How to Buy a Business without Buyer's Remorse

How to Buy a Business without Buyer’s Remorse

Michael S. Blake, CFA, ASA, ABAR Director of Valuation Services, Habif, Arogeti & Wynne

[email protected] 770-353-8373 @unblakeable

Disclaimer

• It is assumed that grownups are watching this presentation and are capable of making their own decisions

• If you’re not a grownup, go back to playing CandyCrush

• The views expressed in this presentation are mine

• Don’t ever do anything without advice of legal counsel

2 HA&W Educational Material

About HA&W

• 60+ year old CPA firm

• 300+ professionals

• Clients in 34 states and 22 countries

• Tax & Audit

• Consulting – Business valuation, forensic accounting, M&A due diligence, and IT assurance


Why Buy a Business?

• See a great entrepreneurial opportunity • Add scale to a business • Synergistic considerations • Beats having a J-O-B job • More income upside than a job • Acquire talent • Acquire market share • Take out a competitor • Change your brand


Finding Businesses for Sale

• Business brokers • Internet listings

(bizbuysell.com), Metrobrokers • GA Association of Business

Brokers • Corporate attorneys • CPA firms • Financial advisors • Investment bankers (buy side

engagements) • Commercial bankers


Can I Afford to Buy a Business?

• 7,056 transactions completed through bizbuysell.com alone in 2013

• Median business sale price in 2013 - $180,000

• Median cash flow - $97,000

• Median revenue – $405,905

• Restaurants and retail enjoyed largest growth in transaction volume since 2010

Data from www.bizbuysell.com


Business Values Should Appreciate

• Slow economic growth is idea for broad business value increases

• Business creation is slow, creating drag on supply

• Lots of cash in corporate balance sheets, private equity

• Liquidity is back in the banks

• Early retirees are buying businesses for 2nd career


Setting Priorities

Must Have

• (Pick an industry)

• Positive cash flow

• Revenues between $1-3 MM

• Within 10 miles of home

• Office lease of with at least 2 years remaining

• No pending or threatened litigation

• Seller willing to stay on at least a year

Nice to Have

• Business is exactly like ones you have run or worked in before

• Above-average cash flow

• Revenues above $5 MM

• Office lease of at least 5 years with below market rent

• Seller willing to stay on at least 3 years

• Owns building


Funding a Purchase

• Cash

• Home equity

• Borrowing against IRA

• Seller financing

• SBA loans

• Commercial credit

• Private equity

Likely to be a combination


Asset Purchase

• Almost always benefits the buyer

• Can amortize intangibles over a 15 year period against tax liabilities

• Limits liability

• More economically efficient

• Whether a purchase is an asset or stock purchase is typically a function of bargaining leverage and skill

• 80% of small business purchases are asset deals


Ask Questions… Lots of Questions


Net Operating Losses

• Business must remain fundamentally the same

• Only available in stock deals

• Acquirer can only apply 3-4% of NOL’s in a given year.


Non-Competition Agreements

• See which are already in place

• Some go away with a change in control

• Most last up to 5 years

• Courts seem to be troubled with terms of 7+ years


Key Person/Personal Goodwill

• Could be most of the value of the business

• What happens when the key person is gone?

• If the key person value can be transferred, how long will it take?


Reputation Analysis

• Glassdoor.com

• Yelp.com

• LinkedIn

• Facebook

You can’t build a reputation on what you’re going to do. --

Henry Ford


Customer Analysis

• 10% - the point where customer concentration becomes problematic

• Will customers survive a change in control?

• What is the nature of the customer relationship?

• Are customer relationships transactional or recurring?

• Talk to customers or hire a firm to do so.


Ratio Analysis and KPI

• Trend over several years

• Benchmark vs. peers

• What is fixable and what is systemic?

• What are the leading indicators?


Keeping the Seller On

• The longer the better

• Most financial incentives lose their impact after 1 year

• Decide role of seller – consultant, advisor, executive?


Financial Analysis

• Normalize financial statements

• Market rent

• Executive/owner compensation

• Discretionary expenses (vacations, cars)

• Charitable contributions/sponsorships


How to Negotiate a Purchase

• Find out what the seller really wants

– Highest cash price

– Retain upside

– Stream of payments/de facto pension

– Security for employees

• Use your “nice to haves” as bargaining chips

• Stick to what you have to have


Leverage Translates into Price and Terms

Earn-outs Seller Notes

Employment Agreements

Escrow Periods

Noncompete Agreements

Asset vs. Stock Sales

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Some Creative Ideas on Financing

• Home equity

• Cash value of life insurance

• Leverage retirement funds

• Seller financing

• Purchasing an annuity for the seller


Pricing the Deal

• Rules of thumb lead to bad deals or bad non-deals

• Wherever there is uncertainty, assume the worst case scenario

• Ignore what the seller says he/she “needs” unless it’s to your benefit

• Run the numbers – make sure the deal comfortably cash flows, if financed


Value is the Result of Tension of Buyer and Seller


Theoretical Value and Real World Value

Value is a function of seller leverage

High Seller Leverage Low Seller Leverage

• Multiple buyers

• Low personal goodwill

• Strong personal position

• Diverse customer base

• Able to compete with buyer

• 10/2

• Highly specialized

• Reliant on owner/operator

• External need to sell

• Customer concentration

• Not a threat to buyer

• Not profitable


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Value: What Someone is Willing to Pay?

• Who is “someone” and what are their circumstances? – Free to decide to buy/sell or not to

buy/sell?

– Is the asset made available to many buyers?

– Could the buyer flip the asset at the same price quickly?

– What was the second highest bid?

– Is the buyer knowledgeable and privy to all relevant facts?

– Were the terms of sale all cash?

– Are non-financial drivers at work?

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Fair Value

• Envisions a hypothetical sale of the company, buyer and seller are both 100% willing and informed.

• Fair value assumes that “fair” means proceeds from a company sale.

• Differs by application. – Accounting, divorce, shareholder disputes, fairness

opinions, buy-sell agreements.

• Differs by state but GA’s is fairly typical. • Designed to favor the hypothetical seller, usually

a minority owner.


Fair Market Value

• IRS Revenue Ruling 59-60 as follows: The price at which the property would change hands between a

willing buyer and a willing seller, neither being under a compulsion to buy or sell and both having reasonable knowledge of relevant facts.

• Involves a hypothetical sale

• Envisages discounts for lack of control and marketability

• Favors the hypothetical buyer

• Used mostly for tax compliance


Not All Transactions Take Place on “Fair” Terms

An offer you can’t refuse…


Other Standards of Value

• Investment Value – value to a specific individual (often the current owner).

• Market Value – the highest value a sane person might conceivably pay for the business or business interest.

– Considers synergies.


Illustration of Standards of Value

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FAIR

MARKET

FAIR MARKET

INVESTMENT VALUE

(SYNERGISTIC VALUE)

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It’s OK to “Overpay” if…

• You realize you’re doing it

• You have concrete reasons for doing it

• The business still cash flows

• You still make an appropriate return


Valuation Methodology is Driven by Data Availability

• If you have good transaction data that is comparable to target, use it

• If you have good comparability with public companies, use it

• If you have credible cash flow forecasts, use those

• Possibly consider multiple approaches if the data is good


Using Advisors

Corporate attorney

CPA (tax and due diligence)

Customer Survey Firm

Business Appraiser

Investment Banker


Summary Thoughts

• Keep your objectives in mind at all times

• Understand why you are interested in the business

• Understand what the seller’s objectives are

• Terms and price are a balancing act and, to some extent interchangeable

• Value is important, but fungible


Thanks!

Questions?

Michael S Blake, CFA, ASA, ABAR 770-353-8373 [email protected] @unblakeable