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

How to Sell Your Business with SBA Financing

Category: SBA Financing Selling Your Business 

Financing is a critical and frequently overlooked aspect of selling your business.  The fact is all cash transactions are very rare other than for very small businesses.  Nearly all business sales have financing, and there are essentially two choices, SBA financing or Seller financing which involves the seller carrying a note.  

SBA Loans; More Cash at Closing for the Owner

SBA 7a loans will finance up to 90% of the acquisition value with a 10% down payment from the buyer.  With this transaction structure the seller receives cash for the full value of the business at the close of escrow.  Bank underwriters often require a small seller note, typically 10% of the transaction value.  With this transaction structure the seller would receive 90% of the transaction value at closing with a note for 10% of the transaction value.  Seller notes are typically 5 years (60 months) ranging from 6% to 8% interest.  

SBA financing requires the business and buyer to qualify for the loan.  The business will be required to provide the last 3 years tax returns plus year to date P&L and Balance Sheet. The business must generate enough cash flow to service the debt with sufficient income remaining for the buyers income requirements.  The buyer must also qualify, buyer requirements are a credit score over 700, sufficient cash for the down payment, working capital, and closing costs plus related business experience.  

There is a common misconception that SBA loans are very difficult to get and take several months.  This can be true in some instances, but this is not the case with the majority of transactions.  Pacific Business Sales uses SBA financing on nearly all of its transactions.  We have direct relationships with several PLP (Preferred Lender Program) banks and we are thoroughly familiar with their underwriting requirements and which banks will lend to specific business types and various deal structures.  By virtue of our experience and banking relationships we typically close our transactions with SBA financing within 60 to 90 days.  

Seller Notes, Quicker & Easier Closing BUT More Risk 

The other option for financing the sale of a business is Seller Financing, a Seller Note.  The typical transaction structure for seller financing is 50% down and 50% of the transaction value financed by the seller for 5 years at 6% to 8% interest. With Seller financing the owner will receive 50% cash at closing and the balance over the next 5 years.  There is substantial risk with Seller financing because the only collateral for the loan is usually the business and if the buyer defaults on the seller note the only recourse is to contact an attorney and take the business back through a judgement.  

There is a tax advantage with Seller Notes.  The owner is taxed as the income is received, thus the seller is taxed on 50% of the transaction value at closing and the balance as payments are received.  

Minimizing Taxes on the Sale of Your Business 

The good news with SBA financing is that you can receive 90% to 100% cash at closing, the bad news is you will be taxed on these proceeds, and depending on the transaction type the tax rate could be high.  We work with several CPAs that have tax strategies that can substantially reduce the taxes on the transaction.  These tax strategies defer the taxes due at closing by approximately 90% and can reduce overall taxes by 30% to 40%.  These tax strategies allow you to invest the proceeds in a trust and pay taxes as funds are withdrawn.  The investments in the trust appreciate tax free until you take funds out.  We can arrange a complimentary meeting with one of our CPA partners where they will explain your options, the cost of the plan and what the tax savings could be.   

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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 Develop an Exit Strategy to Sell Your Business for Maximum Value

Category: Mergers & Acquisitions Selling Your Business 
Bill Grunau

Every business owner wants to realize the maximum value when they eventually sell their business.  The question is what should you do now to prepare for the sale of your business and maximize business value?  

As Middle Market Business Brokers we have sold hundreds of businesses ranging from manufacturing to technology, construction,  and Healthcare plus other industries.  While these businesses are in diverse industries, the companies that sold for premiums and sold quickly had several things in common.  We have outlined the key elements in developing an Exit Strategy to prepare for the sale of your business and maximize the business value. 

Developing an Exit Strategy for the Sale of Your Business 

Here’s a 7 step outline, with details for each step below, for developing an Exit Strategy to maximize the value of your business.  A good exit strategy will also make your business more marketable and reduce your time on market.  Your Exit Strategy is essentially building your business to sell.

  1. Owner Dependency 
  2. Staff 
  3. Infrastructure 
  4. Customer Concentration 
  5. Financial Statements and Tax Returns 
  6. Tax Strategy to Minimize Taxes on the Business Sale
  7. Financial Performance 

Owner Dependency 

Buyers place a great deal of importance on the ease of stepping in and running the business.   Replacement of the owner is a chief concern in every transaction.  

If you have delegated well and have staff handling much of the day to day operations this makes your business more desirable to buyers.  Conversely, if your business is highly dependent on your expertise and customer relationships and there are no staff members capable of taking on these responsibilities buyers worry about how to replace you and the transition.  If you have delegated much of the day to day operations to staff you have built a business.  If your business is completely dependent on you,  you essentially have a job with helpers.  

Your Exit Strategy should address Owner Dependency to minimize owner dependency as well as plan for the eventual ownership transition. 

Staff

Staff is also important to buyers and a key factor in selling a business.  Buyers like to see staff stability (long tenures), good experience, and in larger companies supervisors, foreman, and leads.  If your company is large enough to have managers this is a big plus with prospective buyers.  

We don’t recommend adding unnecessary staff as part of your Exit Strategy as this would reduce profitably and thereby business value.  Rather, we recommend optimizing the staff you have to build a better business that is less dependent on you, has stability and is transferable.  

For example; if you have experienced and long time employees capable of taking on more responsibility, such as becoming a supervisor, start developing them and give them more responsibility.  

Likewise, focus on staff retention, especially for key employees.  

Infrastructure 

Businesses with excellent systems, procedures, and a well trained staff operate more efficiently and also are more marketable when they are offered for sale.  Buyers see businesses with systems and infrastructure as an easier acquisition and transition as compared to those where everything is in the owner’s head.  This doesn’t mean you need to create reams of documents covering every minute detail of your operations, but the essential procedures and policies should be in place to cover day to day operations.  The goal is to create a business where you are easy to replace and a new owner can step in without relying on you for an extended period of time.  

Customer Concentration 

If your company has a broad customer base that’s great as it minimizes the risk and financial impact of losing any one customer.  

If your company has one or several customers that represent a substantial percentage of your business this increases risk and is a concern for prospective buyers.   We have successfully sold companies with customer concentrations as high as 70% for one customer.  It’s not an easy transaction when a single customer represents a very high percentage of the company’s annual sales and it can make the sale of the business take much longer as well as affecting business value.   

If your company has high customer concentration there are essentially two actions you can take when developing your Exit Strategy. 

  1. Development and implement a plan to diversify your customer base.  This may involve simply developing new customers in your existing area and services or expanding your geographic area and services.  
  2. Securing long term relationships.  In some industries it may not be feasible to simply add more customers due to the company servicing a very narrow niche.  Being a niche player has its pluses and minuses.  On the positive side, niche suppliers often command better margins.  On the negative side these markets are also often narrow and have limited customers which result in high customer concentration.  If you have high customer concentration but have had long term relationships with these customers this can be dealt with in the sale with an experienced Business Broker.  The key is to show the relationship is mature, secure, and most importantly transferable to a new owner. 

Financial Statements 

Your company’s financial statements are absolutely critical in the successful sale of your business.  The tax returns must be current and your P&L should closely match the tax returns (note there are commonly small differences).  

Your company will be valued based on the tax returns and the Discretionary Earnings calculated from there. Discretionary Earnings are the Net Profit from the tax returns plus owner’s salary and all benefits/expenses.  

Below we talk further about financial performance and Discretionary Earnings. Read more about calculating DE here. 

In developing your Exit Strategy make sure you review your P&Ls and tax returns with your CPA and clean them up if necessary.  After an offer is received you will have to prove the company financial performance in Due Diligence and this goes much easier with well organized financial statements. 

Tax Strategy to Minimize Taxes on the Sale of the Business

There will be taxes on the sale of your business.  The question is how much.  There is no simple answer to what your tax liability will be.  It depends on many factors including the type of sale, Stock or Asset Sale, the structure of the sale, the type of entity your company is and your past tax returns (depreciation, etc).  

There are actions you can take to minimize or defer your taxes on the sale of your business.  Tax planning should be a key part of your Exit Strategy and you should meet with an expert.  If your CPA says there’s not much you can do about it and you’ll just have to pay the taxes (yes, some of our sellers were told this) you should seek a CPA that is familiar with this type of tax planning and get some additional advice.  There are several tax strategies available that can substantially reduce and defer your taxes.  These strategies have a wide range in cost, complexity and savings.  A CPA familiar with this type of tax planning can advise you on your options. 

Financial Performance 

Your company bottom line, or in this case Discretionary Earnings, has a direct and proportional relationship to the value of your company.  Broadly speaking, for every dollar added to your net profit, two to three dollars are added to the value of your business.  So if you add say $10,000 to your bottom line or Discretionary Earnings your business value increases between $20,000 and $30,000.   

A common mistake made by business owners is to focus on minimizing their annual tax liability and in doing so they often gut their net profit.  As a result they are also gutting their business value.  This doesn’t just impact the current year, it impacts your business value for as much as 3 years because a business is valued on the tax returns for the past 3 years.  

Before we address how to preserve business value without paying excessive taxes, let’s discuss Discretionary Earnings aka DE.  Businesses are not valued simply on the Net Profit shown on the tax returns because most businesses have a large amount of owner’s salary and benefits included in the expenses.  Discretionary Earnings is used to value small and midsized businesses instead of Net Profit or EBITDA.  DE is the total economic benefit the owner derives from the business.  It is calculated by taking the tax return net profit and adding the owner’s salary plus all benefits and expenses run through the business.  

As you can see, you can minimize the Net Profit and preserve the DE by tracking owner benefits and expenses on your tax returns.  It is best to have owner benefits and expenses well identified in separate expense categories so they can be easily verified during Due Diligence and underwriting if SBA financing will be used.  

Another,  often overlooked, way to minimize taxes without reducing Discretionary Earnings and thereby business value is starting a retirement plan.  The owner’s retirement contribution is added back as an owner’s benefit.  Many business owners think the cost of a retirement plan such as a 401K or Defined Benefits Program is prohibitive because they would have to include employees in the plan.  We have sold several businesses that had retirement plans. The owners were able to contribute substantial amounts into the plan and the costs of providing the plan to the employees was reasonable.  Offering a retirement plan is also great for employee retention and recruitment.

Revenue and profit growth is obviously a key financial metric.  Businesses showing steady growth often sell at a premium and businesses with declining revenue and profits are difficult to sell, often being discounted.  Driving revenue and earnings growth should be a focal point of your Exit Strategy.  It should be noted that businesses with steady or flat revenue and earnings are also very marketable.  For buyers, the key here is minimizing risk and financial stability delivers this. 

ADDITIONAL INFORMATION ON SELLING A BUSINESS

When to Sell Your Business, When Not to, and When to Sell Anyway

Category: Selling Your Business 

When is the best time to sell your business? It seems obvious, when you can get the most money for it. But when is that? Are there other things to consider? And how do you know when it is time to sell your business anyway?

When to Sell Your Business

The best time to sell your business is when it is doing well. Businesses that show steady growth in revenue and profits command a premium.

  1. Revenue and profits have been increasing steadily
    These businesses receive a premium.
  2. Steady or flat sales and profits
    When sales and profits have a steady track record, even if they are relatively flat, these are seen by buyers as solid businesses.
  3. Before you are burned out or must sell
    Businesses deliver their best results when the owner is actively involved, engaged, and driving the business. If you wait until you are burned out and tired or must sell due to personal or health reasons the business and financial performance will eventually suffer and with that the value of the business will drop. It is best to sell your business well before you’re burned out or must sell.

When NOT to Sell Your Business

There are a number of times and reasons not to sell your business, here are a few of them…

  1. Sales and/or profitability have been declining. If sales and/or profitability have been dropping AND you know you can turn things around you should wait.
  2. Sales increased recently, but there is no track record or history yet.  You won’t recognize the full value of the recent increase in sales until you complete the current year and your tax returns are available.  It is possible to get a small premium if you sell before the year is final and tax returns are available, but to realize the full value you should wrap up the year and put the business on the market when you have final year end P&Ls and tax returns to prove it.  
  3. An increase in sales and/or profitability is expected, but has not happened yet.  This is the same as above.  Until the increased sales and profitability have actually happened and are shown on year end tax returns it does not add any value to the business.  The “opportunity” may entice buyers but it will not result in an increased value.  
  4. Litigation is pending.
  5. The company is in a distressed situation such as sales, profits, loss of a major customer, etc.  Selling a business that is in a distressed situation will result in a discount on the business value.  The discount will depend on how severe the situation is.  If you can turn things around you will be able to substantially increase the value of your business.  

When to Sell Anyway

There is a time when you should sell your business regardless of other circumstances. These instances include:

  1. Sales & profits are flat and not likely to improve
    If your sales and profits have been flat and are not likely to increase the value of your business will also remain flat. This in itself is not bad, but the risk is that if sales and/or profits start to decline, the value of your business plummets. In general, for every dollar of profit lost the value of the business will drop $2 to $3. Likewise if the business suffers an ongoing trend of declining sales it may not be sellable or if so only as a distressed sale at a severe discount.
  2. Health concerns
    If you are unable to run the business due to health issues it is a good time to sell before your health issues affect the performance of your business.
  3. Burn out
    If you are no longer committed to the business and engaged eventually sales and profits will decline and drag the value of the business down with them.

Some of the things that create a discount:

  • Necessity for a Very Quick Sale: Price is a major factor in the time it takes to sell a business. If you must sell a business very quickly the price will suffer greatly.
  • Poor Books and Records: Businesses with poor books and records or poor documentation of the owner’s benefits and add backs contributing to the Discretionary Earnings are difficult to sell because the earnings are very hard to prove. Businesses with poor books and records are sold at a discount than businesses with excellent books and records.
  • No Infrastructure: The infrastructure of the business is critical for the buyer to be able to successfully acquire and run the business. Businesses that are heavily dependent on the owner are much more difficult to sell and as a consequence of this the selling price generally suffers.
  • Declining Sales and/or Profits: Buyers love businesses that are growing in revenue and profits for obvious reasons. Businesses with steady to flat sales and profits are also very marketable. When a business has declining sales and profits buyers see this as increased risk, likewise, SBA lenders see this as risk and in many cases will not finance the purchase of a business with declining sales. If there is a sensible explanation and a clear path to recovery this certainly helps, but the selling price will be reduced and the time on market will be substantially longer. 
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ADDITIONAL INFORMATION ON SELLING A BUSINESS

The Other Side of COVID-19, How Do I Sell My Business after a Pandemic?

Category: Business Valuation Selling Your Business 

COVID19 has clearly thrown a wrench into the plans of business owners that were preparing to sell their business, or has it?  

Businesses that were forced to shut down during the Stay Home or Shelter in Place orders may find it  necessary to either postpone the sale or reduce the price of your business based on the current market conditions.  However, businesses that have been able to continue to operate such as essential service providers will be in high demand during and after the pandemic is over.  Likewise, businesses that are able to recover quickly after being forced to shutdown or slowdown during the pandemic will also be in demand as our economy recovers.  

What will be the impact of COVID-19 on Business Values and Marketability? 

Business sales/transactions have plummeted during the pandemic because many sellers have pulled their businesses from the market or decided to wait until the pandemic passes to put their business on the market.  Likewise, many buyers are now on the sidelines waiting for this to pass and businesses to be broadly open again before they are comfortable with the economic climate and the general health and safety risks associated with the pandemic .  With that being said, Pacific Business Sales has had several offers on businesses we represent and several transactions in escrow during the pandemic. These are businesses that have been able to continue operating because they are essential services or e-commerce businesses.  

Of course the larger question is what will happen once the Stay at Home orders are lifted and businesses are open again?  

Business Values after COVID-19

Businesses are valued based on cash flow, more specifically Discretionary Earnings (DE) and a multiple is applied to the DE.  Valuation multiples are based on the size of the business and it’s industry, these multiples do not change much over time or with the economy.  For example the multiples in previous economic down turns remained relatively the same, including during 2008. Business values do drop as a result of an economic downturn due to a drop in Discretionary Earnings.  

What will determine the value of your business after the pandemic is over is the DE the business is generating at that time.  Post COVID-19 valuations can take into account the economic impact of the pandemic by normalizing the company’s revenue and earnings during that period.  Below we discuss how businesses will be valued going forward and how revenue and earnings will be adjusted to account for the impact of COVID-19.  

SBA Financing and Valuations

We have spoken with our top SBA lenders about the impact of COVID-19 on business valuations and financing for the purchase of a business.  The lenders understand that many businesses will see a significant drop in sales during the pandemic and stay at home orders. Underwriting guidelines will be modified to account for this event and to normalize the company’s revenue and earnings.  

The approach bank underwriters and business appraisers (valuation analysts) will be using is as follows.  Revenue and earnings during the pandemic and until the Stay at Home Order is lifted will be removed and replaced with average sales and earnings figures from the previous year or perhaps a 3 year average.  This will normalize the revenue and earnings to remove this catastrophic event from the revenue, earnings and valuation.  

Preparing Your Business for Sale After COVID-19

If your business was not affected by the Stay at Home orders and COVID-19 then preparing your business for sale will follow the normal steps.  If your business was shut down or had a substantial slowdown there will be additional action to take. We have outlined the Post COVID-19 steps to prepare your business for sale below.  

Preparing to Sell Your Business after COVID-19 Pandemic & Stay at Home Orders 

  1. Recovery & Stability:
    As businesses open and recover the key thing buyers and SBA lenders will be looking for is financial recovery and stability.  No one expects any business to recover instantly, but they will be looking for solid indications the business is recovering and getting back on track.  Obviously you have a huge motivation to do this as quickly as possible regardless of the prospective sale, but this is also a factor in selling the business.

  2. Financial Books & Records:
    Books and records are always important in the sale of a business and post pandemic they will be even more important.  It is vital that you have good books and records showing the costs associated with the shut down or slow down as well as documentation of any one time costs related to the pandemic.  It will be important to have your 2019 Tax Return prepared and ready to file plus all of your financial records in order for the past 3 years to prove revenue and expenses that correlate to the same timeframe as the COVID-19 timeframe.

    For companies that continued to operate during the Stay at Home orders it will be important to document any extraordinary expenses during that time and document the sales and earnings during that time as well as afterward. 

    After businesses reopen it will be important to have good books and records showing your recovery, new orders, revenue, customers, earnings and actions taken to recover. 

  3. Operations & Infrastructure:
    Infrastructure is a major selling point with buyers.  It doesn’t necessarily directly add value, but it definitely makes a business more marketable and sell more quickly. 

    If your business is shut down or has slowed down now is a great time to work on systems and procedures, get organized and improve your infrastructure.  

  4. Marketing:
    As with infrastructure, having a marketing program in place does not directly add value, but it does make the business more attractive to buyers.  Likewise, a good marketing program should improve your sales and speed the recovery of your business which will increase the value of the company.

  5. Customer Concentration & Stability:
    Customer concentration and stability is always important to both buyers and lenders.  During the recovery customer retention will be key. Of course many of your customers will be recovering too and of course this is expected and understandable.  The key thing will be able to show the customers have been retained.

  6. Staff:
    Staff is also always important to buyers, and conversely businesses that are heavily reliant on the owner are very difficult to sell, often selling at discounts.  If you have staff it will be important to ensure they return to work when your business reopens. If you are shut down or have slowed down now is a great time to think about how you can improve your staff, how to delegate more of your work, and build a better team.  Businesses with a solid staff and that are less reliant on the owner are much more marketable.  

Selling a Distressed Business During COVID-19

If your business is distressed because of COVID-19 and the Stay at Home orders it can still be sold.  Distressed businesses sell at very steep discounts, often for the value of the assets, but they can be sold even during this time.  

Information Required for a Distress Sale

  1. General business information: 
    1. business name, address, corporation name
    2. Type of business
    3. Years established
    4. Building square footage and type
    5. Number of employees
    6. Equipment list (we will send this to you)

  2. Financial Statements
    Note if the business is closed and this will be an asset liquidation sale the information below is not required.  If the business is open or likely to reopen the information below will be required. 
    1. 2020 P&L by Month 
    2. Last 3 years Tax Returns (Federal only) 
    3. Last 3 years P&Ls 

INFORMATION ON BUYING-SELLING A BUSINESS

 

How to Sell a Business with a Business Broker

Category: Selling Your Business 

It seems like selling a business with (through) a Business Broker would be relatively straightforward, one would think that you would just do a Google search for Business Brokers, pick one, put the business on the market, the broker goes to work and presto your business is sold.   It’s not that simple. To successfully sell your business there is a lot to do including; preparing to take the business to market, while it is on the market, and after an offer is accepted. 

3 Things To Do Before You Put Your Business on the Market 

If you are not ready to put your business on the market now, and have time to prepare, here are some things that will increase the value and marketability of your business.  Also see our blog 7 Steps in Preparing Your Business for Sale.  

  1. Financial Statements 
    Meet with your CPA to review your financial statements.  Your business value will be calculated  using the last 3 years tax returns to calculate the Discretionary Earnings (DE)

    Simply put, DE is the Net Income from the tax returns + Owner’s Salary + Owner’s Benefits/expenses (non business essential) + Interest + Depreciation + Amortization.  When you meet with your CPA make sure all of your owner’s benefits/expenses are well documented and expensed on the tax return (if they are not on the tax return they cannot be added back for the DE calculation).  Also make sure your financial statements are consistent and well documented.
     
  2. Focus on Revenue & Profitability
    Your business will be valued based on a multiple of DE (Discretionary Earnings).  Thus for every dollar of profit or DE you add to the bottom line you will create roughly an additional $2 to $3 in value.

    When preparing your tax returns keep in mind that by minimizing profits on your tax returns you are also minimizing the value of your company.  For example, if you reduce your reported profits by say $10,000 you will probably save $2,000 to $3,500 in taxes and feel pretty good about it. On the other hand, if you were selling your business that $10,000 reduction in net profit reduced the value of your business by $20,000 to as much as $35,000.  So in broad terms, for every dollar you save on your taxes by reducing profits you lose $10 in value and once the tax returns are filed this cannot be undone.

    There are ways to minimize profits and taxes without affecting the value of your business.  One way is through retirement plans, other ways include owner’s expenses such as auto, travel, meals, and insurance increasing owner’s benefits.  These expenses reduce net profit and thereby taxes, because they are an owners benefit they are added back in the calculation of Discretionary Earnings (DE) which is the earnings figure used to calculate business value. 

Spring Cleaning
The appearance of a business makes a difference with buyers and the marketability of the business.  Of course an industrial business, machine shop, construction company, etc is not expected to look like the offices of a white collar high tech company, but the business should be organized, clean, and look professionally run. 

When a buyer sees a warehouse or shop that is cluttered and disorganized this makes an indelible impression as to how the business is run in general.  Likewise, if the business is well organized and has a professional appearance this makes an important impression with respect how the business is run. 

Choosing the Right Business Broker 

Selecting the right (best) Business Broker to sell your business is perhaps the most important step in selling your business.  We’ve outlined 9 things to ask your business broker before making your choice below, also see our blog How to Choose a Business Broker for more information. 

  1. Full Time Licensed Professional Business Broker:  
    In California and many other states Business Brokers are required to have a Real Estate License.  Also make sure they are a full time Business Broker and not dabbling at selling business on the side.  

  2. Experience: 
    Ask about their experience. Depending on the industry and the complexity of the transaction a Business Broker should have years of business sales experience and have an understanding and be conversant in regards to your business.  It is important to select a Business Broker that knows when a Stock Sale is needed and when it is not and how to do both types of transactions. It is equally important for your Broker to have excellent lender relationships and be knowledgeable about SBA financing.  And finally you will be relying on your broker to screen and talk with buyers guiding them through the process. You will want to ensure your Broker indeed does this with buyer inquiries.

  3. Upfront Fees:
    Ask if they charge any upfront fees.  Our firm, Pacific Business Sales, does not charge upfront fees.  Our commission is paid at the close of escrow through the Sellers proceeds.

  4. Professional Organization Memberships:
    Are they a member of CABB (California Association of Business Brokers) and/or the IBBA (International Association of Business Brokers)

  5.  Examples of Marketing:
    Ask how they will market the business and ask for examples of what they send to the buyers after they have signed an NDA.  While our firm prepares a comprehensive Confidential Information Memorandum (typically 20 to 30 pages), it is fairly common for Business Brokers to prepare a one or two page summary for the business and that’s it.  Ask for examples of their work and how your business will be marketed.

  6. Transaction Process:
    Ask the Business Broker to explain the transaction process and ask if they work with SBA lenders.  See our Our Steps in Selling a Business

  7. Confidentiality & Buyer Screening: 
    It is important that the sell of your business remain confidential while the business is being marketed to various buyers. Ask your Business Broker how they handle confidentiality. Screening buyers helps with confidential information being distributed to only those buyers who qualify for the business acquisition.  Buyers are also screened in order to minimize time wasted for all parties involved. It’s best to have your Business Broker interview an interested buyer prior to meeting with a seller and field initial questions. 
  8. Purchase Offer:
    Ask about how the purchase offer will be handled.  Do they use an LOI (letter of intent), a custom (in-house purchase offer) or a standard purchase offer?  At Pacific Business Sales we use the CABB Purchase Agreements and associated documents and the CABB LOI. There are many problems and risks with a custom  LOI. LOIs typically are non-binding and often leave out many key deal terms that need to be negotiated later, and should be reviewed by your attorney before you accept it since it is a non standard legal agreement, which will result in a legal expense to you.  There are similar problems with custom in-house purchase agreements. Since they are not an industry standard form and were created by the Business Broker’s firm independently or the buyer’s attorney you should have this reviewed by your attorney, there are risks with non standard contracts and they may not be as comprehensive as the CABB agreement.  The problem with custom or non standard agreements is often not what’s in the agreement as much as what’s missing and knowing if the agreement was done properly. 

  9. Trust:
    It is important to build trust with your Business Broker, you can start by looking at their online reviews,  ask for references and be comfortable with how they conduct their business valuation of your business.

    It is common for business brokers to use broad “rules of thumb” or free comps (comparable sales) data from business for sale websites for valuations.  These methods are acceptable for very small businesses such as restaurants and retail but they are not accurate for larger businesses or for industries such as manufacturing, technology, Healthcare, construction,  etc.

    At Pacific Business Sales we use Peercomps for our business valuations. Peercomps is a paid professional business valuation program using the same valuation methodology employed by business appraisers/valuation analysts.  The comparable sales data in Peercomps is from actual closed SBA financed transactions and the business appraisal from those transactions. We have found that the Peercomps valuation software and database is very accurate and our valuations closely match the appraisal value when our transactions go into underwriting for SBA financing. 

3 Things to Do While Your Business is On the Market

  1. Revenue and Profitability:
    Maintain  revenue and  profitability. This is very important while your business is on the market. A business can take anywhere from three months to one year to find a willing qualified buyer.  If the revenue drops the Discretionary Earnings follow and these factors will reduce the price you will be able to obtain for your business at the time of offer.

  2. Don’t Lose Focus:
    It’s not the time to take your foot off the gas or take extra vacations.  A loss of focus will result in decreased revenue and lower profitability affecting DE which again will result in a price adjustment. 

  3. Changes:
    Any significant changes that occur in your business while it is on the market let your Business Broker know about: 
    Staff and Equipment changes, addition or cancellation of any major contracts and/or customers,  new workman’s comp claims, new lease terms, significant industry changes, a drop or increase in sales revenues.

    Keep your Broker well informed of changes and the status of your business.

After an Offer is Made 

 

  1. Due Diligence:
    Due Diligence is one of the most important times in the sale of your business. The buyer is going to want to verify that the business is what it was represented as at the time of the offer. This is where the real work begins.  The buyer will request various items, see our Blog Preparing for Due Diligence on the Sale of Your Business

  2. Escrow:
    After due diligence is completed and signed off it is time to open Escrow.  Escrow instructions will be sent out to both buyer and seller. Escrow typically takes 30 days and the clock does not start ticking until Escrow receives the signed Escrow instructions from both parties with the deposit check from the buyer.

  3. Continuity:
    After an offer has been accepted, Due Diligence is complete and escrow is open it is easy to become complacent and feel like “phew, I’m done”.  In one sense the major hurdles have been cleared but you’re not done yet. It is vital to keep the business running well, just as if you haven’t sold it.  If the business has a decline in sales, loses a major customer or some other significant negative event happens, before the close of escrow, while you are still running the business this could cause the deal to fall through.  The purchase agreement has a clause about Continuity which specifies the seller is responsible for continuing to operate the business in the usual way and protect and preserve the assets and goodwill. Simply put, the seller is responsible to ensure the business continues as normal. 

INFORMATION ON BUYING-SELLING A BUSINESS

Small Business Survival through COVID-19

Category: Mergers & Acquisitions Selling Your Business 
Bill Grunau

COVID-19 has shut down businesses across the US and worldwide.  In most US states non-essential businesses have been ordered or requested to close, employees have been told to work from home, and the general population has been told to stay home as much as possible.  These are times no one has faced before and business owners are facing challenges no one could have anticipated or planned for. As a business owner you must plan carefully, think strategically, and above all else take action to ensure the survival of your business.  Many people depend on you and your company; your employees, customers, and community all depend on small business owners like you.  

Companies Providing Essential Services 

Some companies are fortunate to provide essential services such as defense/military equipment and manufacturing, healthcare, essential construction services, financial services, etc.  While the nature of their business requires these companies to stay open, which ensures their financial survival, they are facing unique challenges during this time that must be dealt with. 

  1. Health and Safety of your Staff:
    The health and safety of your staff should be of paramount concern.  Since they are needed to work during this crisis it is critical to educate them in good health practices in the workplace and at home to minimize the risk of them becoming ill and potentially infecting others.  If they suspect they are sick they should stay home and see a doctor if necessary. Ensure that your staff are taking this seriously.
  2. Maintaining a Safe Workplace: 
    1. Implement Work from Home where possible
    2. Provide hand sanitizers and hand washing soap/sinks 
    3. Maintain Social Distancing at the workplace 
    4. Encourage the staff to wipe down workstations and clean the facility
  3. Keep Customers Informed:
    Stay in touch with your customers and let them know your company is operating.  Let your customers know what steps you have taken to maintain a safe workplace and a healthy staff. Keep them informed of schedule or delivery changes. 
  4. Maintain Your Supply Chain:
    Contact your suppliers to confirm they are open and your scheduled deliveries are on schedule.  Consider looking into backup suppliers in case your supply chain is interrupted.
  5. Manage Cash Flow and Expenses:
    Although you are fortunate enough to still be operating this is a turbulent time with business conditions changing constantly and quickly.  Preserve your cash in case customers start paying more slowly and to cover unexpected expenses or interruptions in your cash flow. Likewise, now is a time to watch expenses carefully in order to maintain both cash and profitability.  If cash becomes tight you can work with your vendors, creditors, bank and landlord.  
  6. Preserve and Expand Lines of Credit:
    Your credit lines may be needed if cash gets tight. You can explore the possibility of getting higher limits on your credit lines and credit cards in case you need them later.

Companies facing temporary shut down

Many companies such as restaurants, hospitality, retail, and consumer service businesses will have no choice but to shut down during this crisis.  The duration of these shutdowns is unknown and as a business owner you have no way of knowing what the economy will look like when your business emerges and reopens.  Below are some steps to take to ensure your survival and plan for your re-emergence.  

  1. SBA Disaster Loan:
    The SBA has a special disaster loan program for COVID-19 affected businesses.  You can apply online but be aware the website is running slow from the flood of applications.  There is an 800 number for help, but it is flooded as well and wait times are very long. The process requires a lot of paperwork (listed below), but you can complete it on your own with some patience.  NOTE: you can save your work on the application if you don’t have everything you need at the time and come back to complete it later.

    SBA COVID-19 Disaster Loan – Economic Injury Disaster Loans  link: disasterloan.sba.gov/ela

    • Loans up to $2 million
    • Loans are for substantial economic injury where the business is unable to meet its obligations
    • Required Documentation
      • Disaster Loan Application – 3 pages completed online
      • IRS 4506T transcript authorization (you can fill this out online and submit it)
      • Company/Corporate Tax Returns (you can upload or email separately) 
      • SBA form 413 Personal Financial Statement (you can complete online) 
      • If 2019 taxes have not been filed, 2019 Year End P&L is sufficient
      • Year to Date P&L and Balance Sheet 
      • SBA form 1368 monthly sales (you can complete online and email separately)  
      • NOTE – if you have problems uploading your documents you can email to disasterloans@sba.gov or fax to the SBA at 202-275-5852
  2. City & State Small Business Relief Programs:
    Several cities and states have launched small business emergency loans ranging from microloans in the $5,000 range to loans up to $200,000.  You can do a Google Search for your city and state and also see the list below from Forbes.

    List of Small Business Relief Program, Forbes
    https://www.forbes.com/sites/advisor/2020/03/20/list-of-coronavirus-covid-19-small-business-relief-programs/#df4830e89dd0

    List of Banks Offering Relief to Customers Affected by COVID-19, Forbes
    https://www.forbes.com/sites/advisor/2020/03/12/list-of-banks-offering-relief-to-customers-affected-by-coronavirus/#765f8cc53ee3
     
  3. Manage Lines of Credit:
    If you have lines of credit you are likely going to have to tap into them.  View these as your safety net and do your best to minimize the use of these, you will likely need these credit lines when it’s time to reopen.  

  4. Control Expenses & Cash:
    Even though you are shut down there are still expenses rolling in.  Work with your vendors, landlord, creditors and bank to minimize your payments until you reopen.  
  5. Insurance:
    Check your insurance policies to see if you have business interruption insurance.  If so you may be covered for some of your lost revenue.
  6. Helping Your Staff:
    If your business is shut down you likely have had to lay off your staff.  Every business owner dreads laying off their staff. If you are in a financial position to help them in any way or offer them some form of work during the shutdown that’s great, if not, you can help them with unemployment insurance through the state.  Make sure you keep them informed about the status of the company and when you may be able to reopen.
  7. Keep Customers Informed:
    Make sure you keep your customers informed along the way through email, social media, and your website.  They will be essential to your re-emergence from this.
  8. Planning & Re-Emerging:
    Start planning now for reopening and rebuilding now.  COVID-19 will pass and while this is a very difficult time, your business can survive and re-emerge.  Planning for reopening now will make the process go smoother and faster, plus it will be a productive distraction while you are shut down.  

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

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