Buying an Exciting Business. How to Buy a Business Do not rush into a deal. Do not rush into a deal. Analyze your skills, abilities, and interests. Analyze

Buying an Exciting Buying an Exciting BusinessBusiness

How to Buy a BusinessHow to Buy a Business

Do not rush into a deal.Do not rush into a deal.Analyze your skills, abilities, and interests.Analyze your skills, abilities, and interests.Develop a list of criteria.Develop a list of criteria.Prepare a list of potential candidates Prepare a list of potential candidates

(Remember the “hidden market”).(Remember the “hidden market”).


Is the right type of business in a market Is the right type of business in a market which you want to operate?which you want to operate?

How critical to your ultimate success is How critical to your ultimate success is experience in the business?experience in the business?

Will the company generate sufficient cash Will the company generate sufficient cash to pay for it self?to pay for it self?


Will the company leave you with a suitable Will the company leave you with a suitable rate of return on your investment?rate of return on your investment?

Should you be starting a business and Should you be starting a business and building it from the ground up rather than building it from the ground up rather than buying an existing one?buying an existing one?


Investigate and evaluate candidate, Investigate and evaluate candidate, businesses and select the best one.businesses and select the best one.

What experience do you have in that What experience do you have in that particular business?particular business?

What is the company’s potential for What is the company’s potential for success?success?

Negotiate the deal.Negotiate the deal.


What changes will you have to make?What changes will you have to make?Explore financing options.Explore financing options.What price and payment method are What price and payment method are

reasonable for you?reasonable for you?Ensure a smooth transition.Ensure a smooth transition.

Some Critical Areas for Analyzing an Some Critical Areas for Analyzing an Existing BusinessExisting Business

Why does the owner want to sell.... Why does the owner want to sell.... the the realreal reason? reason?

What is the physical condition of the What is the physical condition of the business?business?

What is the potential for the What is the potential for the company's products or services?company's products or services?

Some Some CriticalCritical Areas for Analyzing an Areas for Analyzing an Existing BusinessExisting Business

Customer characteristics and Customer characteristics and compositioncomposition..

Competitor analysis.Competitor analysis.What legal aspects must I consider?What legal aspects must I consider?

Some Some AdvantagesAdvantages for Buying a for Buying a BusinessBusiness

Business may continue to be successful.Business may continue to be successful.Can use experience of previous owner.Can use experience of previous owner. ““Hit the ground running”.Hit the ground running”.Business may have best location.Business may have best location.Employees and suppliers are in place.Employees and suppliers are in place.

Some Some AdvantagesAdvantages for Buying a for Buying a BusinessBusiness

Equipment is installed.Equipment is installed. Inventory is in place and trade credit Inventory is in place and trade credit

exists.exists.Easier time finding financing.Easier time finding financing. It’s a bargain.It’s a bargain.

Some Some DisadvantagesDisadvantages for Buying for Buying a Businessa Business

It’s a loser.It’s a loser.Possible “ill will” from previous owner.Possible “ill will” from previous owner.Employees may not be suitable.Employees may not be suitable.Location may be unsatisfactory.Location may be unsatisfactory.Equipment may be obsolete.Equipment may be obsolete.


Change and innovation can be difficult.Change and innovation can be difficult. Inventory may be obsolete.Inventory may be obsolete.Accounts receivable may be worth less Accounts receivable may be worth less

than face value.than face value.


Change and innovation can be difficult.Change and innovation can be difficult. Inventory may be obsolete.Inventory may be obsolete.Accounts receivable may be worth less Accounts receivable may be worth less

than face value.than face value. Business may be overpriced.Business may be overpriced.

Valuing Accounts ReceivableValuing Accounts Receivable

Age of Accounts

(days)

Amount

Probability of Collection

Value

0-3031-6061-90

91-120121-150

151+

Total

$40,000$25,000$14,000$10,000$7,000$5,000

$101,000

.95

.88

.70

.40

.25

.10

$38,000$22,000$9,800$4,000$1,750$500

$76,050

The Legal Aspects ofThe Legal Aspects ofBuying a BusinessBuying a Business

Lien - creditors’ claims against an asset.Lien - creditors’ claims against an asset.Bulk transfer - protects business buyer Bulk transfer - protects business buyer

from the claims unpaid creditors might from the claims unpaid creditors might have against a company’s assets.have against a company’s assets.

The Legal Aspects ofThe Legal Aspects ofBuying a BusinessBuying a Business

Restrictive covenant - contract in which a Restrictive covenant - contract in which a business seller agrees not to compete with business seller agrees not to compete with the buyer within a specific time and the buyer within a specific time and geographic area.geographic area.

Ongoing legal liabilities - physical Ongoing legal liabilities - physical premises, product liability, and labor premises, product liability, and labor relations.relations.

Bulk TransferBulk Transfer

Seller must give the buyer a sworn list Seller must give the buyer a sworn list of creditors.of creditors.

Buyer and seller must prepare a list of Buyer and seller must prepare a list of the property included in the sale.the property included in the sale.

Buyer must keep the list of creditors Buyer must keep the list of creditors and property for six months.and property for six months.

Bulk TransferBulk Transfer

Buyer must give notice of the sale to Buyer must give notice of the sale to each creditor at least ten days before each creditor at least ten days before he takes possession of the goods or he takes possession of the goods or pays for them (whichever is first).pays for them (whichever is first).

Determining the Determining the ValueValue of a Business of a Business

Balance Sheet Technique.Balance Sheet Technique. Variation: Adjusted Balance Sheet Variation: Adjusted Balance Sheet

TechniqueTechnique..Earnings ApproachEarnings Approach

Variation 1: Excess Earnings ApproachVariation 1: Excess Earnings Approach

Variation 2: Capitalized Earnings ApproachVariation 2: Capitalized Earnings Approach

Variation 3: Discounted Future Earnings Variation 3: Discounted Future Earnings ApproachApproach

Market ApproachMarket Approach..

Balance Sheet TechniquesBalance Sheet Techniques

“ “ Book Value” of Net Worth = Total Assets - Total LiabilitiesBook Value” of Net Worth = Total Assets - Total Liabilities

= $266,091 - $114,325= $266,091 - $114,325

= $151,766= $151,766

Variation:Variation: Adjusted Balance Sheet Technique: Adjusted Balance Sheet Technique:

Adjusted Net Worth = $274,638 - $114,325Adjusted Net Worth = $274,638 - $114,325

= $160,313= $160,313

EarningsEarnings Approaches Approaches

Variation 1: Excess Earnings MethodVariation 1: Excess Earnings Method

Step 1: Compute adjusted tangible net worth:Step 1: Compute adjusted tangible net worth:

Adjusted Net Worth = $274,638- $114,325Adjusted Net Worth = $274,638- $114,325

= $ 160,313= $ 160,313

Step 2: Calculate opportunity costs of investing:Step 2: Calculate opportunity costs of investing:

Investment - $160,313 X 25% = $40,078Investment - $160,313 X 25% = $40,078

SalarySalary = $25,000 = $25,000

TotalTotal = $65,078 = $65,078


Step 3: Project earnings for next year:Step 3: Project earnings for next year:

$74,000$74,000

• Step 4: Compute extra earning power Step 4: Compute extra earning power (EEP) = Project Net Earnings – Total Opp. Cost(EEP) = Project Net Earnings – Total Opp. Cost

= $ 74,000 - $ 65,078= $ 74,000 - $ 65,078

= $ 8,922= $ 8,922


Step 5Step 5: Estimate the value of the : Estimate the value of the intangibles ("goodwill"):intangibles ("goodwill"):

Intangibles = Extra Earning Power x "Years Intangibles = Extra Earning Power x "Years of Profit" Figure*of Profit" Figure*

= 8,922 x 3 = = 8,922 x 3 = $26,766$26,766

* Years of Profit Figure ranges from 1 to 7; for * Years of Profit Figure ranges from 1 to 7; for a normal risk business, it is 3 or 4.a normal risk business, it is 3 or 4.


• Step 6Step 6: Determine the value of the : Determine the value of the business:business:

Value = Value = TangibleTangible Net Worth + Value Net Worth + Value of of

IntangiblesIntangibles

= $160,313 + 26,766 = = $160,313 + 26,766 = $187,079$187,079

Estimated Value of the business = Estimated Value of the business = $187,079$187,079

Capitalized Earnings MethodCapitalized Earnings Method Variation 2: Capitalized Earnings Method:Variation 2: Capitalized Earnings Method:

Value= Value= Net Earnings (Net Earnings (AfterAfter Deducting Owner's Salary) Deducting Owner's Salary) Rate of Return*Rate of Return* * Rate of return reflects what could be earned on a * Rate of return reflects what could be earned on a similar-risk investment.similar-risk investment. Value = Value = $74,000 - $25,000 $74,000 - $25,000 = = $196,000$196,000 25%25%

Discounted Future Earnings MethodDiscounted Future Earnings Method Variation 3: Discounted Future Earnings Variation 3: Discounted Future Earnings

Method: Method:

Step 1Step 1: Project earnings five years into the : Project earnings five years into the future: future:

3 Forecasts: Optimistic Pessimistic Most Likely

Compute a Compute a weighted averageweighted average of the earnings: of the earnings:

Pessimistic + (4 x Most Likely) + OptimisticPessimistic + (4 x Most Likely) + Optimistic 66

Discounted Future Earnings MethodDiscounted Future Earnings Method

Step 1Step 1: Project earnings five years into the : Project earnings five years into the

future:future:

Year Pess ML Opt WeightedAverageYear Pess ML Opt WeightedAverage

1 $65,000 $74,000 $92,000 $75,5001 $65,000 $74,000 $92,000 $75,500

2 $74,000 $90,000 $101,000 $89,1672 $74,000 $90,000 $101,000 $89,167

3 $82,000 $100,000 $112,000 $99,0003 $82,000 $100,000 $112,000 $99,000

4 $88,000 $109,000 $120,000 $107,3334 $88,000 $109,000 $120,000 $107,333

5 $88,000 $115,000 $122,000 $111,6675 $88,000 $115,000 $122,000 $111,667


Step 2Step 2: Discount weighted average of future : Discount weighted average of future

earnings at the appropriate present value rate:earnings at the appropriate present value rate:

Present Value Factor = 1 Present Value Factor = 1

(1+k)(1+k)

where...where...

k = Rate of return on a similar risk k = Rate of return on a similar risk investment.investment.

t = Time period (Year - 1, 2, 3...n).t = Time period (Year - 1, 2, 3...n).


Step 2Step 2: Discount weighted average of future : Discount weighted average of future earnings at the appropriate present value rate:earnings at the appropriate present value rate:

Year Weighted Average x PV Factor = Present Year Weighted Average x PV Factor = Present ValueValue

1 $75,500 .8000 $60,4001 $75,500 .8000 $60,400 2 $89,167 .6400 $57,0672 $89,167 .6400 $57,067 3 $99,000 .5120 $50,6883 $99,000 .5120 $50,688 4 $107,333 .4096 $43,9644 $107,333 .4096 $43,964 5 $111,667 .3277 5 $111,667 .3277 $36,593$36,593 Total Total $248,712$248,712


Step 3Step 3: Estimate the earnings stream : Estimate the earnings stream beyond five years:beyond five years:

Weighted AverageWeighted Average

Earnings in Year 5 x 1Earnings in Year 5 x 1

Rate of Rate of ReturnReturn

= $111,667 x 1 = $446,668= $111,667 x 1 = $446,668

25%25%

Step 4Step 4: Discount this estimate using the present : Discount this estimate using the present value factor for year 6:value factor for year 6:

$446,668 x .2622 = $446,668 x .2622 = $117,116$117,116

Step 5Step 5: Compute the value of the business:: Compute the value of the business: Value = Value = Discounted earnings + DiscountedDiscounted earnings + Discounted

in years 1 through 5 earnings in yearsin years 1 through 5 earnings in years 6 through ? 6 through ?

= $248,712 + $117,116 = = $248,712 + $117,116 = $365,828$365,828

Estimated Value of Business = Estimated Value of Business = $365,828$365,828


Market ApproachMarket Approach Step 1Step 1: Compute the average Price-Earnings (P-: Compute the average Price-Earnings (P-

E) Ratio for as many similar businesses as E) Ratio for as many similar businesses as possible:possible:

Company P-E RatioCompany P-E Ratio 1 3.31 3.3

2 3.8 Average P-E Ratio=3.9752 3.8 Average P-E Ratio=3.975

3 4.1 3 4.1

4 4.74 4.7

Step 2Step 2: Multiply the average P-E Ratio by next : Multiply the average P-E Ratio by next year's forecasted earnings:year's forecasted earnings:

Estimated Value = 3.975 x $74,000 = Estimated Value = 3.975 x $74,000 = $294,150$294,150

Exit Exit StrategiesStrategies

• Straight business saleStraight business sale• Family limited partnership (FLP)Family limited partnership (FLP)• Sell controlling interestSell controlling interest• Restructure the companyRestructure the company• Use a two-step saleUse a two-step sale• Establish and employee stock Establish and employee stock

ownership plan (ESOP) ownership plan (ESOP)

The Five Ps of NegotiatingThe Five Ps of Negotiating

Preparation –

Examine the needs of both parties and all of the relevant external factors affecting the negotiation before you sit down to talk.

Poise – Remain calm during the negotiation.

Never raise your voice or lose your temper, even if the situation gets difficult or emotional.

It’s better to walk away and calm down than to blow up and blow the

deal.

Persuasiveness –

Know what your most important positions are, articulate them, and offer support for your position.

Persistence –

Don’t give in at the first sign of resistance to your position, especially if it is an issue that ranks high in your list of priorities.

Patience – Don’t be in such a hurry to close the

deal that you end up giving up much of what you hoped to get. Impatience is a major weakness in

a negotiation.

ConclusionConclusion

The business is 'up and running' already. The business is 'up and running' already. It is likely to have an existing client base. It is likely to have an existing client base. The previous owners are likely to lend The previous owners are likely to lend

support and goodwill. support and goodwill. There is a tried and tested business There is a tried and tested business

formula to emulate. formula to emulate.

ConclusionConclusion

Generally more chance of success than Generally more chance of success than starting a similar business from scratch.starting a similar business from scratch.

A large amount of time and travel required A large amount of time and travel required to research the opportunities available. to research the opportunities available.

May require relocating your self / family. May require relocating your self / family.

By- By-

Athar A RizviAthar A Rizvi Roll No. 72015Roll No. 72015

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Buying an Exciting Business. How to Buy a Business Do not rush into a deal. Do not rush into a deal. Analyze your skills, abilities, and interests. Analyze