Let’s assume that you own and operate a company that manufactures a product in an industry that is eroding or going downhill. What are your choices or alternatives?
- Run the company as a “cash cow,” resigning yourself to the fact that your industry is slowly declining or is no longer a growth industry. Keep what you are doing profitable even if you
have to increase prices and/or cut costs.
- Increase R&D to develop new products.
- Acquire or merge with a competitor or strategic partner.
- Expand geographically.
- Diversify within the same familiar market.
- Sell the company now before there is further erosion in your industry
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A close review of the financial statements is always in order when considering the acquisition or merger of a company. However, that is only part of what a buyer is acquiring. Other important assets are:
- Repeat customers or clients
- Patented product, government approvals, profitable copyrights
- Broad customer or client base (diverse & growing)
- Long-term contracts
- Recognizable brand or product name
- Experienced management team and trained work force
- Valuable intellectual property
- Proprietary products
- Profitable alliances
- Contracts/non-competes with valuable employee
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According to a Price Waterhouse Coopers survey of more than 300 privately held U.S. businesses that have been sold or transferred, the most common steps companies take to improve their prospects for a sale, prior to taking the company to market, include:
- Improving profitability by cutting costs
- Restructuring debt
- Limiting owners’ compensation
- Fully funding the company pension plan
- Seeking the advice of a consultant or intermediary
- Improving the management team
- Upgrading computer systems/processes
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If you’ve never bought or sold a business before, then the factors that drive and influence business valuations likely seem a bit murky. In a recent Divestopedia article from Kevin Ramsier entitled, “A Closer Look at What Drives and Influences Business Valuations,” Ramsier takes a closer look at this important topic.
Business brokers and M&A advisors play a key role in helping business owners understand why their business receives the valuation that it does. No doubt, the final assessed value is based on a wide array of variables. But with some effort, clarity is possible.
In his article, Ramsier points out that “value means different things to different buyers” and that the “perceived value depends on the circumstances, interpretation and the role that is played in a transition.” It is important to remember that no two businesses are alike. For that reason, what goes into a given valuation will vary, often greatly.
Looking to EBITDA
Ramier points to several metrics including return on assets, return on equity and return on investment. Another important valuable for companies with positive cash flow is a multiple of EBITDA, which stands for “earnings before interest, taxes, depreciation and amortization.” EBITDA is widely used in determining value. On the flip side of the coin, if the company in question has a negative cash flow, then the liquidation value of the business will play a large role in determining its value.
Primary Drivers to Consider
Ramsier provides a guideline of Primary Drivers of Valuation, Secondary Drivers of Valuation and Other Potential Drivers of Valuation. In total there are 25 different variables listed, which underscores the overall potential complexity of accurately determining valuation.
In the Primary Drivers of Valuation list, Ramsier includes everything from the size of revenue and revenue stability to historical and projected EBITDA as well as potential growth and margin percentages. Other variables, ones that could easily be overlooked, such as the local talent pool and people training are also listed as variables that should be considered.
Support for the Business Owner
The bottom line is that determining valuation is not a one-dimensional affair, but is instead a dynamic and complex process. One of the single best moves any business owner can make is to reach out to an experienced business broker. Since business brokers are experts in determining valuation, owners working with brokers will know what to expect when the time comes to sell.
Quality employees are essential for the long-term success and growth of any business. Many entrepreneurs learn this simple fact far too late. Regardless of what kind of business you own, a handful of key employees can either make or break you. Sadly, businesses have been destroyed by employees that don’t care, or even worse, are actually working to undermine the business that employs them. In short, the more you evaluate your employees, the better off you and your business will be.
Forbes’ article “Identifying Key Employees When Buying a Business”, from Richard Parker does a fine job in encouraging entrepreneurs to think more about how their employees impact their businesses and the importance of factoring in employees when considering the purchase of a business.
As Parker states, “One of the most important components when evaluating a business for sale is investigating its employees.” This statement does not only apply to buyers. Of course, with this fact in mind, sellers should take every step possible to build a great team long before a business is placed on the market.
There are many variables to consider when evaluating employees. It is critical, as Parker points out, to determine exactly how much of the work burden the owner of the business is shouldering. If an owner is trying to “do it all, all the time” then buyers must determine who can help shoulder some of the responsibility, as this is key for growth.
In Parker’s view, one of the first steps in the buyer’s due diligence process is to identify key employees. Parker strongly encourages buyers to determine how the business will fair if these employees were to leave or cross over to a competitor. Assessing if an employee is valuable involves more than simply evaluating an employee’s current benefit. Their future value and potential damage they could cause upon leaving are all factors that must be weighed. Wisely, Parker recommends having a test period where you can evaluate employees and the business before entering into a formal agreement.
It is key to never forget that your employees help you build your business. The importance of specific employees to any given business varies widely. But sellers should understand what employees are key and why. Additionally, sellers should be able to articulate how key employees can be replaced and even have a plan for doing so. Since, savvy buyers will understand the importance of key employees and evaluate them, it is essential that sellers are prepared to have their employees placed under the microscope along with the rest of their business.
Where your money is concerned, myths can do damage. A recent Divestopedia article from Tammie Miller entitled, Crazy M&A Myths You Need to Stop Believing Now, Miller explores 5 big M&A myths that can get you in trouble. Miller points out that many of these myths are believed by CEOs, but that they have zero basis in reality.
The first major myth Miller explores is the idea that the “negotiating is over once you sign the LOI.” The letter of intention is, of course, important. However, this is by no means the end of the negotiations and it is potentially dangerous to think otherwise. The negotiations are not concluded until there is a purchasing agreement in place. As Miller points out, there is a great deal that can go wrong during the due diligence process. For this reason, it is important to not see the LOI as the “end of the road.”
Another myth that Miller wants you to be aware of is that you don’t have to take a company’s debt as part of the purchase price. Many business brokers, such as Miller, recommend that buyers don’t take seller paper.
A third myth that Miller explorers is a particularly dangerous one. The idea that everyone who makes an offer has the money to follow through is, unfortunately, simply not true. Oftentimes, people will make offers without securing the money to actually buy the business. No doubt, this wastes everyone’s time. As the business owner, it can derail your progress. If you are not careful, it could actually prevent you from finding a qualified buyer.
Another myth is built around the notion that sellers don’t need a deal team in order to sell their business. Again, this is another myth that has no real foundation in reality. While it may be possible to sell your business without the assistance of an experienced M&A attorney or business broker, the odds are excellent that doing so will come at a price. According to Miller, those working with an investment banker or business broker can expect, on average, 20% more transaction value!
Additionally, there are other dangers in not having a deal team in place. A business broker can handle many of the time-consuming aspects of selling a business, so that you can keep running your business. It is not uncommon for business owners to get stretched too thin while trying to both run and sell a business and this can ultimately harm its value.
Miller’s final myth to consider is that you must sell your entire business. It is true that most buyers will want to buy 100% of a business, but a minority ownership position is still an option. There are many reasons to consider selling a minority stake, so don’t assume that selling your business is an “all or nothing” affair.
Ultimately, Miller lays out an exceptional case for the importance of working with business brokers when selling or buying a business. Business brokers can help you avoid myths. In the end, they know the lay of the land.
Before buying any business, a seller must ask questions, lots of questions. If there is ever a time where one should not be shy, it is when buying a business. In a recent article from Entrepreneur magazine entitled, “10 Questions You Must Ask Before Buying a Business”, author Jan Porter explores 10 of the single most important questions prospective buyers should be asking before signing on the dotted line. She points out to remember that “there are no stupid questions.”
The first question highlighted in this article is “What are your biggest challenges right now?” The fact is this is one of the single most prudent questions one could ask. If you want to reduce potential surprises, then ask this question.
“What would you have done differently?” is another question that can lead to great insights. Every business owner should be an expert regarding his or her own business. It only makes sense to tap into that expertise when one has the opportunity. The answers to this question may also illuminate areas of potential growth.
How a seller arrives at his or her asking price can reveal a great deal. Having to defend and outline why a business is worth a given price is a great way to determine whether or not the asking price is fair. In other words, a seller should be able to clearly defend the financials.
Porter’s fourth question is, “If you can’t sell, what will you do instead?” The answer to this question can give you insight into just how much bargaining power you may have.
A business’ financials couldn’t be any more important and will play a key role during due diligence. The question, “How will you document the financials of the business?” is key and should be asked and answered very early in the process. A clear paper trail is essential.
Buying a business isn’t all about the business or its owner. At first glance, this may sound like a strange statement, but the simple fact is that a business has to be a good fit for its buyer. That is why, Porter’s recommended question, “What skills or qualities do I need to run this business effectively?” couldn’t be any more important. A prospective buyer must be a good fit for a business or otherwise failure could result.
Now, here is a big question: “Do you have any past, pending or potential lawsuits?” Knowing whether or not you could be buying future headaches is clearly of enormous importance.
Porter believes that other key questions include: “How well documented are the procedures of the business?” and “How much does your business depend on a key customer or vendor?” as well as “What will employees do after the sale?”
When it comes to buying a business, questions are your friend. The more questions you ask, the more information you’ll have. The author quotes an experienced business owner who noted, “The more questions you ask, the less risk there will be.”
Business brokers are experts at knowing what kinds of questions to ask and when to ask them. This will help you obtain the right information so that you can ultimately make the best possible decision.
Selling a business can be an exciting and rather lucrative time. But going through the sales process means embracing the notion that you’ll have to be very prepared for whatever might be thrown your way. A key aspect of preparing to sell your business is to know what types of buyers you’re likely to encounter.
It is only logical to anticipate the types of buyers you may be dealing with in advance. That will allow you to plan how you might potentially work with them. Remember that each buyer comes with his or her own unique desires and objectives.
The Business Competitor
Competitors buy each other all the time. Frequently, when a business is looking to sell, the owner or owners quickly turn to their competitors. Turning to one’s competitors when it comes time to sell makes a good deal of sense; after all, they are in the same business, understand the industry and are more likely to understand the value of what you are offering. With these prospective buyers, a great confidentiality agreement is, of course, a must.
Selling to Family Members
It is not at all uncommon for businesses to be sold to family members. These buyers are often very familiar with the business, the industry as a whole and understand what is involved in owning and operating the business in question.
Often, family members are prepared and groomed years in advance to take over the operation of a business. These are all pluses. But there are some potential pitfalls as well, such as family members not having enough cash to buy or not being fully prepared to run the business.
Quite often, foreign buyers have the funds needed to buy an existing business. However, foreign buyers may face a range of difficulties including overcoming a language barrier and licensing issues.
Dealing with an individual buyer has many benefits. These buyers tend to be a little older, ranging in age from 40 to 60. For these buyers, owning a business is often a dream come true, and they frequently bring with them real-world corporate experience. Dealing with a single buyer can also help expedite the process as you will have fewer individuals to negotiate with.
Financial buyers are often the most complicated buyers to deal with, as they can come with a long list of demands. That stated, you should not dismiss financial buyers. But just remember that they want to buy your business strictly for financial reasons. That means they are not looking for a job or fulfilling a lifelong dream. For financial buyers, the key point is that your business is generating adequate revenue.
A synergistic buyer can be an excellent candidate. The reason that synergistic buyers can be such a good fit is that their business in some way complements yours. In other words, there is a synergy between the businesses. The main idea here is that by combining the two businesses they will reap a range of benefits, such as access to a new and very much aligned customer base.
Different types of buyers bring different types of issues to the table. The good news is that business brokers know what different types of buyers are likely to expect out of a deal.
Every business has to be concerned about maintaining confidentiality. In fact, it is common for business owners to become somewhat obsessed with confidentiality when they are getting ready to sell their business.
It goes without saying that owners don’t want the word that they are selling to spread to the public, employees or most certainly their competitors. Yet, there is something of a tug of war between the natural desire for confidentiality and the desire to sell a business for the highest amount possible. At the end of the day, any business owner looking to sell his or her business will have to let prospective buyers “peek behind the curtain.” Let’s explore some key points that any good confidentiality agreement should cover.
At the top of your confidentiality list should be the type of negotiations. This aspect of the confidentiality agreement is, in fact, quite important as it stipulates whether the negotiations are secret or open. Importantly, this part of the confidentiality agreement will outline what information can be revealed and what cannot be revealed.
Also consider the duration of the agreement. Your agreement must be 100% clear as to how long the agreement is in effect. If possible, your confidentiality agreement should be permanently binding.
You will undoubtedly want to outline what steps will be taken in the event that a breach does occur. Having a confidentiality agreement that spells out what steps you can, and may, take if a breach does occur will help to enhance the effectiveness of your contract. You want your prospective buyers to take the document very seriously, and this step will help make that a reality.
When it comes to “special considerations” category, this should be elements that apply to the business in question. Patents are a good example. A buyer could learn about inventions while “kicking the tires,” and you’ll want to be quite certain that any prospective buyer realizes that he or she must maintain confidentiality regarding any patent related information.
Of course, do not forget to include any applicable state laws. If the prospective buyer is located outside of your state, then that is an issue that must be adequately addressed.
A confidentiality agreement is a legally binding agreement. And it is important that all parties involved understand this critical fact. Investing the money and time to create a professional confidentiality agreement is time and money very well spent. An experienced business broker can prove invaluable in helping you navigate not just the confidentiality process, but also the process of buying and selling in general.
What exactly does the term “goodwill” mean when it comes to buying or selling a business? Usually, the term “goodwill” is a reference to all the effort that a seller puts into a business over the years that he or she operates that business. In a sense, goodwill is the difference between an array of intangible, but important, assets and the total purchase price of the business. It is important not to underestimate the value of goodwill as it relates to both the long-term and short-term success of any given business.
According to the M&A Dictionary, an intangible asset can be thought of as asset that is carried on the balance sheet, and it may include a company’s reputation or a recognized name in the market. If a company is purchased for more than its book value, then the odds are excellent that goodwill has played a role.
Goodwill most definitely contrasts and should not be confused with “going concern value.” Going concern value is usually defined as the fact that a business will continue to operate in a fashion that is consistent with its original intended purpose instead of failing and closing down.
Examples of goodwill can be quite varied. Listed below are some of the more common and interesting examples:
- A strong reputation
- Name recognition
- A good location
- Proprietary designs
- Trade secrets
- Specialized know-how
- Existing contracts
- Skilled employees
- Customized advertising materials
- Technologically advanced equipment
- Custom-built factory
- Specialized tooling
- A loyal customer base
- Mailing list
- Supplier list
- Royalty agreements
In short, goodwill in the business realm isn’t exactly easy to define. The simple fact, is that goodwill can, and usually does, encompass a wide and diverse array of factors. There are, however, many other important elements to consider when evaluating and considering goodwill. For example, standards require that companies which have intangible assets, including goodwill, be valued by an outside expert on an annual basis. Essentially, a business owner simply can’t claim anything under the sun as an intangible asset.
Whether you are buying or selling a business, you should leverage the know how of seasoned experts. An experienced business broker will be able to help guide you through the buying and selling process. Understanding what is a real and valuable intangible asset or example of goodwill can be a key factor in the buying and selling process. A business broker can act as your guide in both understanding and presenting goodwill variables.