Time to Sell Your Business

A Buyer's Quandary

Statistics reveal that out of about 15 would-be business buyers only one will actually buy a business. It is important that potential sellers be knowledgeable on what buyers go through to actually become business owners. This is especially true for those who have started their own business or have forgotten what they went thorough prior to buying their business.

If a prospective business buyer is employed, he or she has to make the decision to leave that job and go into business for and by himself. There is also the financial commitment necessary to actually invest in a business and any subsequent loans that are a result of the purchase. The new owner will likely need to execute a lease or assume an existing one, which is another financial commitment. These financial obligations are almost always guaranteed personally by the new owner.

The prospective business owner must also be willing to make that "leap of faith" that is so necessary to becoming a business owner. There is also the matter of family and personal responsibilities. Business ownership, aside from being a large financial consideration, is very time consuming, especially for the new business owner.

All of these factors have to be weighed very carefully by anyone that is considering business ownership. Buyers should think carefully about the risks - and the rewards. Sellers should also put themselves in a buyer's position. The services of a professional business broker or intermediary can help determine the relative pros and cons of the transaction.

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A Few Things to Consider

Buyers Want Cash Flow

The first thing to keep in mind is that the vast majority of buyers want to buy cash flow. Sit down with your accountant or bookkeeper and begin to get your financial statements in order with cash flow the order of business. Cash flow is not the same thing as profit. Most buyers look at the profit and loss statement or tax return, and look at owners or family compensation. They will consider any excess compensation to employees and family members. Buyers will also look at large one-time expenses such as a new computer system, or remodeling. They will consider non-cash items like depreciation and amortization. Interest expenses will be reviewed, as will owner perquisites. These are items that a professional business broker considers when advising a selling client on a suggested selling price.

Appearances Do Count

The time to replace that old worn-out piece of equipment is before you decide to sell. Don't assume that a new owner will want to do it or that the price will be slightly lower because you haven't replaced it. The time to "spiff up" the business is now, even if you aren't selling. Fix the sign, replace the carpet, paint the place - make it look good. Even if you're not selling, it's just plain good for business, and you never know when the time to sell occurs. Keep-in-mind that anything that increases sales also increases profits and the all-important cash flow!

Everything has Value

There are other things that add value to your business. Don't discount the value of customer lists, proprietary products and/or techniques, well-maintained equipment, secret recipes, customized software programs, or good employees. These are termed "off-balance sheet items," and although not used in most pricing models, they add to value. Look at your business very carefully so you don't overlook those items that make your business more attractive to the buyer.

Eliminate the Surprises

Long before you put your business on the market -- eliminate the surprises! Review every facet of the business and remedy any problems that could appear during the sale process. No one likes surprises -- most of all potential buyers. Whether legal, accounting, environmental, or anything else - solve it now.

We as professional business brokers can assist you in the planning process. We know what buyers are looking for and are familiar with current market conditions.

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A Lease Primer

The following is provided as a simple explanation of common leasing arrangements within small business transaction. it not intended to provide legal advice.>

The New Lease

A new lease is created generally when the prior lease has expired or is about to and when there are going to be substantial changes to the existing lease. A new lease would be executed between the purchaser of the business and the landlord. It is a new document either drafted by an attorney or used in a standard form that is available at stationery stores and in many books. A new lease involves negotiations between the owner or purchaser of the business and the landlord.

The Sub-Lease

A sub-lease is nothing but a lease within a lease. For example, if the seller of a business is permitted to sub-lease the premises, he or she, as far as a new owner is concerned, is the landlord. In this case, the actual landlord is still dealing with the seller and has no relationship with the buyer. Obviously, the seller needs the permission of the landlord or lessor to assign or sub-lease.

The Assignment of the Existing Lease

This is the most common form of allowing a buyer the use of the premises in which the business is located. In an assignment, the seller is "assigning" all rights to the existing lease to the new buyer. Once the assignment is executed, the seller usually has no more rights in that lease. However, in most assignments, the landlord reserves "all rights" in the lease. In other words, the seller, who may be a tenant or an assignee, is still responsible to the landlord if the buyer does not perform.

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Buyer Introduction

Going into business for yourself is a big step, one that can be full of apprehension and even fear. Almost 90 percent of all those who purchase a small business have never owned a business. Most of them bought a business that was different than what they had been looking for. These business buyers had the opportunity to explore the marketplace and subsequently found a business more to their liking. In most cases, the seller financed the sale of his or her business.

As you begin your search for a business, keep in mind that running your own business is more than a job; it is a lifestyle change. In most cases, it is a very big lifestyle change. Usually, you will be working longer hours, you will be making all of the decisions - and, as the expression says, "you will be the chief cook and bottle washer." In other words, you will be doing all of the work from running the business to, in may cases, sweeping the floor and changing the light bulbs. Most buyers are looking for many of the following in considering the purchase of a business:

Pride in the service or the product
Flexibility
Income
Control of your own destiny
Recognition
Security
Privacy
Status
Customer and employee contact

WHAT TO LOOK FOR

1. How long the business has been in business.

A business with a long track record means there are good reasons for that business to be operating. It will be well known in the area, and people will be used to patronizing the business or using its services. The longer it has been in operation, generally, the better the business.

2. How long the present owner has owned the business.

The longer the present owner has been in business, the more likely he or she has been successful. People don't stay in business if they are not making money.

3. Why the present owner is selling.

If the owner of a business has been in business for six months, is 37 years old and wants to retire, you should be suspicious. The more valid the reason for sale, the more realistic the seller will be in considering your offer. However, keep in mind that after five or six years or more, people do get restless or "burn-out" sets in, or people look for new challenges. Why the seller is selling is an important question - get the answer.

4. Why Books and Records are important.

The financial records of the business are a good indication of how well the business has been doing over the years. Keep in mind that tax records are not designed to show the business in the best light: no one likes to pay more taxes than they have to, and owners of businesses are no different. Generally, tax returns are a worst case scenario. You need to be able to look at the expenses and discover which ones are non-cash items, such as depreciation, and business use of home and vehicles. How important was the business trip to Las Vegas? A professional business broker can point these items out to you. When in doubt, however, seek outside assistance.

Keep in mind that financial records are only history. There are no guarantees that they will or can be duplicated or repeated. All of your profits are future. In the final analysis, the financial records of the business are an indicator of what the business has done; what you do with its future is up to you.

5. How to determine if the seller is reporting all income.

The simple answer is - that you can't! Not reporting income is against the law. You should consider only the income that the seller can show you. We all know, of course, especially in cash type businesses, there is the possibility that the seller is not reporting all of his or her income for tax purposes. This "underground economy" has been well-documented and is in the billions of dollars. Many sellers will tell you about how much they are "skimming," but you should ignore their statements, since they have no way of proving these amounts. In determining whether a business is the right one for you, you should base the decision on the figures actually supplied to you by the seller.

THE BOTTOM LINE

Being in business for yourself can be a daunting prospect. There are no guarantees. At some point, after all of your investigation is completed, you will still have to make that "leap of faith" that is necessary to proceed with the purchase of the business. You will have to work hard, perhaps even "tighten your belt" a little and perform many different jobs to be successful in your own business. But, if running your own show, making your own decisions, not having to worry about job security (remember, no one can fire you from your own business), and just being on your own are important - then owning a business is for you. After taking this leap of faith, almost all business owners will tell you that they would never go back to being an employee.

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Buyer Types

The strategic buyer is one engaged in a similar or related business to the one being purchased. Generally, the strategic buyer is willing to pay the highest price since it provides a quick entry to a related business. Buying a business is much easier than trying to replicate it.

The competitive buyer offers a lot of synergies that can reduce costs and perhaps increase market share - which also obviously reduces competition. However, this is a less popular type of buyer because sellers are usually reluctant to approach the competition.

The financial buyer brings little, if any, synergy to the deal. However, these buyers do bring financial knowledge and use it to increase the profits of the business. They generally make changes and work to increase the value in order to sell it at a profit in five to seven years. The financial buyer almost always insists on owning 100 percent of the acquired business.

The overseas buyer can be difficult to find, and usually wants to acquire larger companies. This type may look at a smaller firm if they feel that it provides an entry to the U.S. market, and will pay well for such a company.

A customer, vendor or supplier is also a possible acquirer, but vertical integration is not perceived as a viable acquisition strategy today.

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Buyers and Sellers -
What to Expect from a Business Broker?

Anyone who is considering selling - or - buying a business wants to know the advantages of using the services of a business broker. They also want to know what to expect from using their services.

From the Seller's Viewpoint

Let's look at these questions from the seller side first. In most cases, the business broker is listing the business for sale. In most cases the business broker is representing the seller and is duty-bound to represent the seller honestly and fairly. A business broker is also charged with trying to get the highest possible price - and the best deal - for the seller. However, sellers must understand that, no matter how hard the business broker tries, it is the marketplace that ultimately determines the price and terms - not the business broker or the seller.

The business broker will keep the seller informed, on a regular basis, of the status of the listing and will do everything possible to maintain the confidentiality concerning the sale of the business. However, selling a business is a two-way street and requires cooperation on both sides - seller and business broker. The broker needs to be kept aware of current information regarding the business, such as sales trends, major equipment purchases, inventory fluctuations and the like. The broker and the seller must work together; they are on the same side, and they should work as a team.

In some states, business brokers act as transaction brokers. They do not represent anyone; instead, they work for the transaction - their job is to make the sale work and go together. Despite the fact that they may not represent either buyer or seller, they still must treat both sides honestly and fairly.

Although in most states, the business broker does represent the seller, he or she must still deal honestly and fairly with the buyer.

From the Buyers Viewpoint

The advantages of a buyer in working with a business broker are the many opportunities that can be presented to the buyer. Many buyers may think they want a certain kind of business, but, in fairness, they have no idea of the various businesses that may be available.

No one likes to waste their time, and business brokers can show buyers businesses that fit their pocketbook and still can provide the necessary income to provide for their families. Buyers want candor in the presentation of the business. The business broker is an intermediary - he or she can resolve issues and misunderstandings easily and quickly.

Professional business brokers bring value to the process of buying and selling businesses. They understand the issues and the details involved in the business transaction. They have the knowledge and experience to bring the sale to a successful close. If the buyer and seller are honest with the business broker - a win-win situation will result. In return, business brokers need a seller who is really a seller and a buyer who is really a buyer. Buyers and sellers should have high expectations about what the business broker can offer. At the same time, the business broker has the right to have the same expectations from them.

Almost all businesses include all of the following:

Fixtures and equipment
Inventory (or stock-in-trade)
Goodwill (the reasonable expectation of future profits)
Lease
Leasehold improvements

In addition, it is possible that a business might include one or more of the following:

A franchise
Customer and/or mailing lists
Patents/copyrights
Secret recipes
Proprietary software or other technology

All of these components, and others, may have a positive or negative affect on the asking, and ultimate, selling price of the business.

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Buying (or Selling) a Business

The following is some basic information for anyone considering purchasing a business. Is may also be of interest to anyone thinking of selling their business. The more information and knowledge both sides have about buying and selling a business, the easier the process will become.

A Buyer Profile

Here is a look at the make-up of the average individual buyer looking to replace a lost job or wanting to get out of an uncomfortable job situation. The chances are he is a male (however, more women are going into business for themselves so this is rapidly changing). Almost 50 percent will have less than $100,000 in which to invest in the purchase of a business. More than 70 percent will have less than $250,000 to invest. In many cases the funds, or part of them, will come from personal savings followed by financial assistance from family members. He, or she, will never have owned a business before. Despite what he thinks he wants in the way of a business, he will most likely buy a business that he never considered until it was introduced, perhaps by a business broker.

His, or her primary reason for going into business is to get out of his or her present situation, be it unemployment, job disagreement, or dissatisfaction. The potential buyer now wants to do their own thing, be in charge of their own destiny, and they don't want to work for anyone. Money is important but it's not at the top of the list, in fact, it is probably fourth or fifth on their priority list. In order to pursue the dream of owning one's own business, the buyer must be able to make that "leap of faith" necessary to take the plunge. Once that has been made, the buyer should review the following tips.

Importance of Information

Understand that in looking at small businesses, you will have to dig up a lot of information. Small business owners are not known for their record-keeping. You want to make sure you don't overlook a "gem" of a business because you don't or won't take the time it takes to find the information you need to make an informed decision. Try to get a understanding of the real earning power of the business. Once you have found a business that interests you, learn as much as you can about that particular industry.

Negotiating the Deal

Understand, going into the deal, that your friendly banker will tell you his bank is interested in making small business loans; however, his "story" may change when it comes time to put his words into action. The seller finances the vast majority of small business transactions. If your credit is good, supply a copy of your credit report with the offer. The seller may be impressed enough to accept a lower-than-desired down payment.

Since you can't expect the seller to cut both the down payment and the full price, decide which is more important to you. If you are attempting to buy the business with as little cash as possible, don't try to substantially lower the full price. On the other hand, if cash is not a problem (this is very seldom the case), you can attempt to reduce the full price significantly. Make sure you can afford the debt structure--don't obligate yourself to making payments to the seller that will not allow you to build the business and still provide a living for you and your family.

Furthermore, don't try to push the seller to the wall. You want to have a good relationship with him or her. They will be teaching you the business and acting as a consultant, at least for a while. It's all right to negotiate on areas that are important to you, but don't negotiate over a detail that really isn't key. Many sales fall apart because either the buyer or the seller becomes stubborn, usually over some minor detail, and refuses to bend.

Due Diligence

The responsibility of investigating the business belongs to the buyer. Don't depend on anyone else to do the work for you. You are the one who will be working in the business and must ultimately take responsibility for the decision to buy it. There is not much point in undertaking due diligence until and unless you and the seller have reached at least a tentative agreement on price and terms. Also, there usually isn't reason to bring in your outside advisors, if you are using them, until you reach the due diligence stage. This is another part of the "leap of faith" necessary to achieve business ownership. Outside professionals normally won't tell you that you should buy the business, nor should you expect them to. They aren't going to go out on a limb and tell you that you should buy a particular business. In fact, if pressed for an answer, they will give you what they consider to be the safest one: no. You will want to get your own answers--an important step for anyone serious about entering the world of independent business ownership.

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Buying a Franchise? What It's Worth To You

If you are considering entering the world of franchising, an important consideration is assessing the value of the business. All of the following factors either affect or help determine valuations of typical franchise operations:

1. Franchise Agreements:

Typically, franchise agreements can cover a period of twenty years; sometimes with added options. In most situations where a franchise unit has fewer than ten years remaining on the agreement (and options, if any), the value would diminish proportionately.

2. Territory Exclusivity:

Many franchisors do not, as a matter of course, provide an "exclusive" to franchisees within a given territory. More commonly, however, the franchisor will offer a franchisee limited protection for five years, during which time only he or she will be allowed to expand operation to additional units. Even limited protection can be assigned some value; any current territorial rights may have additional -- and significant -- value.

3. Business Hours:

Potential franchisees should consider operating hours when assessing the value of a business. Business in general, and franchise operations in particular, are staying open for increasingly longer periods -- some operate 24 hours a day, seven days a week. Locations in certain areas -- city centers, bus stations, train depots -- may open for shorter hours and fewer days. Since most business owners/managers would prefer the less demanding hours of operation, a premium value will be placed on these units.

4. Location:

This is the most obvious variable. A franchise operation in a suburban or small-town setting has a higher value than one in an inner-city or high-crime-rate area, regardless of other similarities (rent, sales volume, etc.).

5. Cash Flow:

Surprisingly, profitability may not necessarily be the key factor in valuing a franchise operation. A demonstrated, well-documented cash flow can definitely add value to the unit; however, the smart buyer will also look at other variables, such as unusually low food cost or labor costs, sales history, and potential for growth or improvement under new management in determining the overall value. Extreme situations provide the obvious exceptions to importance of cash flow: where the cash flow is extraordinarily high, capitalization of earnings becomes a truer method of valuation; case where the franchise is actually losing money due to inefficient management, would indicate some reduction in value.

6. Leases:

Taking into consideration market variation, the typical rent will be set at approximately ten percent of retail sales. Modifications in value could result if the lease does not cover a period of at least ten years.

7. Remodeling:

Many franchise agreements will require units to be refurbished within a certain number of years (ten is typical), with the franchisee bearing the cost. Since these costs typically fall within a range from $75,000 to $150,000, potential franchisees should pay particular attention to where the operation stands on this timeline. For example, a unit due for remodeling in a year or less could be reduced in value by a fair percentage of the cost of the improvements. The total cost would not be deducted from the value, since these improvements would also be expected to improve business anywhere from five to twenty-five percent.

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Buying Your Own Business:

Important Issues To Understand

Buying your own business can be a complicated procedure. Throughout the buying process, it's important to keep an open mind while searching for a business that will fit your needs, talents, skills and lifestyle. A business broker has many different types of businesses for you to consider; however, you need to remember that there is no such thing as that "perfect" business. Another vital thing to keep in mind is that at some point you must be able to make the "leap of faith" that separates you from being a "looker" to a "doer." This isn't easy, but it must happen if you are ever going to be in business for yourself. The following discussion of other key issues may help in the process:

Importance of Information

Understand that in looking at small businesses, you will have to dig out a lot of information. Small business owners are not known for their record-keeping. You want to make sure you don't overlook a "gem" of a business because you don't or won't take the time it takes to dig out the information you need to make an informed decision. Try to get a understanding of the real earning power of the business. Once you have found a business that interests you, learn as much as you can about that particular industry.

Negotiating the Deal

Understand, going into the deal, that your friendly banker will tell you his bank is interested in making small business loans; however, his "story" may change when it comes time to put his words into action. The vast majority of small business transactions are financed by the seller. If your credit is good, supply a copy of your credit report with the offer. The seller may be impressed enough to accept a lower-than-desired down payment.

Due Diligence

The responsibility of investigating the business belongs to the buyer. Don't depend on anyone else to do the work for you. You are the one who will be working in the business and must ultimately take responsibility for the decision. There is not much point in undertaking due diligence until and unless you and the seller have reached at least a tentative agreement on price and terms. Also, there usually isn't reason to bring in your outside advisors, if you are using them, until you reach the due diligence stage. This is another part of the leap of faith necessary to achieve business ownership. Outside professionals normally won't tell you that you should buy the business, nor should you expect them to. They aren't going to go out on a limb and tell you that you should buy a particular business; in fact, if pressed for an answer, they will give you what they consider to the safest one: no. You will want to get your own answers--an important step for anyone serious about entering the world of independent business.

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Buying Your Own Lifestyle

How about a quaint bookstore in a small village? Or maybe a lovely country inn nestled in the mountains? Perhaps a travel agency--with all those great trips--might sound appealing. Buying a business, no matter what it is, is also buying a lifestyle. What better time to make a lifestyle change than when one is considering the purchase of a business? If you want to move to the mountains, a small town or even right into the middle of the city--you can do it when you buy a business.

Most buyers of businesses, when asked why they want to buy a business or go into business for themselves, state that they want to control their own destiny or don't want to work for anyone else. Making more money is far down the list. In fact, most buyers who have left the more lucrative corporate world claim that they would never go back to it. Although most buyers would probably not admit it, the decision to buy a business is primarily a lifestyle choice. In this context, the type of business or the geographical place is immaterial--it's the switch from job-holder to business owner that is the dramatic change. Just giving up the "frequent flyer" out-of town trips and the constant meetings may be a lifestyle change for many. One buyer said that he saved 1000 hours a year by adding up the cost of commuting and time spent in meetings. For many new business owners, the lifestyle change becomes more important than money.

Sellers of businesses should keep in mind, however, that a lifestyle business is determined by the buyer--not the seller. It is the buyer's perception that gives a business its "lifestyle" quality. No matter how quaint your bookstore may be, buyers are not going to overlook the basics they expect to find before even thinking about the style of life it might provide. Buyers are still going to look at:

Is there enough cash flow to cover the debt service?
Is there also enough to pay a reasonable salary to the owner?
Is there some left over to provide a fair return on assets and the buyer's investment?

Furthermore, there are other considerations. Some typical lifestyle businesses--the country inn or bed and breakfast, for instance--may be real estate driven. That is, the real estate contains the real value of the business; the real profit lies in the equity in the real estate and its possible appreciation. Therefore, in considering these types of businesses, the buyer may be willing to overlook some of the items listed above. The lifestyle decision may outweigh the normal return a prospective buyer expects of a business. There are those who are willing to make less money or overpay for some lifestyle businesses.

Obviously, it could be said that every business offers a lifestyle opportunity for someone. However, only those businesses where there is sufficient buyer interest can qualify as those lifestyle businesses for which buyers are willing to accept lower returns or even to overpay. Again, sellers would do well to remember that lifestyle is in the "eyes of the beholder."

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Common Buyer Questions

Why Should I Buy A Business Rather Than Start One?

An existing business has a track record. The failure rate in small business is largely in the start-up phase. The existing business has demonstrated that there is a need for that product or service in a particular locale. Financial records are available along with other information on the business. Most sellers will stay and train a new owner and most will also supply financing. Finding someone who will teach you the intricacies of running a business and who is also willing to finance the sale can make all the difference.

What Is The Real Reason People Go Into Business For Themselves?

There have been many surveys taken in an attempt to answer this question. Most surveys reveal the same responses, in almost the same identical order of priority. Here are the results of a typical survey, listed in order of importance:

To do my own thing, control my own destiny.
Don't want to work for someone else.
To better utilize my skills and abilities.
To make money.

*It is interesting to note that money is not at the top of the list, but comes in fourth.

How Are Businesses Priced?

Generally, at the outset, a prospective seller will ask the business broker what he or she thinks the business will sell for. The business broker usually explains that a review of the financial information will be necessary before a price or a range of prices can be suggested for the business.

Most sellers have some idea about what they feel their business should sell for - and this is certainly taken into consideration. However, the business broker is familiar with market considerations and, by reviewing the financial records of the business, can make a recommendation of what he or she feels is what the market will dictate. A range is normally set with a low and high price. The more cash demanded by the seller, the lower the selling price; the smaller the cash requirements of the seller, the higher the price.

Since most business sales are seller-financed, the down payment and terms of the sale are very important. In many cases, how the sale of the business is structured is more important than the actual selling price of the business. Too many buyers make the mistake of being overly-concerned about the full price when the terms of the sale can make the difference between success and failure.

An oft-quoted anecdote may better illustrate this point: If you could buy a business that would provide you with more net profit than you thought possible even after subtracting the debt service to the seller, and you could purchase this business with a very small down payment, would you really care what the full price of the business was?

What Should I Look For?

Obviously, you want to consider only those businesses that you would feel comfortable owning and operating. "Pride of Ownership" is an important ingredient for success. You also want to consider only those businesses that you can afford with the cash you have available. In addition the business you buy must be able to supply you with enough income - after making payments on it - to pay your bills.

However, you should look at a business with an eye toward what you can do with it - how you can improve it and make it more productive and profitable. There is an old adage advising that you shouldn't buy a business unless you feel you can do better than the present owner. Everyone has seen examples of a business that needs improvement in order to thrive, and a new owner comes in and does just that. Conversely, there are also cases where a new owner takes over a very successful business and not soon after, it either closes or is sold. It all depends on you!

What Does It Take To Be Successful?

Certainly, you need adequate capital to buy the business and to make the improvements you want, along with maintaining some reserves in case things start off slowly. You need to be willing to work hard and, in many cases, to put in long hours. Unfortunately, many of today's buyers are not willing to do what it takes to be successful in owning a business. A business owner has to, as they say, be the janitor, errand boy, employee, bookkeeper and "chief bottle washer!" Too many people think they can buy a business and then just sit behind a desk and work on their business plans. Owners of small businesses must be "doers."

What Happens When I Find A Business I Want To Buy?

When you find a business, the business broker will be able to answer many of your questions immediately or will research them for you. Once you get your preliminary questions answered, the typical next step is for the broker to prepare an offer based on the price and terms you feel are appropriate. This offer will generally be subject to your approval of the actual books and records supporting the figures that have been supplied to you. The main purpose of the offer is to see if the seller is willing to accept the price and terms you offered.

There isn't much point in continuing if you and the seller can't get together on price and terms. The offer is then presented to the seller who can approve it, reject it, or counter it with his or her own offer. You, obviously, have the decision of accepting the counter proposal from the seller or rejecting it and going on to consider other businesses.

If you and the seller agree on the price and terms, the next step is for you to do your "due diligence." The burden is on you - the buyer - no one else. You may choose to bring in other outside advisors or to do it on your own - the choice is yours. Once you have checked and approved those areas of concern, the closing documents can be prepared, and your purchase of the business can be successfully closed. You will now join many others who, like you, have chosen to become self-employed!

Why Should I Go To A Business Broker?

A professional business broker can be helpful in many ways. They can provide you with a selection of different and, in many cases, unique businesses, including many that you would not be able to find on your own. Approximately 90 percent of those who buy businesses end up with something completely different from the business that they first inquired about. Business brokers can offer you a wide variety of businesses to look at and consider.

Business brokers are also an excellent source of information about small business and the business buying process. They are familiar with the market and can advise you about trends, pricing and what is happening locally. Your business broker will handle all of the details of the business sale and will do everything possible to guide you in the right direction, including, if necessary, consulting other professionals who may be able to assist you.

Your local professional business broker is the best person to talk to about your business needs and requirements.

Do I Need An Attorney?

It may be advisable to have an attorney review the legal documents. It is important, however, that the attorney you hire is familiar with the business buying process and has the time available to handle the paperwork on a timely basis. If the attorney does not have experience in handling business sales, you may be paying for the attorney's education. Most business brokers have lists of attorneys who are familiar with the business buying process. An experienced attorney can be of real assistance in making sure that all of the details are handled properly. Business brokers are not qualified to give legal advice.

However, keep in mind the fact that many attorneys are not qualified to give business advice. Your attorney will be, and should be, looking after your interests; however, you need to remember that the seller's interests must also be considered. If the attorney goes too far in trying to protect your interests, the seller's attorney will instruct his or her client not to proceed. The transaction must be fair for all parties. The attorney works for you, and you must have a say in how everything is done.

If you know someone who has owned their own business for a period of time, he or she may also be a valuable resource in answering your questions about how small business really works.

You have to make the final decision that "leap of faith" between looking and actually being in business for yourself is a decision that only you can make!

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Dispelling a Buyer Myth

Most prospective business buyers really don't know from the outset the exact type of business they want to buy. Experienced business brokers and intermediaries know that many business buyers end up with what is sometimes a far cry from what first captured their imagination.

Take, for example, the old story of the buyer who saw (and probably smelled) a doughnut shop in his business dreams. This was the business he was sure he wanted to own and operate - until he discovered that someone, most likely him, had to get up at 3 a.m. to make the day's baked goods. It is important that, before making the dream a reality, those prospective buyers understand just what the business is and how it fits their personalities - what they want to do and what they don't want to do! Obviously, if getting a good night's sleep is important, owning a doughnut shop is not a good idea.

In searching for a right business, here are some of the crucial questions a prospective business buyer might ask himself or herself:

Does the business look exciting and interesting to me?
Do I feel that I can improve the business?
Would the business offer me pride of ownership?
Would I feel comfortable operating the business?

Professional business brokers can offer many different businesses for a prospective buyer to consider. Prospective business buyers can discuss their needs and wishes with a professional business broker who can then show them opportunities that they might never discover on their own.

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Dispelling Buyer Myths:
What Do They Really Want and Why?

Myth Number One

It's a faulty assumption that prospective business buyers know from the outset the exact kind of business they want to buy. Experienced business brokers and intermediaries have learned that most business buyers end up with what is sometimes a far cry from what first captured their imagination.

Take, for example, the old story of the buyer who saw (and probably smelled) a doughnut shop in his dreams. This was the business he was sure he wanted to buy--until he found out that someone, most likely him, had to get up at 2 a.m. to make the doughnuts a reality. It is important that, before falling in love with a business dream, prospective buyers understand the realities and think hard about their own personalities--what they like and hate to do. Obviously, if one likes a good night's sleep, the doughnut shop is not a good business to go into.

In discovering the right business for the right personality, here are some of the crucial questions a prospective business buyer might ask himself or herself:

Does the business look exciting and interesting to me?
Do I feel that I can improve the business?
Would the business offer me "pride of ownership"?
Would I feel comfortable operating the business?

Myth Number Two

Another wrong theory about buyers is that money is the key motivator in their seeking to own their own business. In fact, if money is a buyer's main reason for desiring to own a business, a "wrong-move" alarm should go off before things go any further. Most studies indicate that money is somewhere below the midway point of the list of reasons people are interested in a self-owned business. Those who go into business for themselves and/or buy a business want to run their own "show," be their own boss and build something for themselves. Money is the by-product (hopefully) of having the opportunity to achieve business success on their own terms.

A recent newsletter from a franchise consulting company contains comments from people who have just purchased franchises. These people provide resounding proof that money is not a major motivator. With franchises, they point out, money can't be an issue, because a new franchise has no income, only the promise of it.

If money doesn't provide the driving force behind buying a business--what does? The following survey shows the real reasons for wanting to be a part of the independent business scene:

Pride in service or product
Control
Freedom
Flexibility
Self-reliance
Customer contact
Income
Employee contact
Recognition
Privacy
Security
Status

No matter what the reason for buying a business and regardless of the type of business desired, savvy prospective buyers seek help from a business intermediary throughout the buying process. Although business brokers generally represent the seller, the buyer also reaps the benefits of expert guidance. The business broker will show the buyer businesses that fit the profile of the buyer's "dream," but the broker will also introduce the buyer to new territory--and new possibilities.

And what about the buyer who dreamed of doughnuts? He is purportedly now content, testing the wares in the mattress section of his franchise furniture store.

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Early Possession

There are times when the buyer and seller think it would be a great idea if the buyer began operation of the business prior to the closing of the sale. Why? Here are some typical reasons:

The buyer needs the income.
The seller has really "had it."
The time it takes to close a deal has been excessively long.
The seller is in poor health and can't operate the business (or something similar.)
The buyer feels the business is deteriorating and wants to get in before it all goes.

So, analyzing the reasons above for early possession, does the end justify the means? The answer is a resounding NO. Sellers (who often are as enthusiastic about early possession as the buyer) should remember that the sale hasn't closed yet and the buyer may still have second thoughts. Early possession can create a real obstacle to a closing, whether it's real estate, a business, or almost any other commodity. It makes good business sense to let the early possession "idea" remain just that: an idea and nothing more.

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For Business Buyers and Sellers:

A Guide

Your best guide for buying or selling a business isn't words on paper--it's the competent presence of a business broker. Although business brokers generally represent the seller, the buyer also reaps the benefits of expert guidance. A business broker provides vital services for both parties and acts as the "glue" for holding together the pieces of the business sale process. Here's how a business broker will work with both the buyer and the seller:

The Business Broker and the Buyer

Business brokers prefer to talk to people in person, and the buyer is no exception. During a preliminary meeting in the business brokerage office, the broker will typically ask the prospective buyer questions such as these:

Do you have the necessary funds to buy a business?
Is the cash readily available?
3. What is your time-frame for buying a business?
What are your expectations about the purchase of a business?

After this fact-finding meeting, the broker can then show the buyer businesses that are both feasible and that fit the buyer's requirements. Further steps the broker will lead the buyer through are as follows:

Since sellers are (rightly) concerned about confidentiality, the broker will ask the prospective buyer to sign a non-disclosure or confidentiality agreement.
The broker will provide the prospective buyer with preliminary information about one or more businesses, including pertinent financial data.
The broker will arrange for the buyer to see businesses of interest.
Once the buyer has indicated strong interest in a particular business, the broker can then supply additional information and schedule further on-site appointments.
When the buyer is ready, the business broker will be the best source for answering questions, addressing concerns, resolving loose ends, and offering a business broker's unique expertise in the business sale transaction.

The Business Broker and the Seller

When it comes time to sell, one of the best decisions a business owner can make is to continue managing his or her business efficiently (and profitably), while depending on the services of a business broker to orchestrate the steps of the sale. To make the seller's job easier and more effective, the business broker will...

...Determine the right buyer for a particular business.

For locating and qualifying prospective buyers, a business broker uses computerized databases to access comprehensive lists of local, national, and international buyers--all to increase the chances of selling a business at peak value.

...Advise the seller on pricing.

The business broker is an expert in placing a realistic price on the business and incorporating intangibles; thus reducing the danger that every seller fears--under-pricing the business. At the same time, the business broker can help the seller to understand that the selling price is dictated by the marketplace--not by a well-meaning accountant or friend who may have an unrealistic idea of what the business is worth.

...Prepare a marketing strategy

and offer advice about essential marketing tools, such as a business description memorandum; in fact, the broker will help the seller in all key aspects of presenting the business as effectively as possible. Later, the broker can also help in the structuring of the sale transaction.

...Present offers and point out both strengths and weaknesses.

The business broker will be a vital advisor during most stages of the negotiation, bringing to "the table" objectivity as well as negotiation skills developed through years of experience in the buying and selling of businesses

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Looking At The Numbers

What Should You Look For When Considering a Business to Purchase? Unfortunately, too many prospective buyers want to know the asking price first and then how much money can they make. These are the wrong questions to ask initially. You need to know how much cash the seller requires as a down payment. There is no point in looking at a business no matter how good the numbers are if the seller wants three times as much cash as you are willing to invest.

Remember the actual amount of money a business earns is usually much more than just the bottom line. A smart approach is to get more information on the business, and even make a visit, before ruling it out or getting too involved in the numbers. It's all part of the learning process.

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Negotiating the Price Gap Between Buyers and Sellers

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.

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Secrets to Closing the Sale Successfully

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.

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Strong Selling Points:
Let Your Strengths Work for You

"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 phrasedefine 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.

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Success in the 21st Century:
Do You Have What It Takes?

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.

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The Anatomy of a Deal

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.

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The Big Question:
Independent versus Employee Status

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.

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The Buy-Sell Agreement:
No Business Should Be Without One

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.

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The Buying Process

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!

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The Deal Is Almost Done - Or Is It?

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?

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The Entrepreneur:

Both Sides

Strong Points

Flexible and positive attitude
Creative and comfortable with risk-taking
Goal-focused and committed to success
Organized
Energetic

Weak Points

Impatient with achieving goals
Distractible; tolerant of interruptions
Distrustful of "the new" (especially technology)
Tendency to stray from business plan
Failure to delegate authority and tasks

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The Pre-Sale Business Tune-up

Sellers are often asked, "do you think you will ever sell your business?" The answer varies from, "when I can get my price" to "never" to "I don't really know" to everything in between. Most sellers may think to themselves when asked this question, "I'll sell when the time is right." Obviously, misfortune can force the decision to sell. Despite the questions, most business owners just go merrily along their way conducting business as usual. They seem to believe in the old expression that basically states, "it is a good idea to sell your horse before it dies."

Four Ways to Leave Your Business

There are really only four ways to leave your business. (1) Transfer ownership to your children or other family members. Unfortunately, many children do not want to become involved in the family business, or may not have the capability to operate it successfully. (2) Sell the business to an employee or key manager. Usually, they don't have enough cash, or interest, to purchase the business. And, like offspring, they may not be able to manage the entire business. (3) Selling the business to an outsider is always a possibility. Get the highest price and the most cash possible and go on your way. (4) Liquidate the business - this is usually the worst option and the last resort.

When to Start Working on Your Exit Plan

There is another old adage that says, "you should start planning to exit the business the day you start it or buy it." You certainly don't want to plan on misfortune, but it's never to early to plan on how to leave the business. If you have no children or other relative that has any interest in going into the business, your options are now down to three. Most small and mid-size businesses don't have the management depth that would provide a successor. Furthermore liquidating doesn't seem attractive. That leaves attempting to find an outsider to purchase the business as the exit plan.

The time to plan for succession is indeed, the day you begin operations. You can't predict misfortune, but you can plan for it. Unfortunately, most sellers wait until they wake up one morning, don't want to go to their business, drive around the block several times, working up the courage to begin the day. It is often called "burn-out" and if it is an on-going problem, it probably means it's time to exit. Other reasons for wanting to leave is that they face family pressure to start "taking it easy" or to move closer to the grandkids.

Every business owner wants as much money as possible when the decision to sell is made. If you haven't even thought of exiting your business, or selling it, now is the time to begin a pre-exit or pre-sale strategy.

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The Serious Buyer

A serious buyer should have the answers to the following questions:

Why are you considering the purchase of a business at this time?
What is your time-frame to find a suitable business?
Are you open-minded about different opportunities, or are you looking for a specific business?
Have you set aside an amount of capital that you are willing to invest?
Do you really want to be in business for yourself.
Are you currently employed or unemployed?
Are you the decision maker or are there others involved?

The real key to being a serious buyer, however, is whether you can make that "leap of faith" so necessary to the purchase of a business. No matter how much due diligence a buyer performs, no matter how many advisors there are to advise the buyer, at some point, the buyer has to make a leap of faith to purchase the business. There are no "sure things" and there are no guarantees - if a buyer is not comfortable being in business, he or she should not even contemplate buying a business.

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The Small Business Market:

Reading Between the 'Negative' Lines*

Experienced buyers of large businesses have tended to spurn the smaller business, citing traditional "negatives" involved in this type of transaction. Now big-time buyers are throwing away the don't-buy-small book; or at least, they are beginning to read between the lines. The so-called shortcomings of the small business acquisition can actually be opportunities in disguise.

Let's take a look at these small-business negatives and see the possibilities or (improvements) inherent in each:

A Good Small Business Is Hard To Find

Experienced buyers often complain about the difficulty of locating a viable smaller business. Furthermore, when a business of possible interest is found, the owner/seller is often trying to manage the transaction single handedly, foregoing the advice of professionals. This negative issue can be resolved instantly by the use of a business broker. For the seller, the business broker will offer the support and expertise needed to launch and consummate the sale. For the buyer, the business broker will pinpoint appropriate businesses for sale, using a knowledge of the marketplace and extensive databases to shortcut the search process.

Business brokers will also be able to present the buyer with small businesses that are not "shopworn," as can be the case when a business sale has floundered--again and again--in the inexpert hands of the seller. The bigger-time buyers will especially appreciate this, since they are always on the lookout for the unusual and first-time seller.

One Person Is Key

When the owner is also the key employee, what happens after the business is sold? How can the new owners/investors hope to replace the one person who has essentially been the business? This traditional concern paints a far too gloomy--and, in fact, inaccurate--picture. Too many small business owners only think that they are irreplaceable. In most cases, they are not. In fact, new management can bring with it the fresh enthusiasm and energy essential for significant growth. For example, viewed from the outside, the quaint gift shop that is an extension of the personality of its owners might have become just that--too quaint, a clutter of Aunt Susie's jams, somebody else's painted beach rocks, aged potpourri. The new management clears out a space to serve gourmet coffees, stocks gift items from an endangered rainforest made by third-world peoples, and the business takes on a whole new life.

Casual Company Structure

Lines of responsibility often blur in the small-business management structure. This problem is compounded when, as in many cases with the small to mid-sized business, the owner is also the manager. Daily concerns override long-term planning, and decisions tend to be driven by instinct rather than by in-depth analysis. The typical informality of small business management is not an insoluble problem by any means. The use of expert, highly specialized consultants and the instituting of an enthusiastic board of directors are two possible initial steps to take. Both groups--consultants and board members--will be invaluable resources to support the existing management and to help formalize the company's structure. With the burden of managing the business more clearly defined and more equably distributed, a small business will have better opportunities for rapid change and growth.

An additional tip for those owner-managers considering selling their business: Experienced buyers will be more impressed with your business, no matter what the size, if you prepare an operating manual that details the current operation scheme and charts the responsibilities of each employee.

The Owner Keeps the Books

With many small businesses, the owner keeps track of operations and financial reporting procedures--off the cuff or in the head. Even when careful records are kept on paper or computer, the systems may not have kept up with the business and the times. (The operating manual mentioned above will help owners as they plan to sell their business.) The good news for buyers is that the changes needed to update most small business systems will not call for major overhauls. Simple systems improvements can effect dramatic results.

Goodwill Is What's (Mostly) for Sale

A small business is not typically rich in assets. The investment in capital equipment is minor, and, in the case of S corporations, the majority of earnings go to the owner or owners. What is left to attract the experienced buyer? Mostly goodwill--just what most buyers don't want to hear. There are, however, two positive sides to the low-assets "negative." First, it is possible for the new owner to increase assets by the purchase of equipment and by frugal management decisions. Second, the business with a small asset base might receive a lower valuation, which will naturally appeal to any buyer; the experienced buyer will see the further benefit of using the resulting higher cash flow as a means to grow the business.

Leaving the issue of assets aside, most small businesses, in general, are going to sell for much lower multiples than the larger business. A buyer must "buy into" an exit strategy wherein the business will be re-sold on the basis of a higher multiple of earnings as well as simply higher earnings. This strategy has appeal for those buyers who want to buy small businesses at reasonable valuations.

Small Customer/Supplier Base

It is not atypical for a small business to rely on just one customer for 50 percent of its trade, or on a handful of customers for as much as 90 percent. Businesses with such small customer bases (and similarly small supplier bases) survive by cultivating strong relationships and loyalties. This one-on-one way of doing business poses a potential problem for buyers who are doubtful about maintaining these customer-supplier ties.

The seller can alleviate the buyer's concerns by agreeing to stay on board, as needed, to help maintain key relationships with customers and suppliers. The smaller the customer base--with a few major customers forming the bulk--the more important the seller's ongoing participation will be. In addition, sellers can use paperwork to their advantage, creating detailed listings of current customers and suppliers, as well as leads to those used in the past or with future potential.

The Uncertain Seller

Is the business really for sale? This is a vital question that any buyer wants answered. In the case of a small business, the decision to sell will involve many emotional factors, including the reluctance on the part of the seller to part with what has been such a large chunk of his life. If the need to sell is caused by family difficulties or by personal burnout, these are fluctuating issues that may leave the seller running hot and cold.

When the seller's decision-making powers have become skewed, it is wise to enlist the help of a professional. The business broker can assess the seriousness of the seller--as well as that of the buyer. Once it has been determined that both parties are serious, the business broker will keep an eye on the chemistry of each player, fostering patience on the part of the buyer and guiding the seller on a steady path toward a successful sale.

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The Term Sheet

Buyers, sellers, intermediaries and advisors often mention the use of a term sheet prior to the creation of an actual purchase and sale agreement. However, very rarely do you ever hear this document explained. It sounds good but what is it specifically?

Very few books about the M&A process even mention term sheet. Russ Robb's book Streetwise Selling Your Business defines term sheet as: "A term sheet merely states a price range with a basic structure of the deal and whether or not it includes the real estate." Attorney and author Jean Sifleet offers this explanation: "A one page 'term sheet' or simply answering the questions: Who? What? Where? and How Much? helps focus the negotiations on what's important to the parties. Lawyers, accountants and other advisors can then review the term sheet and discuss the issues." She cautions, "Be wary of professional advisors who use lots of boilerplate documents, take extreme positions or use tactics that are adversarial. Strive always to keep the negotiations 'win-win.'"

If the buyer and the seller have verbally agreed on the price and terms, then putting words on paper can be a good idea. This allows the parties to see what has been agreed on at least verbally. This step can lead to the more formalized letter of intent based on the information contained in the term sheet. The term sheet allows the parties and their advisors to put something on paper that has been verbally discussed and tentatively agreed prior to any documentation that requires signatures and legal review.

A term sheet is, in essence, a preliminary proposal containing the outline of the price, terms and any major considerations such as employment agreements, consulting agreements and covenants not to compete. It is a good first step to putting a deal together.

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The Value of a Business:

Get to the Heart of the Matter

What is the value of your business? There are many ways to approach that question -- based on complex formulae or just a good hard look at the balance sheet, but no answer based purely on numbers is going to be exactly right. Even factoring in that most popular of abstracts -- goodwill -- the true essence of an operation is not likely to be revealed.

To find the real value of a business, we must go to its very heart: the attitude, work habits, managerial style, customer/marketplace savvy, and community reputation of the person in charge. The business owner or manager is the final, and most cogent, indicator of business worth. Check out the following healthy signs, and then listen to the heartbeat of your own business and its leadership style:

Optimistic Attitude

Many business owners today are more pragmatic and take price in being less of an "incurable optimist." The owner of yesterday wasn't afraid to follow the words of Willy Loman in Death of a Salesman: "A salesman has got to dream, boy. It comes with the territory." A decline in optimism is an unfortunate trend. In a world driven by technology and scientific analysis, it's easy to forget the importance of the right attitude. If business owners aren't positive, how can they expect customers and employers to be? The owner who believes business is bad will probably not see it getting any better. Of course, there are always the real-life factors -- banks that won't lend, customers who stop buying, services that become obsolete. However, if these problems didn't exist, there would be something else to keep the negative thinkers occupied.

How to project a positive attitude? Begin with the easiest. Sprucing up the place of business with fresh paint, newly-cleaned carpeting, well-stocked shelves, for example, will say a lot for the health of a company. Less visible, but highly important, is a positive outlook on the future of the business. Business owners should be prepared to spend what it takes to generate new business, and should take the time to explore new possibilities for long-range success. If the company currently has no mission statement or business plan, creating one will speak volumes abut owner's enthusiasm for the future of the operation.

Healthy Managerial Style

In the modern workplace, where you can hardly see the business through the forest of "managers," it's good to get back to basics. Too often owners get bogged down in busy work, or in "managing the managers." They should occasionally take time off to work the floor, drive the delivery truck, sell the product. Owners who put themselves in the trenches are in touch with the business -- and this first-hand understanding will be evident to anyone taking stock of the company's worth.

An equally healthy approach to managing is preparing for contingencies. The owner's style should include appropriate delegation of duties and a backup managerial plan in case of unforeseen calamity.

And finally, owners should project a general sense of well-being and energy. This may be easier said than done, but it's important to note. Anyone taking stock of a business will draw a quick, and key, first impression from the very posture and tone of voice the owner presents.

Customer relations say a lot about the "heart" of a business. The business owner's approach to handling customers sets the standard for everyone down the ladder. A healthy business avoids treating the customer like a number -- or maybe worse, like a stranger. For example, successful big-time operations who deal with customers by telephone make it a point to ask for the proper pronunciation of a name, or request permission to use the customer's first name. Added to basic courtesies is the sense that salespeople are happy to take the time necessary to answer questions and/or deal with problems.

Whether products and services are sold by phone or on the floor, employees should be well-versed experts on whatever they're selling. Again, large outfits have established high standards to emulate; for instance, the outdoor equipment chain with salespeople who can not only fit hiking boots to a T (or a toe), but also know how to clean, weatherproof and care for the leather, vibram, or nylon of which the boots are made. Every hour spent training salespeople in the product pays huge dividends for the company's long-term success.

Conspicuous Image

To foster the image of an on-going, healthy business concern, business owners need to keep their image prominent before the public. Advertising can build image at the same time it attracts business. Anything from a display ad within the yellow pages listings, to a monthly "home-baked" newsletter, to the offering of free seminars, can portray the business as more than just the sum of its products. An example of image-making at its best comes from the owner of a natural foods store in a metrowest Boston town. She not only produces her own monthly newsletter (with product information and coupons, plus general health articles), but she also sponsors evening lectures on subjects such as acupuncture, aromatherapy, women's health, and children's nutrition. What's more, she offers free tours of her in-house cookie "factory" to local schools. The samples the kids take home are the best cost-per-inch ad value imaginable!

For the less adventurous, there are plenty of conservative ways to make ads pay. Every Saturday for years, the sports section of a Los Angeles newspaper carried a one-inch ad for the "Best Hamburger in Town." No catchy phrases, no dazzling graphics, but the ad was there -- and there -- and there again. The consistency sold the restaurant's product and its image and eventually, the eatery became a 10 plus chain.

Community Involvement

To further promote the business -- and its owner -- as a rock-solid and permanent part of the local scene, there are opportunities just waiting to be tapped. Taking an active role in the Chamber of Commerce, trade or service associations, and sponsorship of worthy local events is great public relations. In addition to the more traditional public donations -- providing kids' sports team uniforms, taking out ads in yearbooks -- the business can band together to join walkathons, or volunteer to man the phones for public TV or radio fundraisers. Doing "good" makes the business owner and the employees feel good about themselves.

"Feeling good" is a good point at which to conclude our journey to the heart of a business. Dollars and cents will always be important in establishing value, but it's a kind of people-sense that will give the truest reading.

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The Very Expensive Desk Lamp

This is a story based on a true incident - only some of the details have been changed. The buyer and seller were ready to close on a business when the buyer asked to look at the list of fixtures and equipment that were to be included in the sale. After a few minutes reviewing the list, the buyer said that the desk lamp on the owner's desk was not listed. The seller explained that the lamp was a gift from his parents many years ago and therefore it was not included. The buyer got very upset, stating that the lamp was just perfect for that desk and he wanted it. The seller tried to explain that the lamp had lots of sentimental value, but that he would replace it with another desk lamp. This did not satisfy the buyer, and in order to stop the sale from falling part, the seller agreed to subtract $1,000 from the purchase price to keep the lamp. That made the desk lamp a very expensive one.

The point of this is that when buyers look at a business, they assume that everything they see is included in the sale. Sellers should keep this in mind when selling their businesses. If something is not going to be included in the sale, remove it from the premises prior to any prospective buyer looking at the business. Sellers sometimes think that they can remove the painting on the office wall since their grandmother painted it. The picture really looks good on the wall never imagining that the buyer also will think it looks great on the wall - and the problems begin.

Business broker professionals have seen deals fall apart over a piece of family memorabilia that was never intended to be included in the sale, but was there when the buyer looked at the business. The word to sellers is to remove anything - and the key word is anything - that is not included in the sale. The alternative is to list everything that is not included on the listing agreement, but it is usually less complicated simply to take them home.

One other thing - if there is a piece of equipment that is inoperative, such as the computer on the back desk, or the refrigerator in the basement of the restaurant - get rid of it. Or make sure the listing agreement states that the following equipment is inoperative. Again, it's really easier just to remove these items.

A professional business broker will see that these potential deal breakers won't disrupt the closing.

Tips for Buyers

Don't be greedy.

Sellers deserve a fair price for the years they have spent developing their business. Be prepared to pay for the goodwill of the business.

Have a good reason to be buying.

Buying a business is hard work! It takes a commitment! Spend time deciding why you want the responsibility of owning a business.

Be prepared.

Be prepared with a resume and financial statement. Remember, the seller will most likely be your banker and will want to know that you can run the business successfully.

Keep an open mind.

There are no perfect businesses.

Don't forget the tax benefits.

Remember tax benefits are realized from intangible as well as tangible assets.

Offer a reasonable down payment.

A low down payment indicates a lack of commitment. When sellers question commitment, serious negotiations are in jeopardy.

Businesses are priced on cash flow.

A business making huge profits with few assets could save you money later in capital outlay for expansion.

Time is of the essence.

After all parties have agreed upon price and terms it is important to quickly proceed toward closing.

Meet the landlord.

Landlords usually have little to gain by cooperation. Therefore, come to meetings armed with resume and financial statement.

Full disclosure.

Disclose pertinent information early and avoid surprises that might destroy your credibility.

Tips on Avoiding the Deal Breakers

About 50 percent of deals that get to the Letter of Intent stage fall apart. Professional M&A intermediaries often tell their clients that a normal deal falls apart three or four times before it closes. One intermediary quipped that the sale only begins once it has fallen apart. What can a seller do to avoid the sale falling apart more than the normal number of times - so it stays together and closes? Here are some tips:

The right advisors

One of the most important steps is to hire the right advisors. This begins with the right professional M&A specialist. The right attorney should be added to the team. The right one is an attorney who has been through the sales process many times - one who is a deal maker seeking solutions not a deal breaker seeking "why not to" reasons. The accountants must be deal oriented, and if they are the firm's outside advisor, they should be aware that they may not be retained by the buyer, and must still be willing to work in the best interest of putting the deal together.

Getting through due diligence.

One of the three or four times a deal can fall apart is half-way into the due diligence phase, when the buyer finds something he or she did not expect. No one likes surprises, and they can't all be anticipated. An experienced buyer will probably work his way through it, but a novice may walk away. Although sellers too often hope a potential problem doesn't surface, it always does. Avoid the surprises by putting everything on the table even if it seems inconsequential. It's much better to expose all the warts up front than to have them surface later.

Where is all the money going?

Prior to offering their business for sale, sellers should figure out what the net proceeds will be after paying off any debt not being assumed, current payables, closing costs and tax obligations. The middle of due diligence is no time for the seller to realize that the proceeds from the sale aren't what he or she anticipated. On the buyer's side, there are times when current sales and profits are suddenly going south. If the seller anticipates this happening, the buyer should be told up front the reason for the rapid decline. Otherwise, if it comes as a surprise to the buyer, it might cause some restructuring of the deal.

No chemistry between the buyer and the seller

If everything goes smoothly (a rare occurrence), the buyer and the seller don't have to be good buddies. However, if problems or surprises develop, good chemistry can save the day. Sometimes a golf outing or a good dinner can bring the parties together. If both parties want the deal to work, having them get together socially - and privately - can, many times, overcome a stubborn legal or financial issue.

Obviously, not all deals work. However, the odds of the deal closing are greatly improved if both the buyer and the seller consider the areas discussed above. Surprises can work both ways, and the buyers too should place their cards on the table. However, when all else fails, it is the desire of both parties wanting the transaction to work that will ultimately close the deal!

Mistakes that Sellers Make

Not being flexible in structuring the deal
Not checking out the prospective buyer
Not believing that time is of the essence
Negotiating to win everything
Nit-picking every item
Not maintaining confidentiality - and failing to insist that the buyer proceed on a confidential basis
Not retaining competent advisors
Not meeting the buyer halfway

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Today's Business Buyer

For a business to sell, there has to be a seller - and a buyer. The buyer of today is a bit different than the one of yesterday. Today's buyer is not a risk-taker, is concerned about the financials and seems to be overly concerned about price. Unfortunately, buyers have to understand that they cannot buy someone else's financial statements. They might be a good indication of what a new buyer can do with the business, but everyone does things differently. It is these differences that ultimately determine how the business will do. The price may not be the right question for the buyer to ask. What is usually the most important question is how much cash is required to buy it.

Today's buyer is finicky, due certainly in part to the fact that, he or she is not a risk taker. Quite a few buyers enter the business buying process and, at the last minute, cannot make the leap of faith that is necessary to conclude the sale. The primary reason that buyers actually buy is not for the reason one might think. Money or income is about third, maybe even fourth on the list.

Buyers buy because they are tired of working for someone else. They want to control their own lives. In some cases, they have lost their job, or are being transferred to a place that they don't want to move to, or are very unhappy in their job. Surveys indicate that about half of the people in the county are unhappy in their jobs. People buy a business to change their lifestyle. A recent newspaper article quoted a very successful business woman, who left her job and bought a book store because she was "looking for a change, a way to be more rooted and be at home more."

The make-up of a typical buyer

The typical buyer of the small business buyer usually has many of the following traits:

90 percent are first time buyers. In other words, they have never been in business before.
Almost all of them are looking to replace a job. Business brokers primarily sell income substitution.
Most buyers will have about $50,000 to $100,000 in liquid funds to use as a down payment.
Most buyers are looking at businesses priced at about $100,000 to $250,000.
Most buyers will not have sufficient funds to pay cash for a business.

Obviously, many others go through the process of looking for a business. However, those buyers who will eventually purchase a business have most of the characteristics outlined above. Going a step further, the serious prospective buyer usually possesses the attributes described below:

Who is a serious buyer

Has the necessary funds and they are readily available
Can make their own decisions
Is flexible in the type and location of a business he or she will consider
Has a realistic and sincere need to buy
Has a reasonably urgent (within three to four months) need to buy a business
Is cooperative and willing to listen

Sellers should take a second look at those who express interest in their business. If the prospect has very few of the above traits, perhaps the seller should move on to the next potential buyer. On the other hand, if you are a buyer, or think you are, take a second look at the traits of the serious buyer. If you don't have many of them, you may not be as serious as you think. You might want to rethink the reasons for owning a business and be sure that this is the right decision for you.

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Today's Business Buyer:

A Profile

Today's independent business marketplace attracts a wide variety of buyers eager for a piece of ownership action. Buyers of small businesses are most likely replacing lost jobs or searching for a happier alternative to corporate life. Buyers of mid-sized and large operations are, typically, private investment companies seeking businesses to build and eventually sell for a profit. This is the broadest possible look at the types of buyers out there. Business owners considering putting their business on the market should be aware of the finer "distinctions" among buyers, as well as what they are looking to buy, and why.

1. Individual Buyer

This is typically an individual with substantial financial resources, and with the type of background or experience necessary for leading a particular operation. The individual buyer usually seeks a business that is financially healthy, indicating a sound return on the investment of both money and time. If these buyers do not have the amount of personal equity required for acquisition, they most likely will turn to family members or venture capital sources for financing. (Buyers and sellers should be aware that, in many cases, seller financing will be an essential element, benefiting both parties in the long run.)

Even when such sources are available, the individual buyer will hit a strong bottom line when it comes to price. Therefore, these buyers will usually limit themselves to transactions involving less than $1 million, cash.

2. Strategic Buyer

This buyer is almost always a company, having as its goal entering new markets, increasing market share, gaining new technology, or eliminating some element of competition. In essence, it is part of this buyer's "strategy" (hence the name) to acquire other businesses as part of a long-term plan. Strategic buyers can be either in the same business as the company under consideration, or a competitor. Example: a bank in one of a state purchases or merges with one in another part of the same state. The acquiring bank enters a new market and "eliminates" competition at the same time.

Strategic buyers will be looking chiefly at businesses with sales over $20 million, with a proprietary product and/or unique market share, and effective management in place and willing to remain.

3. Synergistic Buyer

The synergistic category of buyer, like the strategic type, is usually a company. The difference is that, with this buyer, the acquisition or merger flows from the complementary nature of the purchasing company and the company for sale.

Synergy means that the joining of the two companies will produce more, or be worth more than just the sum of their parts. Example: a large real estate company purchases a mortgage company. It can now use its existing customers (those who buy homes) and offer them the mortgage funds to finance their purchases. The benefits of this type of acquisition help both companies be more competitive and profitable.

4. Industry Buyer

Sometimes known as "the buyer of last resort," this type is often a competitor or a highly similar operation. This buyer already knows the industry well and, therefore, does not want to pay for the expertise and knowledge of the seller. The industry buyer is interested mainly in combining manufacturing facilities, consolidating overhead, and utilizing the combined sales forces. These buyers will pay for assets (but probably not what the seller thinks they are worth); they will not pay for goodwill, covenants not to compete, or consulting agreements with the seller. There can be some cases in which the industry buyer is also a strategic buyer, with the price determined by motivation.

5. Financial Buyer

Most in evidence of all the buyer types, financial buyers are influenced by a demonstrated return on investment, coupled with their ability to get financing on as large a portion of the purchase price as possible. Working on the theory that debt is the lowest cost of capital, these buyers purchase businesses with the sole purpose of making the maximum amount of money with the least amount of their capital invested.

Each type of buyer has distinctive characteristics that correlate to the motivation behind the purchase of a particular company. In addition, the price each is willing to pay for a company is directly proportional to the motive. The relative sizes of acquisitions by different buyer types (compressed into their broader categories), is shown in the accompanying chart (keep in mind that all figures are approximate):

Type of Buyer	Less than $3 million	$3 to 10 million	$10 million:
Sole Proprietors	45%	25%	5%
Public Companies	30%	20%	20%
Private Companies	10%	15%	15%
Investment Groups	20%	30%	0%

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Under-Reporting Comes Under Fire

What is the true income of an independent business? This is a question of interest to many parties--including prospective buyers, investors, and lenders--but nobody is more determined to know the answer than the Internal Revenue Service.

What makes the "truth" about a company's income so elusive? Isn't this what financial record-keeping is all about? Yes and no. Business owners have been known to go from minor figure-fudging to major-league cheating, in an effort to lower the amount of income necessary to report to the IRS in any given fiscal year. In fact, the IRS estimates that two out of three business owners regularly under-report income.

"Unreported income" is the official phrase for this practice; however, in the trade, the word often heard is "skim." It sounds light, healthy, and maybe good for you. But is it? Consider an item from a newspaper in a typical Main Street town, bearing the headline "Business Owners Sentenced":

Two Myrtle Beach business owners were sentenced in federal court in Florence [S.C.] for not declaring money received from poker machines in their bar on their income tax returns, according to a statement by the US Department of Justice.

Roy Gipson of Charlotte and Ann Willis of Myrtle Beach, former operators of Players, a sports bar in the Galleria Shopping Center, were indicted by the federal grand jury in September. They pleaded guilty in October to filing false income tax returns.

(Sun-News, Myrtle Beach, SC)

This is a depressing story, resulting in the sentencing of one of the defendants to three years' probation, three months in a halfway house, several months of home detention, and a $5,000 fine payable within six months. The second defendant was sentenced to three years' probation, two month home detention, and 400 hours of community service. All this for a little poker-machine skimming? How was anyone to know? How did anyone find out?

It's the story behind the story that should really catch the attention of business owners. And especially of potential business sellers, because the unreported income in this case was discovered by IRS agents who went undercover, in "disguise" as typical business buyers.

The undercover agents, acting as any savvy prospective buyer would, wanted a close look at the true worth of the business in order to make an informed "offer." The sellers were happy to comply, and readily admitted that they were not declaring on their tax forms money received from poker machines that had generated more than $120,000 over a two-year period. Truth, in this instance, did not set its tellers free. Business owners are often tempted to have it both ways--under-report to the government, and then, to sellers, reveal that the news is much better than it looks. The Myrtle Beach bar owners are not the only ones who have been tempted to slant the worth of a business in two different directions at the same time. This practice, although illegal, is not uncommon. And when "everybody does it" becomes the perception, even the most reputable, otherwise law-abiding citizens can get caught in their own trap.

As one Delaware restaurant owner of 20-years' excellent standing in his community says, "I made more than a decent income which I disclosed on my tax return. However, over and above my regular salary, I also skimmed a great deal of unreported and untaxed cash for myself and some of my employees. I always thought that most people do it and if I got caught, I could just pay the IRS the taxes due plus some interest and penalties." Instead, when it came time for the restaurateur to sell his business, he disclosed its true worth to prospective buyers who turned out to be--yet again--undercover IRS agents. The restaurateur says, "Without my knowledge, they tape-recorded everything I said. You have no idea what it is like to hear your own voice on a tape recording. I never knew the IRS conducted undercover operations." He adds, "I thought that very few people go to jail for committing tax crimes and those that went to jail were mostly organized crime figures and drug dealers. I now find that sixty percent of all the people committing tax crimes go to jail. They generally serve between one and three years. I am now waiting to be sentenced, but whether or not I go to jail, by the time I'm done paying the taxes, interest and penalties, for every one dollar I skimmed, I will have to pay the IRS three dollars." (This business owner is presently serving a six-year prison sentence.)

Even if a business owner who skims escapes being caught by such a sting operation, he or she will still face a dilemma when it comes time to sell. Whether or not business owners have made the immediate decision to sell, they should prepare for the future by building the image of a successful business. The picture they have painted for the IRS is not likely to be admired by buyers, who will want to pay only for what is reflected on the books, including what is revealed by the tax return. The seller may think it's possible to set a fresh scene for the buyer--one based on the theme of potential; however, buyers will be far more impressed by proof of a good track record.

Here are some suggestions to sellers for unveiling hidden profits and putting them where they will do the most good--in front of prospective buyers:

Think Ahead. Remember that the future is now, and set your mind on long-term instead of short-term benefits. Show maximum profits for each quarter.
Take a Step Back. If necessary, look back on the previous months' financial records and work toward showing the truest--and hopefully, the best--profit situation.
Delve Into the Past. Go even further back and reconstruct records (without showing "skim") that reveal the legitimate profit situation over a meaningful period of time.
List Tax-Deductibles. Make a separate list of salaries, and of fringes and perquisites that are tax-deductible and that provide a current benefit to the business.

And don't forget--it won't be only the buyer who will be impressed by true profits. Loan underwriters and potential investors will be more apt to show favor. And the IRS will send its agents-in-disguise to somebody else's door.

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What is a Contingency?*

A contingency in the sale of a business is a condition in the contract of sale or offer that must be resolved, satisfied or rectified by either a buyer or seller. If they are not satisfied then the sale will generally not go forward. Most offers on a business contain one or more contingencies. The sale may be subject to the buyer obtaining financing, or the seller repaving the parking lot. Experienced business brokers have seen just about every contingency there is. Most of these are placed in the offer by a buyer who has concerns about one or more issue and needs it or them to be satisfied before proceeding with or closing the sale.

It may be as simple as the sale is contingent upon the buyer receiving a five-year extension of the lease by [a certain date]. Or, the offer to purchase may state that the sale is conditional upon the buyer's approval of the seller's books and records.

The difference between the two examples is that in the first one, it is a specific event that must be satisfied, and a time limit is specified. The second example is open-ended, meaning that a buyer could opt out of the deal by disapproving the books and records essentially for any reason.

Here are some tips on contingencies:

There should be a time period in which the contingency must be satisfied. Without it the deal could go on almost forever.
It, or they, as the case may be, should be reasonable. There is no point in making the sale contingent on moving the building to the next state. As they say - "it ain't going to happen."
Contingencies should be limited to very important or critical issues - those that impact whether a buyer will actually purchase the business or not. Minor items should be resolved prior to an offer being written.
Confidentiality or proprietary issues may influence whether a buyer will buy the business, but the seller is not willing to proceed until an offer containing price and terms is agreed upon.

Contingencies come in all sizes and shapes. Very few offers don't contain at least one, and usually more than one. They are an inevitable part of selling - and buying a business. A business broker knows what is reasonable and what is not.

Employee Status

Less than 20% of business entities (a little less than 5 million firms) had paid employees, and these firms accounted for nearly 98% of total revenue - the other 19 million plus businesses with no employees accounted for less than 2% of total U.S. revenue. Firms with more than 500 employees represented less than � of one 1 percent of all employer firms, but accounted for about 50% of total U.S. employment.

Source: BizStats.com

What is Goodwill?

In the practical sense, when selling a business, goodwill is all the hard work and effort the seller has put into the business over the years. When acquiring a business, goodwill is the difference between the tangible assets and the purchase price.

Goodwill value should not be confused with going-concern value. There is a big difference. One leading business appraiser has defined going-concern value as, "The premise that a business will continue to operate consistent with its intended purpose as opposed to being liquidated." In other words, the value of a business for just being in business is the going-concern value. It has nothing to do with whether the business is profitable, "on its last legs," or merely breaking even. Essentially, if the doors are open, a business is a going concern.

Most business owners view goodwill as good service, products and reputation. One dictionary defines Goodwill as, "A desire for the well-being of others; the pleasant feeling or relationship between a business and its customers."

The M&A Dictionary defines goodwill as: "An intangible fixed asset that is carried as an asset on the balance sheet, such as a recognizable company or product name or strong reputation. When one company pays more than the net book value for another, the former is typically paying for goodwill. Goodwill is often viewed as an approximation of the value of a company's brand names, reputation, or long-term relationships that cannot otherwise be represented financially."

Some Examples of Goodwill Items

Phantom Assets
Local Economy
Industry Ratios
Custom-Built Factory
Management
Loyal Customer Base
Supplier List
Reputation
Delivery Systems
Location
Experienced Design Staff
Growing Industry
Recession Resistant Industry
Low Employee Turnover
Skilled Employees
Trade Secrets
Licenses
Mailing List
Royalty Agreements
Tooling
Technologically Advanced Equipment
Advertising Campaigns
Advertising Materials
Backlog
Computer Databases
Computer Designs
Contracts
Copyrights
Credit Files
Distributorships
Engineering Drawings
Favorable Financing
Franchises
Government Programs
Know-How
Training Procedures
Proprietary Designs
Systems and Procedures
Trademarks
Employee Manual
Location
Name Recognition

What goodwill is and how it is represented on a company's financial statements are two different issues. For example: until recently, if a company sold for $5 million, but only had $1 million in tangible assets, the balance of $4 million was considered goodwill. Under previous accounting standards, this goodwill had to be amortized by the acquirer over a 15-year period. This especially affected public companies, since an acquisition could negatively impact earnings, thus reducing the price of its stock. One result of this was that public companies were reluctant to acquire firms in which goodwill was a large part of the purchase price. On the other hand, purchasers of non-public firms received a tax break because of the amortization.

The accounting profession recently took another look at goodwill and changed the way goodwill is handled. The reason for this was to bring accounting into today's business world. For years, companies were built around hard assets such as heavy equipment and machinery. Many of today's industrial giants are not really industrial at all. They are built around intangible assets such as patents, brand names, intellectual property, etc. - basically what are considered goodwill items. These businesses don't have huge factories full of workers on assembly lines.

Some new rules or standards were created by the Federal Accounting Standards Board (FASB) and implemented on July 1, 2001. Under this change, goodwill may not have to be written off (unless it is carried at a value in excess of its real value). However, the standards now require that companies, both private and public, have their intangible assets, including goodwill, valued by an outside expert on an annual basis. The rules basically define the difference between goodwill and other intangible assets and how they are to be treated from an accounting and tax reporting standpoint. How they are treated can impact the bottom line and have tax consequences. Also, completely identifying the items that may have been combined into goodwill and establishing separate values may increase the true intangible asset basis.

The upshot of all this is that the meaning of goodwill just got more complicated. Here's a simplification: prior to acquiring a company or placing your business on the market, you should definitely consult your accounting professional. Goodwill may still represent the hard work and effort the seller has put into his or her business over the years -- it just has to be accounted for differently and in more detail.

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What Makes a Deal Close?

For every reason that a pending sale of a business collapses, there is a positive reason why the sale closed successfully. What does it take for the sale of a business to close successfully? Certainly there are reasons that a sale might not close that are beyond anyone's control. A fire, for example, the death of a principal, or a natural disaster such as a hurricane or tornado. There might be an environmental problem that the seller was unaware of when he or she decided to sell. Aside from these unplanned catastrophic events, deals abort because of the people involved.

Here are a few examples of how a sale closes successfully.

The Buyer and Seller Are in Agreement From the Beginning

In too many cases, the buyer and seller really weren't in agreement, or didn't understand the terms of the sale. If an offer to purchase is too vague, or has too many loose ends, the sale can unravel somewhere along the line. However, if prior to the offer to purchase the loose ends are taken care of and the agreement specifically spells out the details of the sale, it has a much better chance to close. This means that a lot of answers and information are supplied prior to the offer and that many of the buyer's questions are answered before the offer is made. The seller may also have some questions about the buyer's financial qualifications or his or her ability to operate the business. Again, these concerns should be addressed prior to the offer or, at least, if they are part of it, both sides should understand exactly what needs to be done and when. The key ingredient of the offer to purchase is that both sides completely understand the terms and are comfortable with them. Too many sales fall apart because of a misunderstanding on one side or the other.

The Buyer and Seller Don't Lose Their Patience

Both sides need to understand that the closing process takes time. There is a myriad of details that must take place for the sale to close successfully, or to close at all. If the parties are using outside advisors, they should make sure that they are deal-oriented. In other words, unless the deal is illegal or unethical, the parties should insist that the deal works. The buyer and seller should understand that the outside advisors work for them and that most decisions concerning the sale are business related and should be decided by the buyer and seller themselves. The buyer and seller should also insist that the outside advisors keep to the scheduled closing date, unless they, not the outside advisors, delay the timing. Prior to engaging the outside advisors, the buyer and seller should make sure that their advisors can work within the schedule. However, the buyer and seller have to also understand that nothing can be done overnight and the closing process does take some time.

No One Likes Surprises

The seller has to be up front about his or her business. Nothing is perfect and buyers understand this. The minuses should be revealed at the outset because sooner or later they will be exposed. For example, the seller should consult with his or her accountant about any tax implications prior to going to market. The same is true for the buyer. If financing is an issue it should be mentioned at the beginning. If all of the concerns and problems are dealt with initially, the closing will be just a technicality.

The Buyer and Seller Must Both Feel Like They Got a Good Deal

If they do, the closing should be a simple matter. If the chemistry works, and everyone understands and accepts the terms of the agreement, and feels that the sale is a win-win, the closing is a mere formality.

When Buying or Selling:

Attorneys Should Be Deal-Friendly and Sale-Wise*

Whether you are buying or selling a business, your legal counsel can make or break the deal. It is important that you emphasize to your attorney that you want the sale to go through. In many instances, the sale of the business fails to close because the attorney for one side or the other makes too many demands of the other side. Certainly, you want your attorney to protect your interests, but not to the point where the demands are so strenuous that the other party or his or her counsel balks. If your attorney understands that you really want to buy--or sell, as the case may be--he or she will be less apt to make outrageous requirements or demands. Below are some things to consider when dealing with your attorney in the buying or selling process.

Both parties should understand just what is being sold--and purchased.
The corporate records should be current and complete.
The seller should have available the current insurance policies and the names of the insurance agents involved.
If there is more than one owner, there should be a designated spokesperson representing the group. This authorization for one of the owners (or stockholders) to represent the business should be in writing and signed by all of the owners.
The buyer and the seller must both have the same understanding of the sale and its terms. Too often, they each have their own perception of the deal. Each party to the sale must understand just what the deal is and who is getting what, or the sale may be doomed before it starts.

To help prevent wrecked deals, good communication between all of the parties involved is a priority. Unless they are told, outside advisors may not realize how much the buyer and the seller want to consummate the sale. The attorney needs to know from the client that this is a serious-minded transaction and that, unless something completely unanticipated is discovered, his or her job is to pull the deal together. Too often what happens is that after the offer is signed and everyone appears to be in agreement, the ball gets dropped. Everybody assumes that everybody else is following through and that all is fine. The attorney for one side or the other attempts to push on an issue that is, normally, not particularly important--and suddenly, what was once a simple transaction now falls apart. Unfortunately, the attorney thinks he or she knows what is best for the client and draws paperwork or demands something without even discussing it with their client. The damage is done, the other side gets angry, and another sale "bites the dust."

The use of a professional business broker can, in many cases, alleviate this problem. The business broker--having been through the process many times, usually much more often than any of the attorneys involved--knows the pitfalls. However, it is important that the parties to sale are operating on the same wave length and have the same understanding of the sale.

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Where Does Your Company Fit?

The recently released 2003 Business Reference Guide provides a breakdown of the size of businesses in the U.S. Since exact data is almost impossible to obtain, some of the following are estimates or educated guesses. For reference purposes, they are divided

Business Size by Employees	% of Total # of Businesses	Average Anual Revenues	Average # of Employees
1 to 4	54.7%	$321,000	2.1
5 to 9	20.8%	$792,000	6.6
10 to 19	12.3%	$1,600,000	13.4
20 to 99	10.1%	$5,701,000	39.2
100 to 499	1.6%	$27,056,000	192.2
500-999	less than 1%	$540,467,000	688.6
Note: Percentages do not add up to 100% due to rounding.

Small Business

Level One - Businesses in this category have annual sales of less than $500,000 and have less than four employees. There are approximately 3.1 million of them and they represent about 55 percent of all of businesses with one employee or more. These businesses tend to sell for $500,000 or less.

Level Two - These businesses have annual sales of $500,000 to $1 million and have five to nine employees. There are approximately 1.2 million of them and they represent approximately 21 percent of all businesses that have one employee or more. They tend to sell for less than $1 million.

Level Three - Businesses in this category have annual sales of $1 million to $2.5 million and have 10 to 19 employees. There are approximately 690,000 of them and represent about 12 percent of all businesses with one employee or more. These businesses tend to sell for less than $2.5 million.

Level three is at the top end of what could be considered small business and begins what might be classified as the larger business or middle market all the way up to the much larger Fortune 100. At the top end - Levels Five and Six - the number of these sizes of businesses and the percentages they represent of the total number is very small. Since these top two levels represent very large companies with huge workforces, the numbers can be misleading. However, using SBA guidelines, Level three ends the very small business category that is 19 or fewer employees. At the same time, it also represents over 85 percent of all businesses with one employee or more. These businesses average annual sales of about $412,600 and average 6.6 employees.

The Larger Business

Level Four - These businesses have annual sales of $2.5 million to $10 million, with an average of approximately $5,200,000. They have 20 to 100 employees with an average of 40. There are about 566,000 businesses in this category, representing approximately 10 percent of all the businesses with one employee or more. These businesses generally sell for $10 million or less.

The Mid-Size Businesses

Level Five - These businesses have annual sales of $10 million to $50 million and have 100 to 500 employees. In general, they average $27,000,000 in annual sales and have on average 192 employees. There are about 90,000 of them, which represent approximately 2 percent of all businesses with one employee or more. They tend to sell for less than $50 million.

The Large Company

Level Six - These businesses have annual sales of $50 million or more, but average $669,219,000 in annual sales. They have 500 or more employees, but average 3,157 employees. It is easy to see that the size of these firms, in general, is weighted to the very large public companies. There are only about 22,000 of them, representing less than 1 percent of all businesses with 1 employee or more. They will usually sell for more than $50 million.

The Number of Businesses that Sell!

The following are rough estimates only.

Category	# of Businesses	# for Sale	# that Sell
Level One	3.1 million	620,000	124,000
Level Two	1.2 million	240,000	48,000
Level Three	690,000	138,000	34,500
Level Four	566,000	113,000	37,500
Level Five	90,000	9,000	4,500
Level Six	22,500	2,250	2,250

Note: All figures are rounded and totals may be slightly more or less than 100 percent. They are estimates only. The term "sell" refers to an actual sale, merger, or any major change in ownership.

Non-competition agreement - is used to prevent an employee from working for the competition in the event they leave or are terminated by a company.

Non-disclosure agreement - is used to prevent an employee from revealing company secrets or any confidential information to anyone else.

Non-solicitation agreement - is used to prevent an employee from solicitation or doing business with any of a former company's employees or its customers or clients.

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Why Do Deals Fall Apart?

In many cases, the buyer and seller reach a tentative agreement on the sale of the business, only to have it fall apart. There are reasons this happens, and, once understood, many of the worst deal-smashers can be avoided. Understanding is the key word. Both the buyer and the seller must develop an awareness of what the sale involves--and such an awareness should include facing potential problems before they swell into floodwaters and "sink" the sale.

What keeps a sale from closing successfully? In a survey of business brokers across the United States, similar reasons were cited so often that a pattern of causality began to emerge. The following is a compilation of situations and factors affecting the sale of a business.

The Seller Fails To Reveal Problems

When a seller is not up-front about problems of the business, this does not mean the problems will go away. They are bound to turn up later, usually sometime after a tentative agreement has been reached. The buyer then gets cold feet--hardly anyone in this situation likes surprises--and the deal promptly falls apart. Even though this may seem a tall order, sellers must be as open about the minuses of their business as they are about the pluses. Again and again, business brokers surveyed said: "We can handle most problems . . . if we know about them at the start of the selling process.

The Buyer Has Second Thoughts About the Price

In some cases, the buyer agrees on a price, only to discover that the business will not, in his or her opinion, support that price. Whether this "discovery" is based on gut reaction or a second look at the figures, it impacts seriously on the transaction at hand. The deal is in serious jeopardy when the seller wants more than the buyer feels the business is worth. It is of prime importance that the business be fairly priced. Once that price has been established, the documentation must support the seller's claims so that buyers can see the "real" facts for themselves.

Both the Buyer and the Seller Grow Impatient

During the course of the selling process, it's easy--in the case of both parties--for impatience to set in. Buyers continue to want increasing varieties and volumes of information, and sellers grow weary of it all. Both sides need to understand that the closing process takes time. However, it shouldn't take so much time that the deal is endangered. It is important that both parties, if they are using outside professionals, should use only those knowledgeable in the business closing process. Most are not. A business broker is aware of most of the competent outside professionals in a given business area, and these should be given strong consideration in putting together the "team." Seller and buyer may be inclined to use an attorney or accountant with whom they are familiar, but these people may not have the experience to bring the sale to a successful conclusion.

The Buyer and the Seller Are Not (Never Were) in Agreement

How does this situation happen? Unfortunately, there are business sale transactions wherein the buyer and the seller realize belatedly that they have not been in agreement all along--they just thought they were. Cases of communications failure are often fatal to the successful closing. A professional business broker is skilled in making sure that both sides know exactly what the deal entails, and can reduce the chance that such misunderstandings will occur.

The Seller Doesn't Really Want To Sell

In all too many instances, the seller does not really want to sell the business. The idea had sounded so good at the outset, but now that things have come down to the wire, the fire to sell has all but gone out. Selling a business has many emotional ramifications; a business often represents the seller's life work. Therefore, it is key that prospective sellers make a firm decision to sell prior to going to market with the business. If there are doubts, these should quelled or resolved. Some sellers enter the marketplace just to test the waters; to see if they could get their "price," should they ever get really serious. This type of seller is the bane of business brokers and buyers alike. Business brokers generally can tell when they encounter the casual (as opposed to serious) category of seller. However, an inexperienced buyer may not recognize the difference until it's too late. Most business brokers will agree that a willing seller is a good seller.

Or...the Buyer Doesn't Really Want To Buy

What's true for the mixed-emotion seller can be turned right around and applied to the buyer as well. Buyers can enter the sale process full of excitement and optimism, and then begin to drag their feet as they draw closer to the "altar." This is especially true today, with many displaced corporate executives entering the market. Buying and owning a business is still the American dream--and for many it becomes a profitable reality. However, the entrepreneurial reality also includes risk, a lot of hard work, and long intense hours. Sometimes this is too much reality for a prospective buyer to handle.

And None of the Above

The situations detailed above are the main reasons why deals fall apart. However, there can be problems beyond anyone's control, such as Acts of God, and unforeseen environmental problems. However, many potential deal-breakers can be handled or dealt with prior to the marketing of the business, to help ensure that the sale will close successfully.

A Final Note

Remember these three components in working toward the success of the business sale:

Good chemistry between the parties involved.
A mutual understanding of the agreement.
A mutual understanding of the emotions of both buyer and seller.
The belief, on the part of both buyer and seller, that they are involved in a good deal

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