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Sellers generally desire all-cash
transactions; however, oftentimes
partial seller financing is
necessary in typical middle market
company transactions. Furthermore,
sellers who demand all-cash deals
typically receive a lower purchase
price than they would have if the
deal were structured differently.
Although buyers may be able to
pay all-cash at closing, they often
want to structure a deal where the
seller has left some portion of the
price on the table, either in the
form of a note or an earnout.
Deferring some of the owner's
remuneration from the transaction
will provide leverage in the event
that the owner has misrepresented
the business. An earnout is a
mechanism to provide payment based
on future performance. Acquirers
like to suggest that, if the
business is as it is represented,
there should be no problem with this
type of payout. The owner's retort
is that he or she knows the business
is sound under his or her
management, but does not know
whether the buyer will be as
successful in operating the
business.
Moreover, the owner has taken the
business risk while owning the
business; why would he or she
continue to be at risk with someone
else at the helm? Nevertheless,
there are circumstances in which an
earnout can be quite useful in
recognizing full value and
consummating a transaction. For
example, suppose that a company had
spent three years and vast sums
developing a new product and had
just launched the product at the
time of a sale. A certain value
could be arrived at for the current
business, and an earnout could be
structured to compensate the owner
for the effort and expense of
developing the new product if and
when the sales of the new product
materialize. Under this scenario
everyone wins.
The terms of the deal are
extremely important to both parties
involved in the transaction. Many
times the buyers and sellers, and
their advisors, are in agreement
with all the terms of the
transaction, except for the price.
Although the variance on price may
seem to be a "deal killer," the
price gap can often be resolved so
that both parties can move forward
to complete the transaction.
Listed below are some suggestions
on how to bridge the price gap.
- If the real estate was
originally included in the deal,
the seller may chose to rent the
premise to the acquirer rather
than sell it outright. This will
decrease the price of the
transaction by the value of the
real estate. The buyer might
also choose to pay a higher rent
in order to decrease the
"goodwill" portion of the sale.
The seller may choose to retain
title to certain machinery and
equipment and lease it back to
the buyer.
- The purchaser can acquire
less than 100% of the company
initially and have the option to
buy the remaining interest in
the future. For example, a buyer
could purchase 70% of the
seller's stock with an option to
acquire an additional 10% a year
for three years based on a
predetermined formula. The
seller will enjoy 30% of the
profits plus a multiple of the
earnings at the end of the
period. The buyer will be able
to complete the transaction in a
two-step process, making the
purchase easier to accomplish.
The seller may also have a "put"
which will force the buyer to
purchase the remaining 30% at
some future date.
- A subsidiary can be created
for the fastest growing portion
of the business being acquired.
The buyer and seller can then
share 50/50 in the part of the
business that was "spun-off"
until the original transaction
is paid off.
- A royalty can be structured
based on revenue, gross margins,
EBIT, or EBITDA. This is usually
easier to structure than an
earnout.
- Certain assets, such as
automobiles or
non-business-related real
estate, can be carved out of the
sale to reduce the actual
purchase price.
Although the above suggestions
will not solve all of the pricing
gap problems, they may lead the
participants in the necessary
direction to resolve them. The
ability to structure successful
transactions that satisfy both buyer
and seller requires an immense
amount of time, skill, experience
and most of all - imagination.
Copyright BBP 2003
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There are
several
things to
consider
when buying
or selling a
business.
The most
important is
to listen to
the other
side. There
are always
reasons why
someone
wants
something -
even if you
don't agree
at first.
Find out
where the
other side
is coming
from, then
make a
decision on
whether you
can live
with it or
not.
Next,
whether you
are the
buyer or the
seller, you
can not have
everything
your way.
You can't
win on every
point or
issue. Be
prepared to
give in on
those areas
that are not
as important
as those you
feel most
strongly
about. If
you are a
seller, you
may not be
able to get
a real high
price and a
real high
down
payment. You
will have to
decide which
is more
important.
The same is
true for the
buyer. You
can't have
it both
ways.
Always
enter the
purchase or
sale of a
business
with a
spirit of
cooperation
rather than
one of
confrontation.
The buyer or
the seller,
as the case
may be, is
not the
enemy. If
the seller
wasn't
interested
in selling,
the business
would not be
for sale. If
the buyer
did not like
the business
there would
be no
negotiation
or eventual
sale.
The
secret of a
successful
negotiation
is laying
out all the
points on
the table
for
discussion.
It is key to
understand
where
everyone is
coming from
and to
understand
what is and
what is not
important to
each party.
When there
is a sense
of
cooperation
among all of
the players,
a successful
deal will
usually
result.
Copyright
BBP 2003
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"Independent
business
owner" is a
phrase with
two
meanings. Of
course, it
means being
the owner of
an
independent
business.
But another
way to look
at
"independent
business
owner" is to
let this
phrase
define the
very
personality
of the
person at
the helm.
Independent.
Confident.
Self-assured.
Strong-willed.
These are
vital
entrepreneurial
attributes,
but,
ironically,
they can
sometimes
work against
the business
owner when
it comes
time to
sell.
Since
business
owners are
the type who
know about
selling --
either
products or
services--
and about
making deals
-- haven't
they had to
cope with
suppliers,
customers,
and
competitors
throughout
their
business
careers? --
it's not
surprising
that owners
approach
selling
their
businesses
with these
tried-and-true
tactics and
ideas.
Sellers who
have spent
years
building a
business are
often
unaware of
how
completely
different
the process
of selling a
business is.
Savvy
sellers,
realizing
the
importance
of a selling
approach
equal to
this very
important
task, will
depend on
the guidance
of a
business
intermediary.
With
professional
guidance,
sellers can
benefit from
their
personal
strengths
instead of
letting them
get in the
way of the
selling
process. The
following
"strong"
selling
points are
signposts on
the road
leading to a
successful
transaction.
Price
Your
Business To
Sell
Sellers
are good
"business
people;"
they
naturally
are after
the best
possible
price for
their
business.
Realistic
pricing is
perhaps the
most
important
factor in
selling from
a point of
strength.
Understanding
the
marketplace,
up-to-the-minute
and not some
high mark
just past or
in the
possible
future, is
key.
The
pricing of a
business,
different
from the
simpler
means of
valuing
based on
goods or
services,
depends on
industry-tested
valuation
techniques,
with
intangibles
incorporated
to ensure
that the
business
will not be
underpriced.
The price of
a business
is arrived
at by a
variety of
factors, one
of the chief
of which is
the
intensity of
a buyer's
interest in
a particular
business.
Know
Your Buyer
The
seller,
although
good at
"psyching
out"
customers
and vendors,
may not be
as adept at
sizing up
potential
buyers. Some
buyers are
professional
window-shoppers;
talking a
good game
but never
really ready
to play.
There are
also the
buyers who
would play
ball -- if
they only
knew where
the action
was! First
locating and
then
qualifying
buyers is a
key function
of business
brokers.
They will
use
computerized
data bases,
professional
associations
and other
networks
nationally
and
internationally
-- all to
increase the
chances of
selling a
business at
top value.
In
addition,
the business
broker will
determine
the right
buyer for
the right
business,
focusing on
those
prospects
who are
financially
qualified as
well as
genuinely
(or
potentially)
interested
in the
business for
sale. As
part of
qualifying
buyers, to
take the
"fear" out
of the
likely need
for seller
financing,
the business
broker will
assess the
ability of a
particular
buyer to run
a business
successfully.
This
invaluable
work by the
broker not
only locates
the best
buyers, it
also frees
the seller
to
concentrate
on his role
in the
selling
process.
Prepare
Your
Business for
Sale
In
addition to
the obvious
need for the
business to
appear clean
and
cared-for,
there are
important
steps the
seller must
take in
advance of
putting the
business on
the market.
In most
cases, a
business
will sell
based on the
numbers.
Your
business
broker will
help you
create a
clear
financial
picture --
in timely
fashion --
and to
prepare
statements
suitable for
presentation
to a
prospective
buyer.
Remember
that buyers
may be
willing to
buy
potential,
but they
don't want
to pay for
it. In fact,
sellers
should be
open to
about all
aspects of
the business
that might
affect the
sale;
otherwise,
once the
real facts
are
revealed,
the deal may
self-destruct.
Business
owners are
accustomed
to coping
with
paperwork,
but few have
had exposure
to the
specialized
contracts
and forms
required
both before
and during
the selling
process. The
business
broker, an
expert at
transaction
details,
will help
guard
against
delays,
problems,
and
premature
(or
inappropriate)
disclosure
of
information.
Maintain
Normal
Operations
Another
vital
activity for
the seller
is to keep
on top of
the
day-to-day
running of
the
business.
When a
business
intermediary
is on hand
to focus on
the
marketing of
the
business,
the seller
can focus on
keeping
daily
operations
on-target.
Sellers are
"people
people," and
may have
visions of
wooing
buyers with
their great
presentation
of the
business.
Even if this
were to
happen,
these
sellers fail
to visualize
the number
of buyers
they would
have to
"woo-and-win"
if handling
the sale on
their own.
Confidentiality
An
adjunct to
maintaining
the status
quo is the
important
task of
maintaining
confidentiality.
Until a
purchase-and-sale
agreement
has been
signed, most
sellers do
not want to
disturb (or
jeopardize)
the normal
interaction
with
customers
and
employees;
nor do they
want to
alert the
competition.
A business
broker helps
by using
nonspecific
descriptions
of the
business,
requiring
signed
confidentiality
agreements,
and
performing a
careful
screening of
all
prospects.
To keep
the sale of
your
business on
firm ground,
be sure that
your
"strengths"
as an
independent
business
owner aren't
actually
weakening
the sale.
Using these
key selling
points along
with the
expertise of
a business
intermediary
will keep
the process
going
strong.
Copyright
BBP 2003
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Now that we crossed that much-heralded bridge to the 21st century and once on the other side, there will be new challenges, but many of the secrets of succeeding in independent business will remain the same. Ask yourself the following questions to see how you measure up to these old-and-new standards of entrepreneurial excellence:
Are you in step with technology?
The 21st century will usher in a brave new world of marketing and financial transactions. The successful independent business person will be in touch with opportunities offered by technology for one-to-one marketing. For example, instead of advertising in print and on radio or TV, businesses can target and reach customers far more directly--through their personal computers.
Marketing on-line will be closely aligned with electronic monetary transactions. This phenomenon will have myriad repercussions on everybody from checkbook printers to the U.S. Postal Service. Many concepts, such as discounts for prompt payment, will cease to have meaning as electronic transactions will narrow and then obliterate the time-lag between receivables and payables. Savvy owners and managers will be prepare themselves now to sign onto these new ways of doing business.
Are you flexible?
A recent survey of successful small business operations revealed that 54 percent of respondents named flexibility as one of the secrets to their success. Today's great product or service could well be obsolete tomorrow, as it becomes increasingly difficult to forecast the competitive environment, new developments in technology, and consumer trends. Success in the next millennium doesn't just mean riding the tide of change; it means being the first to get to shore.
And when you refuse to be flexible? Consider this classic bad example from the world of big business: Apple Computer's failure to foresee the wisdom of licensing rights to its Mac operating system. This failure in flexibility opened the door--and Windows--for Microsoft, thus initiating its own decline.
Are you focused?
Flexibility must be balanced with focus. The readiness to expand or diversify should never threaten the "heart" of the business. As the winds of change blow stronger, knowing the true strengths of a business and having a keen sense of its niche value is essential.
Here's a good once-small-business example of focus: Krispy Kreme Doughnuts, the North Carolina-based company that began with one small shop in 1942. It's going stronger than ever with new franchises all over the country, and has seals-of-approval from The New Yorker and other trend-setting publications. Ignoring the concept of multi-branding, Krispy Kreme sells only its trademark doughnuts, and they are (literally) hot.
Do you have a plan?
The key to balancing between too flexible and too rigid is a good business plan. Although rapid change may make a five-year plan too long-range, the length of vision is not as important as its intensity. The chief value of a business plan is the hard thinking that it engenders. Planning forces business owners and managers to face issues head-on, examining closely the virtues versus the pitfalls of whatever next steps the business might take.
Although the good business plan will contain, in writing, goals that are specific, realistic, measurable, and time-driven, this document will mean nothing without the correct entrepreneurial spirit behind it. Successful business owners live by their goals. This has never been more important than it will be in an age where variables increase exponentially in every possible area--new competitive products and services, technological advances, industry trends and changes.
Are you prepared for your "next life"?
Once you've made it into the land of the successful (or you're tired of trying to get there), what next? One of the signs of a wise entrepreneur is knowing when to make a graceful exit. Business owners who believe they should consider selling only when business is down are missing another opportunity to be a winner. Good timing is the secret to selling success. Instead of waiting for bad times, either in the business itself or in the marketplace in general, sellers should understand that last year might be too late.
A professional business broker can make selling an educated process, doing everything from accessing national and international data bases for marketplace information, to advertising and qualifying buyers, to handling the complex paperwork necessary for the completion of the sale. The business broker will also present and assess offers and, at the appropriate juncture, will help in structuring the sale and negotiating its close.
Even if exiting your business is a step you won't take until the next millenium, it's not too soon to create a strategic exit plan. After overcoming the challenges of making a business successful, the final triumph for the owner is profiting from its successful sale.
Copyright BBP 2003
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The following might be a subtitle for this true account of how one deal was put together: "In spite of everything, you need only one buyer - the right one!" (Although the details are factual, names and financial data are fictional.)
The company (let's call it ElectroCo) has carved a niche in a $ billion industry. It manufactures proprietary electronic products and is owned by a private equity firm that wants to sell it for liquidity reasons. At the beginning of 2001, the private equity group retained an intermediary firm (its fictional name is United Associates) to take the company to market. The goal was to have it sold by the end of the year.
ElectroCo had annual sales of about $12 million, gross margins of 50 percent, an EBITDA of $1.8 million (15 percent) and a reconstructed EBITDA of $ 2 million. It also had been growing over the past ten years at a 10 percent rate and had always been profitable. It had a diverse customer base split about equally between end-users and OEM accounts. However, the seller wanted to set a very aggressive full price, with all-cash in a not-so-vibrant M&A market.
On the plus side, however, the seller was cooperative and provided any information that United needed. It also had audited statements, conservative accounting and instant monthly statements. ElectroCo was, in addition to these factors, on the verge of getting a substantial amount of new business.
In preparing to take the business to market, United Associates came up with a basic game plan. For confidentiality reasons, direct competitors were eliminated from the buyer search. Synergistic buyers were targeted-either because they served similar markets or utilized similar manufacturing methods. United also elected to contact selected private equity groups and other intermediary firms.
More specifically, United planned on creating a list of 100 potential buyers. A buyer was defined as an entity that had signed a Confidentiality Agreement, had been pre-approved by the seller, and therefore, had been sent an Offering Memorandum. United anticipated 15 written Term Sheets leading to five Letters of Intent which, hopefully, would lead to the best deal. United was not sure that they could sell the business at the multiples asked by the seller. However, they succeeded, and that success was to be based on the following:
- Preparing a thorough and compelling Offering Memorandum and pointing out the positive future prospects. This required the complete cooperation of ElectroCo's management team.
- Developing a complete list of as many of the possible buyers both in the U.S. and abroad.
- Contacting the buyers to see if they would be interested in the company, but still maintaining confidentiality.
- Administering all of the potential buyer activity and sending the Offering Memorandum to the appropriate parties.
- Following up with all of the prospects who received the Offering memorandum, arranging tours of the facilities with the serious prospects.
- Setting time frames for expressions of interest, term sheets, and fielding questions from the serious prospects.
- Holding the deal together in spite of the tragic events of September 11th resulted in a two-month delay that could have been much longer.
- Making sure that complete confidentiality was maintained and making sure that any future confidentiality leaks did not occur.
- Constantly reminding ElectroCo's management to stay focused on maintaining sales and profit goals.
- Maintaining communications with both the buyers and ElectroCo's lawyers and other outside advisors.
United was able to develop a list of 85 possible acquirers; however, five would not sign the Confidentiality Agreement. Here is a breakdown of the 85 possible buyers:
| Buyer Type |
|
Number of Buyers
|
| Strategic |
|
45
|
| Some Synergy |
|
20
|
| Private Equity Groups |
|
20
|
Of the 85 possible buyers, 15 were companies or divisions of firms with annual revenues of $1 billion or more. 12 of these 15 were foreign or owned by foreign companies. ElectroCo chose not to deal with four of the buyer firms due to negative industry knowledge. Two of the buyers were individuals that had financial backers. Four buyers were just "bottom fishing." Three of the 85 decided not to move forward due to the events of September 11. One buyer only wanted to acquire assets, not the stock, of ElectroCo. Interestingly, eight of the 85 firms had previously talked to ElectroCo about a possible merger or acquisition.
Of the buyers who elected not to proceed or move forward, the majority felt that acquiring ElectroCo was just not a good fit. Some of the other reasons why other buyers decided not to continue were:
- Management was too thin
- Since ElectroCo was a good company, the price would most likely be too high
- Buyer purchased another firm
- One potential acquirer was acquired itself
- Buying company was having its own internal problems
- Buyer wanted to move company - this was unacceptable to the seller
After all of this, United Associates arranged five visits for acceptable buyers - the target number. Overall, United received:
- Term Sheets 4
- Verbal Offers 2
- Letters of Intent 4
Of the five buyers who visited the business and met with ElectroCo's management, two wanted to acquire the company. These were the best prospects. There were also two other firms, held in abeyance, in case one of the other two didn't work out. One of the original two and ElectroCo's preferred acquirer offered the desired price and terms. The buyer was:
- A public company that wanted to grow through acquisition.
- One with a synergistic product line.
- Unlike some of the private equity groups, not totally focused on the financial aspects.
- One with an appreciation of ElectroCo's product lines, its technology and the company's potential.
United Associates started with 85 possible buyers. The final list came down to just a few and the September 11 tragedy certainly did not help in the sales efforts. ElectroCo was not a company for just anyone. Despite all of this, United got the deal done - proving once again, that you need only one buyer - the right one!
Representations and Warranties
From the buyer's point of view, "the critical aspect of negotiations is what is stated in the representations and warranties such that the document reflects the following:
- Everything you know, you told us.
- Everything you told us is true.
- Everything you didn't know, you should have known."
Nelson Gifford, former CEO of Dennison Manufacturing Company
Both parties and their advisors must understand that Representations and Warranties are not a measure of anyone's honesty, sincerity or integrity, but a method of allocating some of the risks inherent in any transaction. After all, buyers and sellers are entitled to all the benefits of their bargain - nothing more and nothing less.
In almost any sale of a business, the seller makes certain representations. Their purpose is to insure that the seller, and the buyer, are truthfully and accurately representing themselves and their business. These representations and warranties may focus on various legal, financial or environmental aspects of the sale such as: undisclosed liabilities, pending litigation and tax issues. Their purpose is that the seller is warranting that none of these issues will impede the closing or impact the new ownership. The purchasing entity also represents and warrants, for example, that it has the financial capability to purchase the business. These are usually included in the final agreement between the buyer and the seller. They can be as simple as the seller warranting to the buyer that there is a clear and marketable title to the business being sold.
Representations and warranties can also be a lot more complicated. For example, they may not only contain a warranty or representation, but also provide for a remedy if things aren't as stated or certain future events happen. These are much more important in a stock sale than one of just assets. In the stock sale, the buyer is assuming all of the outstanding issues, risks and, if any, future problems. The seller might warrant that there is no pending litigation and then a disgruntled customer files a post-closing lawsuit. The final agreement might state that an agreed-upon dollar amount would be set aside to cover such contingencies. This remedy is known as an indemnification. The purpose of an indemnification is to provide a solution to a breach of the representations and warranties
Representations and warranties should be discussed and agreed upon in the early negotiations of the sale. These early discussions can clear up future misunderstandings and provide a safety net for both parties. There is probably little point in continuing negotiations if the representations and warranties can't be mutually agreed upon at the outset. Intermediaries generally prefer to get agreement on them prior to a Letter of Intent being prepared. From a seller's standpoint, the company should not be taken off the market prior to a general understanding of the Representations and Warranties.
They are one of the most important aspects of any final agreement. The buyer obviously wants to have as many of them, and as broad in scope, as possible. They create a sort of built-in insurance policy. The seller, on the other hand, would like there to be none, or as few and as restricted as possible.
Problems can develop when the buyer, for example, inserts among the representations and warranties, an item that is open-ended or beyond the seller's control. For example, the seller warrants that there are no equipment leases or equipment rental agreements other than described in Schedule F. The buyer doesn't want to be responsible for any equipment agreements that have not been mentioned. However, the seller wants to limit the company's exposure. Keep in mind that in privately held companies, the owner is usually responsible for any indemnification of the representations and warranties, so he or she is very concerned with them. The seller's lawyer might limit the exposure to a dollar amount along with a time period - say three years. Or, as is most common, the buyer agrees to absorb any of the leases up to a dollar amount, anything over which the seller must cover. This means that if some equipment leases do turn-up after the closing, assuming that there has not been any fraud or deception, the method of handling them has already been covered in the agreement.
This time period on the Representations and Warranties is a big concern for sellers. The time periods for the Representations and Warranties surviving the closing can be a deal-killer in the seller's eyes. How long should a seller be responsible for them? Obviously, this is a critical area and has to be carefully negotiated between the parties. Some that might survive the closing would be matters of litigation, insurance and employee issues. Today, an important post-closing issue can be the intellectual property that may be included in the sale. The buyer entity wants to protect itself from any attack on the ownership of the intellectual property, as it may be a key ingredient of the acquisition. By placing a cap on the dollar amount that the seller and/or his or her company is responsible for and placing reasonable time frames on this section of the agreement can usually resolve this sensitive area.
Sellers often want to couch their Representations and Warranties by using the term material in them. In other words the defect must be material to be considered for any type of remedy. Some sellers even want to limit their exposure by stating that the representation is to the sellers' best knowledge. Experts feel that the buyer is buying the business and anything that makes the deal riskier threatens the sale. The seller's claim that to the best of his knowledge there is no other litigation, except that stated on Schedule K, doesn't provide the buyer the protection that he or she needs. Since the words material or sellers' best knowledge might be considered vague or ambiguous, placing dollar limits can usually resolve them.
What all this means is that the Representations and warranties are a big part of the deal. They should not be left to the last. Many sales have fallen apart because a Representation or Warranty and Indemnification were just not acceptable to the seller, or to the firm's board of directors. The buyer's due diligence should uncover many of the issues that will be subsequently incorporated in the agreement as Representations and Warranties, and be addressed prior to the drafting of the agreement. The drafting of them should be left to the pros.
Too many deals have fallen apart, or been delayed, because the buyer or his advisors decided, at the last minute, to insert a "surprise" representation or warranty, that the seller not only did not agree to, but had not even seen - causing the seller to become disillusioned with the buyer. Representations and Warranties should be discussed early in a transaction, perhaps be part of the deal structure items, and any changes after the due diligence period disclosed (or proposed) well before the final draft of documents is circulated.
Note: The above article is not intended to provide legal advice. It is designed merely to offer some insight into the subject of Representations and Warranties. For more information, the reader is advised to consult an attorney, intermediary or other competent advisor.
Copyright BBP 2003
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Are your workers independent contractors or employees? This is a compelling question, especially where the Internal Revenue Service is concerned. Every worker claiming status as a non-employee means payroll taxes and social security contributions that won't fall into the IRS's pocket.
Now many states are taking a closer look at the question, too. They are increasingly on the lookout for new sources of state revenue, including workman's compensation and unemployment insurance, both of which can be bypassed when a business uses independent workers.
What can a business owner/manager do to keep on the right side of both federal and state tax patrols? Here are a few precautionary steps to safeguard the status of workers as independent contractors.
- Encourage (or at least allow) the worker to provide his own assistants, including their hiring, supervision, and compensation.
- Allow workers to establish their own schedule of work days/hours.
- Be sure that workers provide their own equipment and most supplies.
An alternative may be to use an employee of a temporary service. These services can provide personnel experienced in the job required and, since this worker is actually an employee of the temporary service, all federal and state taxes and fees are handled at that end as well. Although you may pay more for this type of worker, you will avoid concerns about meeting government regulations and restrictions that often come packaged with the independent status. When in doubt, always consult your legal and financial advisors.
Copyright BBP 2003
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In the day-to-day activity of making a business work, many owners overlook the importance of the buy-sell agreement. This document (also referred to as a business continuity agreement) is like a will; no one thinks about it until it's too late. However, it may just be the most important written agreement or document you ever create.
If your business has more than one owner, either partners or stockholders, what happens if one or more of them dies or "wants out"? The same thing holds true in family-owned and operated businesses. A buy-sell agreement can dictate the transfer of business ownership under certain events as described within its specifically-written language.
The well-drafted buy-sell agreement is designed to prevent the following:
- The sale of the company because one of the partners or stockholders desires to exit the business and no one can agree on the price or the terms;
- The necessity to sell or dissolve the business due to the lack of a written agreement determining ownership/management of the business in case of a partner's, stockholder's, or family member's death; (Or, what might prove even worse than a precipitous sale, an heir might decide that he or she is going to get involved in the operation of the business.)
- A lack of agreement on who should take control when an active partner, stockholder, or family member becomes disabled and can no longer run the business;
- A serious dispute on any key issue among the partners, active family members, or stockholders that cannot be resolved; and,
- Questions about business operations following a legally-complicated divorce (or other legal entanglement) involving one of the partners, family members, or stockholders.
The buy-sell agreement can help prevent these situations, as well as many other problems that can befall a business enterprise. In a small business, one of the areas frequently overlooked is the buy-out provision, in the event one of the active partners decides to exit. The buy-sell agreement normally, and properly, provides for the partner, family member, or stockholder to have the first right of refusal in this case. But at what price? If two partners are in disagreement over how to run the business, they will most likely never come to an agreement about its value. A method or formula for valuing the business should be included in the buy-sell agreement; otherwise, the first right of refusal would be no right at all.
In larger businesses, especially those that are incorporated, it is important that the buy-sell agreement specify how the stock of the business should be valued. The agreement should also specify whether the stock must be purchased by the company or its shareholders, or if it can be sold to an outsider. In many cases, life insurance coverage is used to purchase the interest or stock in the business, in the event that one of the partners or majority stock holders dies.
The buy-sell agreement is really the key to the continuation of the business. You can see that the buy-sell agreement, if executed properly, can solve problems surrounding retirement, disability, termination, divorce, bankruptcy, death, and business disputes. Given all the benefits of such an agreement, why doesn't every business have one?
The answer is simple; most business owners are too busy trying to get the work done and the bills paid. Creating such a document means that the owners must stand back from the business and decide what should happen under a variety of serious situations. The process is time-consuming and also expensive. There are no pre-printed forms; it isn't possible simply to fill in the blanks and come up with an instant agreement. A lawyer must do the drafting to get a document that will have legal authority in the event that it is ever challenged.
If your business already has a buy-sell agreement, perhaps it is time to review the document, checking for the need to update or amend it. If your business doesn't have a buy-sell agreement, you should seriously consider creating one. It may be the most important business decision you ever make.
Buy-sell agreements, as well as all of the important documents pertaining to the sale of a business, should be handled by an attorney experienced in such matters. It may seem expensive in the short run, but the careful preparation of any agreement that can affect the rights of the buyer or seller will be a bargain in the long term.
Although business brokers cannot provide legal advice, they are familiar with the intricacies of the business sale. They are also familiar with local attorneys who specialize in the details of these transactions. These attorneys will usually be more efficient, and therefore more cost effective than the attorney who handles a general practice.
Business brokers--because of their knowledge and experience--are a good source of information concerning the buying and selling of businesses. They are conversant with the local marketplace, business prices, and terms. In sum, they are an excellent resource.
Copyright BBP 2003
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One of the most common questions asked by those who have never purchased a business (which is incidentally about 90 percent of those looking to buy a business) is how do you actually buy a business. There is no right or wrong way to buy a business. However, it is important that you get answers to all of your questions and that you have all the information necessary to make an informed decision.
Here are the steps to buying a business that over the years have become the most efficient and practical:
Get the Basic Facts
Get preliminary information on price, terms, income, cash flow, and general location. There is no point in continuing the buying process if the amount of cash necessary to buy the business is more than you are willing to invest. At this point, don't worry about the full price. It's important, but the key factor is the amount of cash that is necessary to buy the business. There is very little outside financing available such as banks, etc., for those who are purchasing businesses. The great majority of business purchases are financed by the seller. This is why the amount you are willing to invest is a key issue.
Also, the business has to be able to meet your basic financial needs. You always expect a business to improve under your ownership, but you have to able to meet your living expenses as well as meet the debt service of the business. It is also important to remember that almost all purchase prices and down payments are negotiable. In fact, businesses generally sell for about 15 percent to 25 percent less than the original asking price. There is an old adage that says, "the more cash you willing to invest in a business purchase, the lower the full price; and the less cash you are able to invest the higher the full price.
Visit the Business
Visit the business to see if you like the location and the looks of the business itself - both inside and outside. This is a visual inspection. Pretend you are a customer. It's not time yet to talk to the owner. If the business is the type that does not lend itself to a visit, make an appointment with the seller to inspect the business, or have the seller's representative schedule a visit. There is no point in going any further if you don't like the physical location of the business or the appearance of it.
Get Questions Answered
If you like the business so far, it's time to get your questions answered. For example: What is the rent? How long is the lease? What have been the sales for the past few years? Can the seller support the figures you have been told? Now is not the time to have the seller's books and records completely checked. There will be plenty of time to do that and review other important issues during the due diligence phase. This is the time to get those questions answered that have a bearing on whether you may want to own and operate this particular business. It is also the time to visit with the seller to get your questions answered about the business itself.
Make an Offer
If you now have your basic questions answered and you want to proceed with purchasing this business, it is time to make an offer, subject, of course, to verification of all the information you have received. The main purpose in making an offer is to see if the seller will accept your terms, price, and structure of the sale itself. Remember, you will have the offer subject to your verification of the important information. It doesn't make sense to employ outside advisors and go through the time and expense of due diligence unless you can come to financial terms with the seller.
Due Diligence
At this point, you hopefully have arrived at a meeting of minds with the seller, and you are ready to begin removing the contingencies, performing what is commonly called due diligence.
*Insider Tip
Unless you are completely familiar with the type of business purchased, it is beneficial to include as part of the agreement that the seller will stay with you (30 days is fair with perhaps another 30 to 60 days of telephone consultation a sufficient length of time to teach you the business - at no charge.) If you want the seller to stay longer, it may be best to offer to pay him or her a consulting fee of some type.
Bring In Outside Advisors
Now is the time to bring in any advisors you may want to use to verify the information about the business. You should know most of the information, but you may want to have an accountant review the figures to verify them. You will want a lawyer to assist you with the legal paperwork and to look out for your interests. Keep in mind that outside advisors will most likely not tell you to go ahead with the purchase. They don't want the responsibility of telling you everything is just fine. And, in fairness, it is a business decision. The accountant can tell you that the numbers are what you thought they were. The lawyer can tell you that the paperwork is fine. If you're convinced that the business is right, you should instruct the attorney to put the deal together unless there is something illegal or unethical about it.
Once all the purchase conditions have been eliminated and the closing papers drawn and approved, it is time for the closing. Now the business is yours - congratulations!
Copyright BBP 2003
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The Letter of Intent has been signed by both buyer and seller and everything seems to be moving along just fine. It would seem that the deal is almost done. However, the due diligence process must now be completed. Due diligence is the process in which the buyer really decides to go forward with the deal, or, depending on what is discovered, to renegotiate the price - or even to withdraw from the deal. So, the deal may seem to be almost done, but it really isn't - yet!
It is important that both sides to the transaction understand just what is going to take place in the due diligence process. The importance of the due diligence process cannot be underestimated. Stanley Foster Reed in his book, The Art of M&A, wrote, "The basic function of due diligence is to assess the benefits and liabilities of a proposed acquisition by inquiring into all relevant aspects of the past, present, and predictable future of the business to be purchased."
Prior to the due diligence process, buyers should assemble their experts to assist in this phase. These might include appraisers, accountants, lawyers, environmental experts, marketing personnel, etc. Many buyers fail to add an operational person familiar with the type of business under consideration. The legal and accounting side may be fine, but a good fix on the operations themselves is very important as a part of the due diligence process. After all, this is what the buyer is really buying.
Since the due diligence phase does involve both buyer and seller, here is a brief checklist of some of the main items for both parties to consider.
Industry Structure
Figure the percentage of sales by product line, review pricing policies, consider discount structure and product warranties; and if possible check against industry guidelines.
Human Resources
Review names, positions and responsibilities of the key management staff. Also, check the relationships, if appropriate, with labor, employee turnover, and incentive and bonus arrangements.
Marketing
Get a list of the major customers and arrive at a sales breakdown by region, and country, if exporting. Compare the company's market share to the competition, if possible.
Operations
Review the current financial statements and compare to the budget. Check the incoming sales, analyze the backlog and the prospects for future sales.
Balance Sheet
Three areas should especially be reviewed. Accounts receivables should be checked for aging, who's paying and who isn't, bad debt and the reserves. Inventory should be checked for work-in-process, finished goods along with turnover, non-usable inventory and the policy for returns and/or write-offs.
Environmental Issues
A new but quite complicated process. Ground contamination, ground water, lead paint and asbestos issues are all reasons for deals not to close, or at best not to close on a timely basis.
Manufacturing
This is where an operational expert can be invaluable. Does the facility work efficiently? How old and serviceable is the machinery and equipment? Is the technology still current? What is it really worth? Other areas such as the manufacturing time by product, outsourcing in place, key suppliers - all of these should be checked.
Trademarks, Patents & Copyrights
Are these intangible assets transferable and whose name are they in. If in an individual name - can they be transferred to the buyer? In today's business world where intangible assets may be the backbone of the company, the deal is generally based on the satisfactory transfer of these assets.
Due diligence can determine whether the buyer goes through with the deal or begins a new round of negotiations. By completing the due diligence process, the buyer process insures, as far as possible, that he or she is getting what they bargained for. The executed Letter of Intent is, in many ways, just the beginning.
Buying a Business - Some Key Considerations
- What's for sale? What's not for sale? Is real estate included? Is some of the machinery and/or equipment leased?
- Is there anything proprietary such as patents, copyrights or trademarks?
- Are there any barriers of entry? Is it capital, labor, intellectual property, personal relationships, location - or what?
- What is the company's competitive advantage - special niche, great marketing, state-of-the-art manufacturing capability, well-known brands, etc.?
- Are there any assets not generating income and can they be sold?
- Are agreements in place with key employees and if not - why?
- How can the business grow - or, maybe it can't!
- Is the business dependent on the owner? Is there any depth to the management team?
- How is the financial reporting handled? Is it sufficient for the business? How does management utilize it?
Copyright BBP 2003
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