Why use a Standardized Purchase Offer or LOI to Sell or Buy a Business vs Custom Agreement

Category: Buying a Business Selling Your Business 
Bill Grunau

Purchase Agreements for the sale of a business are either Asset Purchase Agreements, Stock Purchase Agreements or LOI’s (Letters of Intent).  There are effectively two choices when buying or selling a business with respect to purchase agreements.  A buyer can opt to have their attorney draft the purchase agreement from scratch or use a standardized purchase agreement such as the one created by the California Association of Business Brokers (CABB).  

While some buyers may initially find comfort in using an attorney to draft a custom agreement for the transaction, the feeling will be gone when they receive the bill.  The cost for an attorney to draft a purchase agreement or LOI will certainly be several thousand dollars and if there are revisions and amendments as a result of negotiations that bill will continue to climb.  On one transaction in which the buyer insisted on using an attorney to draft an LOI and  the purchase agreement their legal fees were over $40,000.  While this is an extreme example, once they went down this path there was no turning back.  The transaction was successful, just very expensive on their part.  

Thousands of businesses are sold every year and while the businesses are all very different, the transaction process is the same for each business.  Much like CAR (California Association of Realtors) created standardized purchase agreements and associated forms, CABB (California Association of Business Brokers) has done the same for business sales.  

The CABB purchase agreements were drafted by attorneys that are Associate Members of CABB alongside CABB’s most experienced Business Brokers.  Their objective was to produce standardized agreements for business sales likened to residential and commercial  real estate purchase agreements produced by CAR and AIR (Association of Industrial Realtors).

Using the standardized agreements are advantageous in four ways

  1. The CABB forms and agreements are written to include the majority of components in an asset or stock sale and have protections built-in for both buyer and seller. The contracts are easily read and in the case of a stock sale form the foundation of the purchase agreement for your attorney to review rather than creating an entire document from scratch (which you are billed for).  If you choose to use an attorney they can add an addendum with any additional terms or language they feel is required. 
  2. If a buyer hires an attorney to write a LOI or purchase agreement the cost could become prohibitive especially if the LOI or purchase agreement is not accepted.  Remember, while you have paid for that offer or LOI to be drafted, there is no assurance it will be accepted or if accepted the deal will go through.  You will have a lot invested just to present an offer or LOI.  If the terms are acceptable to the seller then the seller needs to engage their attorney to review before acceptance.  And if the seller’s attorney comes back with revisions, then it goes back to your attorney to review the revisions, and perhaps counter some of the revisions.   And on and on… 
  3. If a custom purchase agreement, LOI or contract is written by an attorney the broker cannot give legal advice and has to advise both parties to seek advice from their attorneys.  The legal costs can run into the thousands of dollars before the transaction begins, if it begins.
  4. Many attorneys are not familiar with the nuances in the small and midsize business sale transaction and leave important components out of the LOI or purchase agreement which again will add additional costs through amendments and review.

At Pacific Business Sales we use the standardized CABB forms and purchase agreements for practicality, consistency, and legal cost savings for the buyer and seller.  The CABB forms and agreements are written by attorneys and experienced business brokers specifically for small-midsize business sales.  The forms are comprehensive and many buyers on straightforward transactions opt not engage an attorney.  We advise clients to have their attorney review the purchase agreements if they have any legal questions that would need to be addressed by an attorney. 

Where an attorney is especially useful and required is preparing specific agreements such as a consulting agreement with the seller.  We also recommend sellers have their attorney draft the seller note and security agreement.  

 At Pacific Business Sales our goal is making the transaction go in a smooth and timely manner.. We walk buyers and sellers through the selling process from beginning to end, explaining every step of the transaction.

ADDITIONAL INFORMATION ON SELLING A BUSINESS

Market Update, Effect of COVID19 on Business Value and Sales

Category: Buying a Business Selling Your Business 
Bill Grunau

COVID 19 has impacted our daily lives and how businesses are run.  It has changed the way we do business on a daily basis on a local, national and global scale. What does that mean for business value, how are the sales of businesses being affected, and how does it affect buyers and sellers?

 There are many businesses in the retail industry such as restaurants, retail stores and  personal services that have had to shut down or dramatically scale back operations resulting in limited to no revenue during the Stay at Home orders.  PPP loans, SBA EIDL (Economic Injury Disaster) loans and/or personal savings have kept these businesses going. 

Other businesses that are considered essential and allowed to continue operations.  These ranged from industrial to manufacturing and distribution businesses, construction services, grocery stores and medical, healthcare providers.  The owners of essential businesses saw their revenues either stay the same or have a modest decrease during this time allowing them to stay on the market and sell.  Some businesses such as construction and military manufacturing have seen an increase in business during COVID-19.  Another business segment that has been unaffected by COVID-19 has been ecommerce which has continued to have solid performance during the pandemic.  

Business in the essential services categories or those that have been unaffected by COVID-19 have seen strong demand from prospective buyers, SBA lenders have continued approving acquisition financing, and we are having a very strong year for business sales at Pacific Business Sales.  Business Values for these businesses have not been affected by and the valuation multiples of DE (Discretionary Earnings) and EBITDA remain the same as they historically have been.  

Businesses that have had an economic impact from COVID-19 have generally been pulled from the market with the owners choosing to wait until the business recovers.  The good news here is that we have been on numerous conference calls with SBA Lenders and Business Valuation Analysts (appraisers) discussing how these businesses will be valued going forward and there is a plan and methodology in place.  

The methodology to value a business that has been affected by COVID-19 will be to normalize the COVID-19 period using historical financial data and use projections for the rest of the year and following year.  This of course would be used for businesses that are emerging from the shut down and showing signs of recovery.  

From a “buy side” perspective the market is still very strong with buyers focusing heavily on businesses either unaffected by COVID-19 or minimally affected.  There are buyers for distressed sales and there will be buyers businesses affected by COVID-19 as they recover.  We are seeing a wave of corporate expatriates that have either been laid off, had salaires reduced or are facing the prospects of this.  These buyers are motivated to buy a business to secure their future and leave the corporate rat race.  

The market is still strong for essential businesses and moving forward the businesses that saw a drop in their revenue during this time with a return to normal sales volumes will be able to sell their business with little to no effect on the value of their businesses.  

Businesses are still selling and sellers are still able to receive maximum value for their businesses despite COVID-19.

Additional Information about Selling a Small Business

How Do I Sell My Business After COVID-19? 

When to Sell, When NOT to Sell, & When to Sell Anyway

How to Develop an Exit Strategy for Your Business

How to Value a Small-Midsize Business using Earnings Multiples

 

How to Buy a Business with a Business Broker

Category: Business Valuation Buying a Business 
Bill Grunau

Are you thinking about buying a business to build your future, gain personal freedom and independence but not sure where and how to start?  How do you get started and find the right business?  What are the steps involved to find the best business for you?

Before you start your search for the right business, we suggest you step back and look at what types of businesses are for sale.  It will surprise you how many different types of businesses there are.  We also recommend keeping an open mind with respect to business types and look at broad industries, even look at some that you had not necessarily considered.  

  1. Search & Identify Prospective Businesses:
    The first step involved is to search the businesses for sale listing sites such as Bizbuysell.com, Bizben.com, CABB.org etc. There are a wide range of businesses available at any given time in a variety of industries. You will be able to search by industry and location plus the amount of earnings and price that fits your financial situation.
  2. Get Your Finances & Financing Together:
    Before you inquire about a business for sale get your finances in order.  How much cash do you have for a down payment?  Remember you will also need working capital for operating expenses, closing costs etc.  If you are going to use SBA financing (which we highly recommend) you will be able to leverage your down payment to buy a much larger company.  See our SBA financing page for more information on using SBA financing to buy a business. 
  3. Inquire about the business:
    When you find a business that you are interested in, submit an inquiry from the listing site and you will be sent a Confidentiality Agreement and Buyer Profile to fill out and sign.  Your inquiry will usually go to the listing broker for the business.  Make sure you fill out the Buyer Profile completely, including providing the requested financial information.  Brokers will not provide any confidential information about the business for sale without a complete Buyer Profile and if you do not provide financial information they will assume you are not qualified.  The majority of business sales are Dual Agency transactions, which means the broker represents both buyer and seller in the transaction.  This is common in business brokerage.  
  4. Sign NDA & Receive Confidential Information Memorandum or Business Profile:
    After you have signed the confidentiality agreement and buyer profile the broker will review both to determine if you are qualified to purchase the business. If everything is signed and you qualify you will be sent a Confidential Information Memorandum (CIM). The CIM should have enough information in it for you to determine if you are interested and want to move to the next step.  Be careful not to rule out a business too quickly because the business profile (CIM) lacks detail.  While our firm, Pacific Business Sales, prepares comprehensive business profiles, most brokers prepare a very brief overview of the company.  If the company looks interesting, give it the benefit of the doubt and contact the broker for more information.  
  5. Contact Broker for more info:
    The next step is to contact the broker that provided you with the CIM to discuss the opportunity, provide your background, and if you are interested ask the broker to set up a meeting with the seller to further discuss the business.  Again, if it looks interesting, go ahead and set up a meeting.  Buyers often have the expectation that everything they need to know will be in the CIM or obtained in a quick phone call with the broker and often prematurely pass on a business without really learning about it.  You won’t buy a business from your laptop in your pajamas at home, you have to go to the business, meet the owner, and learn about it.  
  6. Seller Meeting & Visit Business:
    At the seller meeting you will be able to discuss the operations of the business, the sellers role, customer concentration, marketing, employees and their rolls, and general questions about financials such as average inventory, A/R and backlog. There may be other questions depending on the type of business and industry.  The first meeting is not the time for asking detailed questions about the financials and tax returns or to start asking the seller to prove his figures, that is done after an offer is made during due diligence.  During Due Diligence you will have full access to the company financials and plenty of time to drill down into the details to prove the revenue and earnings of the business.  Note in many cases there may be more than one Seller meeting.  Consider the first one an introduction and the second one is where you learn more about the details of the business.  
  7. Write an Offer:
    After your Seller meetings and perhaps some additional phone calls with the broker you will have enough information to write an offer for the business. The broker will sit down with you and go over the contract and guide you through the process. The broker will discuss the down payment options, the best lenders for the transaction if you are using SBA financing, and Stock vs. Asset sale, transaction structure and timeline.  We highly recommend using an industry standard Purchase Offer such as the California Association of Business Brokers (CABB) Asset Purchase Agreement or Stock Purchase Agreement.  
  8. Broker Presents Offer:
    When you have completed and signed the Purchase Agreement your broker will present the offer to the seller.  If the Seller sends a Counter Offer the broker will review it with you.  Note that with the offer you will provide the broker with an Earnest Money deposit.  This deposit is usually held uncashed until you have removed your Due Diligence contingency in writing at which time the deposit will be sent to escrow to formally open escrow.  
  9. Offer Accepted, Due Diligence Starts:
    Once the offer is accepted by both parties Due Diligence starts.  You will be asked to provide a due diligence list of the information you wish to review.  This typically includes bank statements, 3 years of tax returns, employee info, etc.  Due Diligence typically takes 2 to  weeks once you have received the information and the timeline is specified in your offer.  On small businesses it is common for the buyer to do their own Due Diligence review.  In some cases buyers may elect to have a CPA assist them with the financial review and on stock sales or larger transactions buyers sometimes also engage an attorney to advise them.  Regardless of if you engage professional advisors or not, at the end of the day, it is your decision to buy the business or not.  We highly recommend buyers to be directly involved in Due Diligence and not to solely rely on advisors.  
  10. Due Diligence Complete & Escrow Opens:
    When you are satisfied with due diligence escrow is opened and your broker will provide you with a closing checklist in addition to the closing checklist from the bank and escrow.  If you are using SBA financing the bank will have a long list of documentation required and lots of paperwork.  We recommend starting the SBA application as soon as possible as this is the longest lead time item.  
  11. Escrow Closes:
    Once your loan is approved and everything escrow needs is completed the transaction closes and you now own your own business.
  12. Training Starts:
    Training starts after the close of escrow.  Your Purchase Agreement will have a training period specific with a number of weeks and hours per week that are included in the purchase price.  This is  typically 4 weeks, sometimes up to 6 or even 8 weeks.  This is negotiable but keep in mind that Sellers do not want to provide extended training for free, especially if the price was less than full price.  A consulting agreement is often included in the Purchase Agreement for extended training at a specified price. 
  13. Transition: 
    During and after training remember you have bought a business that has been successfully operating for perhaps 20 or 30 years.  We recommend avoiding the temptation to immediately start “fixing” or improving things as the new owner or boss.  Remember there is likely a lot of loyalty to the old owner and employees know the current systems.  Often there are reasons for the way things are done that you may not immediately understand.  Learn the business from the owner, be patient, and only implement changes after you thoroughly understand the entire business from front to back.  

For more about how to buy a business preview my book, “Own your Future, Straight Talk about Buying a Business and Building Your Future.” 

Additional Information

FAQs Buying a Business

How to Value a Small Business

What Questions Should I ask the Seller About Their Business?

What are Discretionary Earnings? 

How to Value a Small Business Using Earnings Multiples

Category: Business Valuation Buying a Business Selling Your Business 
A business owner or prospective seller may want to know the value of their business before deciding to put it on the market.  Buyers may wish to calculate the value or compare the asking price of a business they are interested in. In the case of business owners considering the sale of their business most business brokers offer a free Market Value Analysis and in fact our firm offers a comprehensive Business Market Value Analysis to prospective sellers.  In either case, the simplest method to obtain an approximate business value is to use the Earnings Multiple method (also known as Market Data, Comps, Discretionary Earnings  or DE Multiple).

Most business buyers and sellers/owners are somewhat aware of earnings multiples but few understand how to properly use and apply these multiples to value a business.  There are many myths and opinions about what a business is worth and what “the” earnings multiple is.  In fact earnings multiples vary widely by industry as well as by earnings.  There are different multiples for Discretionary Earnings (DE aka SDE or Seller’s Discretionary Earnings) and EBITDA (Earnings Before Interest Taxes Depreciation & Amortization).  DE multiples are lower than EBITDA multiples because with DE you are multiplying a higher earnings number against a lower multiple and with EBITDA you are multiplying a lower earnings number against a higher multiple.  Ideally you should get roughly the same value for both approaches. There are no valuation multiples for “net profit” for a small-midsize business and simply applying say a DE multiple to Net Profit will result in a dramatically undervalued figure for the business.  As explained below, the Net Profit does not reflect the actual earnings of a small business, thus using it for valuation purposes is meaningless.

While Earning Multiples seem like a simple method to value a business, and they can be, they must be used correctly and on the right earnings value to deliver the correct valuation for a business.  

Discretionary Earnings vs Net Profit vs EBITDA

First you need to understand the difference between each earnings type and how to calculate them, then look at how to apply them.  

  • Net Profit:
    This is the starting point for calculating both DE and EBITDA.  When a business broker or valuation analyst refers to Net Profit this is the Net Profit shown on the company tax returns.  The Net Profit on the company P&L is often different from the Tax Return Net Profit as a result of changes made by the accountant or CPA at year end which were not reconciled with the P&L.  The Tax Return Net Profit is the only figure used for valuation purposes (note that SBA lenders and valuation analysts only use the Tax Return Net Profit).
  • EBITDA:
    EBITDA is actually simple to calculate.  Start with the Net Profit from the Tax Return and add the Interest, Taxes, Depreciation, & Amortization.  This is the non-normalized EBITDA and for very large businesses this figure is correct. For small businesses we must subtract a replacement salary for the owner at market rate.  This would be the salary of a manager to run the business in
    place of the seller.  This is called Normalized EBITDA which is used for small businesses.  
  • Discretionary Earnings (DE):
    DE is the most commonly used valuation multiple and it is also the most complicated figure to calculate.  DE basically is EBITDA + owners salary + owner’s benefits & expenses. This sounds simple enough and it would be except that many owners bury these expenses which can make it difficult to verify these figures.  One key rule for owner’s expense add backs is that they MUST be tied to an expense line item on the tax return. If the expense is not shown on the tax return then it cannot be used as an add back for calculating DE as it was not shown as an expense on the tax return, which is what is used to calculate DE.  

Finding the Right Earnings Multiple for a Business

You can get Discretionary Earnings multiples and Business Valuation Reports from BizBuySell and Peercomps.  BizBuySell offers valuation reports from $19.95 to $59.95 and Peercomps offers a one time comps search for $49 or a one time business valuation for $99.  

The BizBuySell valuation is the simplest to use and the least expensive.  While it is good for determining a price range, the downside is that it is not an accurate valuation program.  You should only use it for validating a price range and not for determining an exact business value. Note that the comparable sales data in BizBuySell is broker provided, meaning that brokers input this data when a business is sold through BizBuySell.  There are thousands of transactions in the database, the problem is that the way brokers record transactions can vary, making the data less consistent than Peercomps.

The Peercomps valuation is more comprehensive and uses better comparable sales data as their database is from actual closed SBA financed transactions.  All SBA loans require an independent (third party) business valuation (appraisal) by a CVA (Certified Business Valuation Analyst). Thus this comparable sales data is more accurate and more consistent than broker provided comps.  The downside of Peercomps is that it is much more complicated to use and obtain an accurate valuation. The user should be familiar with valuation methods in order to use Peercomps.

Steps to Finding Earnings Multiple Comparable Sales Data

  1. In BizBuySell or Peercomps select the Industry-Business Type (e.g. Distribution, Restaurant, Manufacturing, Construction – note that you can select more specific business types)
  2. Narrow the Gross Sales and Income ranges to values below and above the company’s annual revenue and income.  Set a minimum value to eliminate businesses much smaller than the company you are considering and a maximum to eliminate businesses that are much larger.   
  3. You can change the ranges to narrow or expand your results until you have a suitable number of comps (preferably at least 5 to 10 or more.  In some cases there may be very few if it is a small niche).
  4. Now you should have comparable sales multiples for Discretionary Earnings and if you used Peercomps Normalized EBITDA as well.  The next step is to apply the multiples

Important Notes:

  1. Most DE multiples do not include inventory or A/R (Accounts Receivable) and also assume that all liabilities are paid off by the Seller at closing.  
  2. Peercomps multiples include “normal” inventory and BizBuySell comps may or may not.
  3. Normal inventory is the inventory required to operate the business.  Excess inventory is not included in the earnings multiple.

Applying the Earnings Multiple to Determine Business Value

If you are using the valuation report from BizBuySell or Peercomps you can input the company earnings and revenue to obtain a value based on the Mean or Average Discretionary Earnings multiple.  If you elected to obtain comparable sales data only your next step is to multiply the Mean or Average DE multiple to the DE you calculated. This will give you a value based on the Mean or Average multiple.  

It is important to note and understand that the figure you just calculated is not an exact figure.  The multiple you just used is an average.  Thus, half of the businesses in the comps sold for less than that multiple and conversely half sold for more than that figure.  

If you are considering a business that is exceptional it may be worth a premium and the average multiple may be on the low side.  Likewise, if the business is below average it may be appropriate to apply a discount.

7 Factors that Affect Business Value and Earnings Multiples

  1. Quality of Financial Data
  2. Quality of Product or Service
  3. Competition
  4. Years Established
  5. Quality & Experience of Staff
  6. Infrastructure, Systems, Procedures
  7. Customer Concentration

Earnings Multiples are a convenient and relatively simple way to calculate business values, but as we discussed above, it is not an exact value and more of an average value.  If you are buying a business the Business Broker should have a Recast Financial Statement showing the financials from the Seller’s tax returns and all of the add backs to arrive at the Discretionary Earnings.  The Broker should also be able to provide you with Comps Data and a Market Value Analysis.

If you are Selling your business we recast your financial statements and prepare a comprehensive Market Value Analysis as part of our initial review of the business to determine the asking price.  

INFORMATION ON BUYING-SELLING A BUSINESS

What Questions Should I Ask the Seller About His Business?

Category: Buying a Business 
As a Business Broker one of the most irritating things I see buyers do is spend an hour meeting with a seller and walk away knowing very little about the business.  How does a buyer spend an hour with a business owner and learn almost nothing about the business?

Many buyers focus on the P&L and financial statements almost exclusively, asking questions about specific expenses, depreciation (which most sellers have no idea about since their CPA calculates this), Cost of Goods Sold, etc.  While these questions are appropriate and necessary during Due Diligence, in the early stages of considering a business they provide zero insight into the actual business itself.  Consequently when a buyer spends (wastes) their time focusing exclusively on financial questions they walk away with no understanding of the business.  Who are the customers, what is the owner’s role and daily activities, what do the employees do, what experience do the employees have, what is the competitive edge the company has, what marketing does the company do? These questions give you insight into the business, it’s products/services, infrastructure, and operations.

Ask these 7 Simple Questions to Learn Everything About a Business You are Considering Buying

When you meet with a business owner/seller ask them open ended questions. Business owners are very proud of their business and most love to talk about it. By asking general questions you start a dialogue where you will learn all about the business and the owner.

  1. Tell me about your business…
  2. I’d like to know more about your products/services…
  3. What are your daily activities in the business? What are your primary roles?
  4. What are your employees responsibilities?  Tell me about their experience…
  5. What does your company do for marketing?
  6. Are there any customers that represent over 20% of your annual sales?
  7. I would like to know your ideas and suggestions for what I could do to grow the business…

The goal of your initial meeting with the Seller is to learn as much as possible about the business and the owner.  Is this a business you can see yourself running?  How dependent is it on the owner?  What’s the owner like?  What are the employees like and what is their experience?  By asking open ended questions about the business all of this will come out naturally during the discussion and you will gain much more insight into the business than you do from simply asking questions about the P&L.

INFORMATION ON BUYING-SELLING A BUSINESS

5 Signs a Business Purchase is a Bad Deal and When to Walk Away

Category: Buying a Business 
Finding the right business is a long and challenging process for prospective buyers; when a buyer finds a promising business sometimes it is hard to walk away from the deal.  They’ve likely invested a lot of time into the deal and are emotionally attached to it. At that point buyers will really want to find a way to make the deal work. Often hard work and perseverance pays off and it all works out, but there are times when you should walk away.  

When to Walk Away from a Business Purchase Transaction

  1. Seller is Difficult:
    There are many difficult people in the world.  If the seller you are working with is one of them and you can’t work constructively and productively things will not go well.  You will need this seller to train you and you will be relying on him to be cooperative and committed during the transaction and more importantly during transition and training.  If the seller is difficult to work with it will be nearly impossible to have a smooth transaction and the deal may fall apart later anyway.
  2. The Numbers Don’t Make Sense:
    If the figures on the financial statements don’t make sense and cannot be explained to the satisfaction of you or your CPA it may be time to walk.  While there are many good businesses with imperfect books & records/financial statements, the seller and their CPA should be able to explain them to your satisfaction during your meetings and prove it to your satisfaction during Due Diligence.  The trick here is to determine where that line is and when it’s time to walk away.
  3. Cash Flow Doesn’t Pencil Out:
    If the cash flow after debt service and your required income is not meeting your needs you should seriously consider passing on the business.  While you can grow the business and make improvements, it will take time. If the business will meet your needs in the interim that’s fine, but if it is far short of your income needs you should pass on this one.  
  4. Poor Books & Records:
    If the books & records and financial statements are poor it is nearly impossible to verify the actual earnings of the business.  In situations like this you are flying blind with respect to how the business is performing financially.  Some owners have poor computer records, but good paper records (yes, paper records even today).  In these situations it is possible to verify the revenue and income, it is just a lot of work.  It’s your decision as to if it is worth the work and if you can adequately verify the figures.
  5. The Seller is Evasive or Untruthful:
    If the seller is evasive or untruthful you should walk away, in fact, run away from that deal.  If the seller is not forthcoming and open with information it is very difficult to learn the facts about the business and if they are untruthful then you have no way of knowing what is real and what is fiction.  It’s difficult to conclude a transactions successfully if the Seller is not open and willing to provide detailed information.  

Working with a reputable experienced business broker will definitely be an advantage in finding the right business to buy.  An experienced business broker will be able to facilitate the transaction process and coach a buyer on the above problem areas.  From the initial meeting through closing a business broker should be able to have or get all of your questions answered and let you know where there might be a potential problem.  

Not all problems are deal killers and there are many times when a solution can be reached.  However, there are times to walk away because the risk of buying that particular business can be too high.

INFORMATION ON BUYING-SELLING A BUSINESS

Preparing for Due Diligence on the Sale of Your Business

Category: Buying a Business Selling Your Business 
After an offer for your business has been made and accepted the next step is Due Diligence where the buyer will review the books and records of the business to verify the revenue, earnings and veracity of the business.  Due Diligence is a Contingency for both Buyer and Seller; the buyer’s deposit check is not cashed and Escrow is not opened until after both buyer and seller have removed this contingency. When the Due Diligence Contingency is removed the Business Broker will send the Purchase Agreement documents and buyer’s deposit check to Escrow.  Escrow will deposit the buyer’s earnest money deposit check into their trust account, draft the escrow documents, and once these documents are signed Escrow is opened.

During the Due Diligence process the role of your Business Broker is to organize and facilitate the process and most importantly keep it on track.  The buyer and seller may engage other advisors (see below) to assist and advise them during the Due Diligence process.

Due Diligence Timeline

Due Diligence typically takes 3 weeks for a small to midsize business and can take longer for larger or more complicated businesses; or if the records and business information is not readily available from the seller.  At Pacific Business Sales we use the CABB (California Association of Business Brokers) Purchase Agreements for both business Asset Sale and Stock Sale transactions.  The CABB agreement breaks Due Diligence down into three steps shown below with the number of calendar days specified for each step.  The number of days is specified by the buyer when the offer is prepared with the Business Broker.

  1.       Buyer Due Diligence List: typically 3 to 5 days
  2.       Due Diligence Materials Provided: typically 5 to 7 days
  3.       Review of Due Diligence Materials: typically 10 to 14 days for small to midsize transactions, may be     longer for larger or more complex transactions.
  4.       Total number of days for Due Diligence: typically 20 to 30 days.

At the conclusion of the Due Diligence period each party removes the Due Diligence Contingency and the broker will open escrow.  Should either party decide not to remove the Due Diligence Contingency the transaction is terminated and the buyer’s deposit is returned in full (see Wrapping Up Due Diligence below).

Typical Due Diligence Items

Below is a typical Due Diligence list for a small to midsize business.  Note that different businesses and industries will have additional items specific to that business or industry and the buyer’s CPA or financial advisor may have additional items they wish to review.  If the transaction is a Stock Sale, there will be additional items relating to corporate records that require review.

  1. Seller Disclosure Statement (part of CABB Purchase Agreement).
  2. Business Tax Returns, last 3 years.
  3. Sales Tax Returns (if the Seller has a resale account).
  4. Bank statements (month by month), last 3 years and year to date.
  5. Last 3 years P&L statements.
  6. Balance Sheets for last year end and most recent month end.
  7. Sales by product or service type/category.
  8. Customer list (note in some cases this may be redacted for confidentiality).
  9. A/R and A/R aging report.A/P report.
  10. Employee list with roles and responsibilities.
  11. Payroll reports for last 2 or 3 years with W2s.
  12. Inventory and inventory reports.
  13. Workman’s Comp policy, mod rate, and claims report.
  14. General Liability policy.
  15. Current Lease.
  16. Equipment list.
  17. Buyer’s CPA may have additional items requested for review.
  18. Note that lien searches, releases from state agencies including EDD, Franchise Tax Board, and Dept of Fees (formerly State Board of Equalization), and public notice to creditors are done by escrow once escrow is opened.

Due Diligence Advisors

In many transactions the buyer and seller opt to conduct the Due Diligence review on their own. This is typical for small transactions where the financial statements and other records are straightforward.  Some buyers may engage a CPA to assist them with the financial review and if the transaction is a Stock Sale the buyer may also engage an attorney to review the corporate records. Likewise, some sellers may need to engage their CPA or accountant to provide the requested financial information to the buyer and answer questions about the P&L, Balance Sheet, expenses, tax returns, and owner benefits/expense add backs.

  1.       CPA or financial advisor representing the buyer if buyer opts to engage one.
  2.       Seller’s CPA, accountant or bookkeeper to answer questions about financial statements.
  3.       Buyer’s attorney if buyer opts to engage one (typically for larger transactions and on Stock Sales).  The buyer may also use their attorney to draft a consulting agreement with the seller or other specific agreements if required.
  4.       Seller’s attorney if required such as in a Stock Sale to do the stock certificates and stock transactions.
  5.       Buyer and seller’s insurance brokers.

The Business Broker representing the seller and/or buyer if they are a dual agent cannot act as an advisor to either party with respect to Due Diligence as they are not a CPA or accountant and cannot provide financial or legal advice to either party.  The broker can facilitate the Due Diligence process and assist buyer and seller in organizing the process and answer questions relating to the transaction.

Seller’s Due Diligence

Much of the focus of Due Diligence is on the buyer side, but there is also a seller Due Diligence contingency.  During the Due Diligence period the seller has the opportunity to review the buyer’s qualifications, financial wherewithal to complete the transaction and ability to run the business.  Typical seller Due Diligence items are:

  1.       Buyer Resume.
  2.       Buyer Disclosure Statement (part of CABB Purchase Agreement)
  3.       Buyer Personal Financial Statement (often a copy of their SBA loan application).
  4.       Source of Funds.
  5.       Background Check (this is not always requested but can be).

Wrapping Up Due Diligence

At the end of the Due Diligence period the Business Broker will send buyer and seller a Due Diligence Contingency Removal and Authorization to Open Escrow document for signature.  When the Contingency Removal is signed the broker will send the purchase agreement documents and buyer deposit check to escrow to draft Escrow docs, obtain signatures and open Escrow.

If the parties require more time both can agree, and the broker will write an addendum to the Purchase Agreement extending the Due Diligence period.

If the buyer has found problems during Due Diligence the first step is to review the issues with the seller.  Often the perceived issues are either a misunderstanding of the financial statements, a result of missing information, or a minor issue that is resolved after review with the seller.  

If the issue is significant there are three options 1) negotiate an accommodation with the seller which may involve price or terms, 2) accept the agreement as is if the issue is not significant, 3) terminate the agreement in which case the buyer’s deposit check is returned in full and the transaction is cancelled.

Due Diligence is perhaps one of the most important steps in purchasing a business, second only to the actual purchase agreement and negotiation.  With the help of a professional Business Broker to prepare and negotiate the offer and facilitate the process you can look forward to a timely and successful transaction.

Information on Buying-Selling a Business

Buying a Business is Risky! 7 Reasons to Buy One Anyway!

Category: Buying a Business 
For many people the prospect of giving up their job and steady paycheck to start or buy a business is unthinkable, even terrifying.  In fact, a study sponsored by Weebly and conducted by Wakefield Research found that while most Americans think about quitting their job twice a week, one third of those surveyed fear starting a business more than jumping out of an airplane.  No doubt there is an abundance of fear about starting or buying a business, but is it worth the risk? Are those fears warranted?

7 Reasons to Start or Buy Your Own Business

  1. Control Over Your Life and Destiny plus You’re the Boss
  2. Control Over Your Income and Growth
  3. Pursue Your Passion
  4. Set Your Own Schedule
  5. Wealth creation and tax benefits
  6. Your business is an asset you can sell in the future
  7. Corporate jobs don’t last forever

What are the Risks of Starting or Buying a Business?

Starting a business is risky and  in fact most startups fail within the first few years.  SBA and Census Bureau data show that that 30% of new businesses fail in the first two years, 50% in the first five years and 66% in the first ten years.  So there is justification for the fear of starting a business, but what about buying an existing business?

Buying an existing business is entirely different.  The business has already survived the startup and embryonic phase and is likely a mature business.  The products or services are established and proven. Employees are trained and in place. Customer relationships are established.

Start Up Risks vs Buying an Established Business

Startup AdvantagesEstablished Business Advantages
1. Fulfilling-building your dream.1. Lower risk; established customer base plus products & services.
2. You get to do it your way.2. SBA or seller financing to purchase business
3. You can choose your location.3. Immediate cash flow
4. Possibly less cash upfront (but not in the long term).4. Established Businesses Survive Downturns
(see SBA data below)
5. You can start slow and ease into it.5. No startup phase, it’s up and running.
Startup RisksEstablished Business Risks
1. Unproven product-service.1. Every business, even good ones, have problems which you inherit.
2. Unknown brand, product, service.2. Problems you may miss during Due Diligence.
3. No cash flow initially and slow ramp up.3. Industry or economic downturn.
4. No bank financing available, most startups funded with credit cards and cash (see SBA data below).4. You are not capable of running the business.
5. Industry or economic downturn.
6. Expansion financing will be difficult to obtain for several years other than personal credit.
7. You are not successful in running the business.

There is less risk involved in buying a business and problems within the business can become opportunities for the new buyer.  The majority of sellers want to see a buyer of their business continue to be successful and will oftentimes be willing to stay on after the training period with a consulting fee in order to facilitate a smooth transition with both customers and employees.

How to Buy a Business

For more information about buying a business and how to buy a business see the book written by Bill Grunau, “Own Your Future, Straight Talk About How to Buy a Business and  Build Your Future”.    

In our book you will learn: Own Your Future How to Buy a Business

  • How to Work with Business Brokers
  • How to finance an acquisition with Small Business Administration financing;
  • How to use your 401K or IRA funds to buy a business without penalties or taxes;
  • How to write offers;
  • How to conduct due diligence;
  • How to develop a 100-day and first-year plan;
  • How to develop an exit strategy;
    And much more

More SBA Data and Infographics

  1. Small Business Survival Rates and Firm Age
  2. Do Economic or Industry Factors Affect Business Survival
  3. Small Business Facts – why do businesses close?
  4. Credit Card Financing and Small Business

 

Does a Bear Market Affect Business Values and Sales?

Category: Buying a Business Mergers & Acquisitions Selling Your Business 
A Bear Stock Market causes (or is the result of) the values of publicly traded companies to plummet; but does a Bear Market affect the values of small to midsize (SMBs) privately held businesses?  One may think that in a Bear Market the values of SMBs would be pulled down with those on Wall Street, but this is not necessarily the case. 2018 is a good example of how Wall Street can be on a wild ride while SMB values hold steady, revenues and profits remained solid, and sales of privately held businesses are at record levels.  In fact while the Dow and S&P 500 was down overall in 2018 and nearly lost 20% of the value during December, 2018 was actually a very good year for small and midsize businesses.

A Bear Market can be created on Wall Street by economic forecasts, increasing interest rates, slowing earnings growth, world events, and government economic policies. Small business values are driven by earnings, more specifically the Discretionary Earnings or EBITDA of the business.  That’s it, earnings drive value for SMBs. Because the stocks of publicly traded companies are liquid and easily bought and sold, they are susceptible to speculation and when the economic winds shift, they become volatile. Privately held SMBs are not subject to speculation and are held for long term investment by the owners, thus their values are not driven by speculation.  They do not experience meteoric growth in a Bull Market, nor do they plummet in a Bear Market. In fact, the only time the value of a privately held business is of any real concern is when the owners are contemplating selling the business.

What Does Affect the Value of a Small-Midsize Business?

Earnings are the primary determinant and driver of small business value and the earnings of a business can be affected by internal and external forces.  Internal forces (things within the control of the management) such as management, product life cycles (obsolescence), quality, and pricing can cause the revenue and/or earnings of a business to decline.  External forces (things outside the control of management) such as the economy, competition, and commodity/materials prices, to name a few, can also cause the revenue and earnings of a business to decline.

Thus, if the economy is weak or other external forces affect the sales and earnings of a business the value of that business will be directly affected.  In this sense small business values can follow Wall Street values if the economic factors also affect directly the business and its earnings. While external forces cause the stock market to swing wildly and seemingly instantaneously, changes in the values of privately held businesses are only detectable when an owner is preparing to sell the business or perhaps obtain new bank financing.

Growth in revenue and earnings also affect the value of a business.  Businesses that are growing steadily or rapidly generally get a premium, and businesses with declining sales and earnings are discounted.  The industry type (e.g. distribution, e-commerce, healthcare, manufacturing, construction, B2B or B2C services, retail, etc.) drives the earnings multiple for that business, however, the multiple is a constant and does not generally vary much although it can be discounted due to factors such as lower earnings within each industry, dependence on owner for day-to-day operations (little to no employees) and/or poor books and records.  

How is the Value of a Small Business (SMB) Calculated?

When a small business owner is considering the sale of their business and wants to establish the market value, the first step would be to contact a professional business broker and ask for a Market Value Analysis.  At Pacific Business Sales we offer a free Market Value Analysis for our prospective clients and also offer formal third-party valuations for a fee for clients in need of a full appraisal.

To establish the value of a business, the first step of course is to obtain copies of the last three years tax returns, year to date Profit and Loss Statement and balance sheet.  The next step is to recast the financial statements to calculate the Discretionary Earnings, or DE, of the business. Simply put, DE is the total economic benefit or total income the owner realizes from the business.  Recasting the financial statements involves reviewing the expenses shown on the tax returns and P&Ls and adding back owner’s benefits and non-essential expenses that are discretionary to the owner. The tricky or complicated part of recasting financial statements is that only expenses shown on the tax returns can be added back and any owner’s expense must tie to an expense line item on the tax returns.

When the recasting is complete the business broker or valuation analyst will use a valuation program to calculate the market value of the business based on comparable sales (comps) data and often a valuation method such as the income approach.  At Pacific Business Sales we use the Peercomps valuation program and comps database along with other comps databases to calculate the market value of our client’s business.

Knowing the Market Value of your business is a critical first step in preparing to sell your business.  If you would like to meet with us to discuss the prospective sale of your business and the Market Value of your business please use the button below to contact us.

 

Buying a Business in a Bear Market, Bad Idea or Great Opportunity?

Category: Buying a Business 
Is it a bad idea to buy a small-midsize business (SMB) during or Bear stock market or is it a great opportunity?

When Wall Street turns into a Bear Market, buyers for stocks of publicly traded companies hunker down, hold on to their cash, and wait for the storm to pass.  Some may take extreme steps and sell off stocks they are holding to minimize their losses, create additional liquidity, or to recognize losses for tax benefits at year end and then buy in the new year.  Sellers greatly outnumber buyers in a Bear Market; but there are savvy investors that realize there are still solid companies to invest in that have become great buys and they seize this opportunity to buy at substantial discounts.

Does a Bear Stock Market Affect Small-Midsize Businesses ?

The effect of a Bear Stock Market on small-midsize businesses (SMBs) depends on what is driving or causing the Bear Market.  While 2018 was a wild ride on Wall Street with the Dow and S&P 500 losing nearly 20% of its value from the 2018 peak in December, small business values were not affected and in fact 2018 was a record year for small business sales and values.  Overall, 2018 was a great year for small businesses.  

If the stock market is going through a “correction” after prices have soared and it is simply time for the values to be realigned with their actual economic value, then this generally does not affect small business values.  Likewise, if there is a reaction to global markets, oil price fluctuations, interest rate changes, or government policy changes this generally does not affect small business values. While the Dow and S&P 500 react to economic and world events seemingly instantaneously, privately held business values do not react to these fluctuations which are driven by speculation.  Small business values are driven by earnings (link) and as these companies are privately held, they are not subject to investor speculation since they are held for the long term.

Should I Buy a Business in a Bear Stock Market?

While small business values are not directly affected by a Bear Stock Market, a stock market downturn can cause some prospective buyers to pause and wait to see what happens.  This is an opportunity for serious and savvy buyers as there may be less competition for businesses on the market and you are in a better position to negotiate on price and terms.

But what if the Bear Market is the result of an economic downturn, is it still a good time to buy a business?  During the 2007-2008 recession sales of small businesses dropped dramatically and while some businesses suffered during that recession, the good ones recovered and are having record years now.  The point here is that if one of these 2008 survivors was acquired at that time the company would have been purchased for a fraction of today’s value.

Even during an economic downturn there are quality businesses for sale and during a downturn they will be available for far less than what they would sell for when the economy is doing well.