opportunity of working with fellow Chartered Accountants
to assist their clients with the purchase or sale of businesses.
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