Buying a Business
What Type of Business to Buy? - investors seeking to buy a business need to consider a number of external environmental factors that may add more risk to their investment decision. The main ones are as follows:-
- Recession Proof Businesses- is the type of business being offered for sale, likely to suffer greatly in an economic downturn? Some luxury goods and service related businesses are more susceptible to economic fluctuations than others, depending on the nature of what they sell. Economic cycles affect consumers and businesses spending behaviours. In particular, housing related industries and high ticket items such as cars, holidays and larger consumer electrical items tend to suffer in harder times. In boom times, the reverse is true as consumers feel richer and have access to more credit, which they enjoy disposing of on these luxury items. Likewise, small businesses can afford to reinvest in growth activities such as new advertising channels or invest in staff or new plant and machinery.
- Level of Current Competition - is there a high degree of existing competition in the market in which the business operates? If the level of existing competition means that current investment must be sustained or even increased, to ensure survival, perhaps an assessment of the local market competition would be appropriate. Niche markets offer opportunities to dominate market share, yet their potential growth may be limited.
- Management Skills Required - does the business of the sale require any specialist expertise or knowledge to exist? If the buyer does not have the skills, experience or regulatory approvals, how much will it cost to employ self employed specialist consultants or sales staff?
- Strength of its Value Proposition - is it clear what the unique selling points of the business for sale actually are to its customers? Is it simply a 'me too' business, or can it be clearly differentiated by brand or other value-added assets?
- Adaptability of it Business Model - lastly, can its current business model be sustained and grown in light of competitive threats and opportunities? For instance, the growth of the Internet has killed off many traditional high street business models in the retail sector, as well as the financial broker markets. Is there an opportunity to transform the business for the sale using an Internet-based model?, or perhaps using a reseller or franchised based business system? Alternatively, is the business for sale highly locally based and would prove very difficult to relocate?, and if so will this limit its future potential growth opportunities?
Evaluation of a Business for Sale- in order to provide a objective assessment of a business for sale, it is necessary to obtain standard company documents from the vendor, usually under the protection of a nondisclosure agreement. These include the Balance Sheet, Profit and Loss account and other key legal and financial documents. The balance sheet will provide relatively recent record of stock, accounts receivable's, machinery, accounts payable's and any liabilities and debts the business has accrued in the past. The profit and loss account will highlight the future earnings potential of the enterprise and should be reviewed on the basis of recent trends. It should include the discovery of the an explanation of the numbers, rather than just looking at the sterile numbers in themselves. For instance, a small business owner may decide to pay himself a much lower remuneration package (by way of salary and dividends), amount in order to reduce their income tax burden. This may include reviewing allowable expenses such as a company car, gym membership and so on. Assess the profit and loss account based on a thorough understanding of the calculations behind the final numbers sent to companies house. To do this, the use of detailed vendor questioning as well as financial ratios provides a useful comparison to other industries. In particular, the use of the Gearings ratio and the Return on Capital Employed (ROCE) ratio, help measure the levels of debt and assets a business has accrued. Other key documents could include reviewing any trademark, copyright or patent documents, which may help put a value on the intangible assets the business for sale owns.
Business Brokers - there are many business transfer agents or business brokers who can provide a service as a impartial intermediary to help buyers and sellers find each other and negotiate a successful outcome. Normally the business broker will act on behalf of a seller and will receive a commission based on final sale value. They may also charge a flat fee for their advice and research services.
The Impact of Legislation and Red Tape - there is a whole host of regulatory legislation that affects many different industry sectors. In the UK, there are specialist associations providing advice on the laws and regulations affecting an industry sector. These are invaluable sources of information when understanding which specific laws may affect the behaviour of a business you plan to buy. For instance, in the financial services sector, there are a large number of regulations regarding the ability of a business to offer financial advice to potential customers. Here the financial services authority provides strict rule and guidance on who is or is not allowed to offer advice. All new business owners will also have to gain an understanding of the employment laws, health and safety laws, business accounting rules and regulations, pension rights and employees working hours to understand their impact onrecruiting or redundancy practices and ongoing staffing contracts. In addition, more and more legislation from the European Union is being incorporated into the UK legislative system. Therefore new employers must keep up-to-date with to ensure they are complying with the latest laws or industry guidelines and good practice.
Buying a Business with a Property - many businesses for sale include business premises, which inherently form the basis of its business operation. It is important to understand the differences between buying a business with a freehold property as opposed to one with a leasehold property. Businesses with Freeholds are generally more expensive because the owner acquires the rights to sell the property and profit from a rise in its value over time. Conversely, a leasehold property is usually sold on the basis of a fixed lease period where rent is payable to the landlord, (who may own the freehold to that property). It is also important to get written clarification from the vendor regarding any specific contractual or banking covenants, restricting the type of business allowed to operate within premises. These restrictions may have been originally drafted by the local council authority (via planning permissions), or a business bank, via a small business loan. In a recession and credit crunch, businesses for sale that are associated with a fixed business premises are suffering, as the land and building values have fallen considerably. If the business is not easily transferable between one business premises to another, it is important that the termination clauses of the lease be explored before any business is sold.
Negotiation - buying a new business of the sale will involve a long process of intense negotiations to thrash out exactly what is included in the sale and what is not. The vendor will already have a good knowledge of the strengths and weaknesses of his business and will naturally be able to exploit these in any negotiations. Yet to achieve a win-win outcome, it is important that the buyer and the seller have a shared understanding of what they both want from the business transfer. The need to both understand the future plans of the buyer and the direction in which they would like the business to go forward. Any mismatch of expectations or confusion around details may result in ill feeling or even contractual difficulties following the sale.
The initial negotiations usually surround broad principles, until it's time for both parties to agree Head of Terms of the agreement. This defines the terms of a business for sale in principle rather than practice. It does not involve the time and cost associated with the contractual processes and due diligence aspects, (which would inevitably follow leading up to the Final Agreement). It usually takes a Memorandum of Understanding, (or what is sometimes called a Letter of Intent), to formalise the head of terms process. It is usually a representation that the two parties have agreed on the sale but not yet thrashed out the final terms and conditions and it is therefore not legally binding. By documenting the agreement in principle, it avoids confusion, by defining what's involved in the sale and limits and excludes any aspects which could be misinterpreted following the agreement.
Paying The Right Price - there are a number of factors used to determine the exact value of the business. By looking at the profitability of a business in recent years and the total monetary value of its assets and liabilities, it is possible to come up with a number. However, most financial documents do not always tell the whole story of the strengths and weaknesses of a business. The intangible aspects, such brand loyalty and strategic supplier relationships, are critical in a fair business valuation. It key customers or established suppliers decided not to deal with the new owner, future profits may suffer and hence the valuation may not be realistic. The motivations of the vendor also important because they may have personal reasons for wanting. Hence they may under value the business. More and more businesses are coming under the increased threat of company administration from their creditors. Hence the valuation will be considerably less as owners desperate struggle to salvage something from the possible wreckage of a corporate insolvency. To value intangible asset requires careful consideration and an understanding of the local marketplace. With these issues in mind, the popular accounting methods of business valuation are as follows:-
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Asset valuation - this is a simple calculation which looks at the quantifiable assets of the business and subtracts its liabilities, to arrive at a business valuation. This is a simplistic method, as it ignores the potential sales capability of the business as well as its intangible assets.
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Price to Earnings Ratio - here the potential vendor will multiply the industry ratio times the company's most recent profit figure. This measure of valuation is more suited to larger and more established businesses that have long-term profit data available for analysis and can easily be compared to competitors in that sector. Beware that sometimes declared profitability can be manipulated by business owners who aim to reduce their corporation tax burden by reinvesting profits or increasing their own salaries.
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Discounted Cash Flow - this is based on a discounted rate which is a measure of investment risk and capital financing.
The Due Diligence Process - by employing a credit referencing agency and/or an accountancy firm, it is possible to check the facts and figures that have been provided by the seller to the buyer. This is an important stage in the sales process and usually happens before any final contractual offers are made. As well as the standard credit referencing reports on individuals and companies, it is sensible to practically test out the claims and assumptions made by the seller yourself. Ask to speak to key customers, reference sites and key suppliers, in order to get their personal feedback as to the value the business currently provides to them. Sample the products or services it currently offers all initiate some kind of mystery shopping to assess its customer service capabilities.
The Final Agreement - now that the buyer and seller are comfortable they understand what each other want from the deal, it is time to document everything in a final and contractual agreement. This detailed contractual agreement will be arranged between the buyer and sellers' solicitors and will include any indemnities and conditions of sale, which must be met in order that the agreement to be valid. The conditions of sale are critical as they formally recognise the assumptions made throughout the buying process. They also help to ensure there is no confusion or misunderstanding, following the completion of a business of the sale. The business transfer should ideally have little impact on customer sales or operational effectiveness of the business.
The pre-agreed transition and implementation plan would normally form part of the agreement. Practically it would be important to communicate the changes to staff before the sale goes through, (to make sure that there are no staff concerns and that their questions are answered in full). It will also be necessary to inform existing customers (with warranties or credit) and suppliers (with trade agreements and credit) of the change in legal ownership. In particular, outstanding invoices, employment contracts and the warranties need to be enforced and managed. Everybody involved in the process needs to understand what is going on, when it wil happen, how it affects them in their day-to-day job. It is important that the whole process is perceived as a positive change for individuals, who may be naturally worried or concerned about the job security and future career prospects with the company.