Buying an Existing

Business

Copyright ©2009 Pearson Education,

1
Inc. Publishing as Prentice Hall
 Buying a Business
• Average business acquisition requires 19 months from starting the search to closing the deal
For many entrepreneurs the quickest way to enter in the market is to purchase an existing business yet the attraction of
first entry can be big mistake
Buying an existing business requires great deal of analyses and evaluations to ensure that what you are purchasing realy
meets your needs don’t rush …. Be sure that you know absolutely everything that you can learned about the business
before you buy .if vital information such as audited financial statements and legal clearances are not available be
patient and do your home work before you even begin to negotiate a purchase price
Be sure that you have considered answers to each of the flowing questions
• Important questions:
– Does the business meet your lifestyle and financial expectations?
– Do you have the ability to operate the business successfully?
– Is this the type of business you would like to operate ? Do you know the negative aspects of this business
– Is this the best market for this business ?
– Do you know the critical factors that must exist for this business to be successful ?
– Do you have experience required to operate this type of business ? If no will current owner willing to stay three to six months
– Will you need to make any changes of this business or its operating procedures to be successfully . If so what expenses ?
– If the business currently in a decline. Do you have the plan to return the business to profitability?
– If the business is profitable why does the current owner want to sell ? Does their reason given for selling the business make sense to
you ?if not can you verify the reasons
– Have you examined other similar business that are currently for sale or that have sold recently to determine what fair market price
should be

Copyright ©2009 Pearson Education,

2
Inc. Publishing as Prentice Hall
 Buying a Business
• Advantages
– Business may continue to be successful
– Leverage the experience of previous owner
– “Turn key” business
– Superior location
– Employees and suppliers in place

Copyright ©2009 Pearson Education,

3
Inc. Publishing as Prentice Hall
 Buying a Business
• Advantages:
– Equipment installed and productive capacity is
known
– Inventory in place and trade credit establishes
– Easier access to financing
– High value

Copyright ©2009 Pearson Education,

4
Inc. Publishing as Prentice Hall
 Buying a Business
• Disadvantages:
– Cash requirements
– Business is losing money
– Paying for “ill will”
– Unsuitable Employees
– Unsatisfactory location

Copyright ©2009 Pearson Education,

5
Inc. Publishing as Prentice Hall
 Buying a Business
• Disadvantages:
– Obsolete equipment and facilities
– Change and innovation challenges
– Obsolete inventory
– Value of accounts receivable

Copyright ©2009 Pearson Education,

6
Inc. Publishing as Prentice Hall
 Valuing Accounts Receivable
     

Age of Probability of
Accounts Amount Collection Value
 
(days)
0-30 $40,000 .95 $38,000
31-60 $25,000 .88 $22,000
61-90 $14,000 .70 $9,800
91-120 $10,000 .40 $4,000
121-150 $7,000 .25 $1,750
151+ $5,000 .10 $500
     
Total $101,000 $76,050
       

Copyright ©2009 Pearson Education,

7
Inc. Publishing as Prentice Hall
 Buying a Business
• Disadvantages
– Obsolete equipment and facilities
– Change and innovation challenges
– Obsolete inventory
– Value of accounts receivable
 Business may be overpriced

Copyright ©2009 Pearson Education,

8
Inc. Publishing as Prentice Hall
 How to Buy a Business
• Analyze your skills, abilities, and
interests
• Develop a list of criteria
• Prepare a list of potential candidates
– Remember the hidden market of
companies that may be for sale but are
not listed as “for sale”
Rays Market

Copyright ©2009 Pearson Education,

9
Inc. Publishing as Prentice Hall
 How to Buy a Business
• Investigate and evaluate
candidate businesses and
select the best one
• Negotiate the deal
• Explore financing options
• Ensure a smooth transition
Ray’s Market

Copyright ©2009 Pearson Education,

10
Inc. Publishing as Prentice Hall
 The Legal Aspects of
Buying a Business
• Lien - creditors’ claims against an
asset
• Bulk transfer - protects business
buyer from the claims unpaid
creditors might have against a
company’s assets

Copyright ©2009 Pearson Education,

11
Inc. Publishing as Prentice Hall
 Bulk Transfer
• Seller must give the buyer a sworn list of creditors
• Buyer and seller must prepare a list of the property
included in the sale
• Buyer must keep the list of creditors and property for
six months
• Buyer must give notice of the sale to each creditor at
least ten days before he takes possession of the
goods or pays for them (whichever is first)

Copyright ©2009 Pearson Education,

12
Inc. Publishing as Prentice Hall
 The Legal Aspects of Buying a
Business
 Lien - creditors’ claims against an asset
 Bulk transfer - protects business buyer
from the claims unpaid creditors might
have against a company’s assets
• Contract assignment - buyer’s ability to
assume rights under seller’s existing
contracts
Copyright ©2009 Pearson Education,
13
Inc. Publishing as Prentice Hall
 The Legal Aspects of Buying a
Business
• Covenant not to compete (restrictive
covenant) - contract in which a business
seller agrees not to compete with the
buyer within a specific time and geographic
area
• Ongoing legal liabilities - physical premises,
product liability, and labor relations

Copyright ©2009 Pearson Education,

14
Inc. Publishing as Prentice Hall
Five Critical Areas for Analyzing an Existing
Business
1. Why does the owner want to sell...the real reason?
2. What is the physical condition of the business and
its assets?
3. What is the market potential for the company's
products or services?
– Customer characteristics and composition
– Competitor analysis
4. What legal aspects must I consider?

5. Is the business financially sound?

Copyright ©2009 Pearson Education,
15
Inc. Publishing as Prentice Hall
 Determining the Value of a Business

• Balance Sheet Technique

– Variation: Adjusted Balance Sheet Technique
• Earnings Approach
– Variation 1: Excess Earnings Approach
– Variation 2: Capitalized Earnings Approach
– Variation 3: Discounted Future Earnings Approach
• Market Approach

Copyright ©2009 Pearson Education,

16
Inc. Publishing as Prentice Hall
 Balance Sheet Techniques

"Book Value"of Net Worth = Total Assets - Total

Liabilities
= $278,990 -
= $114,325
$164,665

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

 Balance Sheet Techniques

"Book Value"of Net Worth = Total Assets - Total

Liabilities
= $278,990 -
= $114,325
$164,665

Variation: Adjusted Balance Sheet

Technique:
Adjusted Net Worth = $264,638 -
$114,325
= $150,313

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

 Earnings Approaches
Variation 1: Excess Earnings
Method
Step 1: Compute adjusted tangible net
worth:
Adjusted Net Worth = $264,638 -
$114,325 =
$150,
Step 2: Calculate opportunity costs of
investing: 313
Investment $150,313 x 25% = $37,578

Salary
$25,000 Total
$62,578
Step 3: Project earnings for next year:
$74,000

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

 Excess Earnings Method
(Continued
)
Step 4: Compute extra earning power
(EEP):
EEP = Projected Net Earnings - Total
Opportunity Costs
= $74,000 - 62,578 = $11,422

Step 5: Estimate the value of the intangibles

("goodwill"):
Intangibles = Extra Earning Power x "Years of Profit"
Figure*
= 11,422 x 3 = $34,299

* Years of Profit Figure ranges from 1 to 7; for

a normal risk business, it is 3 or 4

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

 Excess Earnings Method
(Continued
)
Step 6: Determine the value of the
business:
Value = Tangible Net Worth + Value of Intangibles

= $150,313 + 34,299 =
$184,612

Estimated Value of the business =

$184,612

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

 Capitalized Earnings Method
Variation 2: Capitalized Earnings
Method:
Value Net Earnings (After Deducting Owner's
= Salary)
Rate of Return*

* Rate of return reflects what could be

earned on a similar-risk investment

Value $74,000 - =
= 25%
$25,000 $196,0
00

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

Discounted Future Earnings Method
Variation 3: Discounted Future Earnings
Method:
Step 1: Project earnings five years into the
future:
3 Forecasts:
 Pessimistic
 Most Likely
 Optimistic

Compute a weighted average of the

earnings:
Pessimistic + (4 x Most Likely) +
Optimistic 6
Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall
 Discounted Future Earnings Method
(Continue
d)

Step 1: Project earnings five years into the

future:
Year Pess ML Opt
1Weighted
$65,00Average
$74,00 $92,00 $75,50
0 0 0 0
2
$74,00 $90,00 $101,0 $89,16
3
0 0 00 7
4
$82,00 $100,0 $112,0 $99,00
5 0 00 00 0
$88,00 $109,0 $120,0 $107,3
0 00 00 33
$88,00
Copyright$115,0 $122,0
© 2009 Pearson Education, Inc.  Publishing as Prentice Hall $111,6
 Discounted Future Earnings Method
(Continue
d)
Step 2: Discount weighted average of future
earnings at the appropriate present value rate:

1
Present Value
Factor = (1 +k)
where... t

k = Rate of return on a similar risk

investment
t = Time period (Year - 1, 2, 3...n)

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

 Discounted Future Earnings Method
(Continued
)

Step 2: Discount weighted average of future

earnings at the appropriate present value
rate:
Year Weighted Average x PV Factor = Present Value

1 $75,500 .8000 $60,400

2 $89,167 .6400 $57,067
3 $99,000 .5120 $50,688
4 $107,333 .4096 $43,964
5 $111,667 .3277 $36,593
Total $248,712
Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall
 Discounted Future Earnings Method
(Continue
d)

Step 3: Estimate the earnings stream beyond

five years:
Weighted 1
x =
Average Earnings Rate of
in Year 5 Return
1 =
= $111,667
25 $446,668
x
%
Step 4: Discount this estimate using the
present value factor for year 6:
$446,668 x .2622 = $117,116

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

 Discounted Future Earnings Method
(Continue
d)

Step 5: Compute the value of the business:

Value Discounted Discounted

+
= earnings in earnings in
years 1 years
through 5 6 through ?
= $248,712 + $117,116 =
$365,828
Estimated Value of Business =
$365,828

Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall

 Market Approach
Step 1: Compute the average Price-Earnings
(P-E) Ratio for as many similar businesses as
possible:
Company P-E Ratio
1 3.3
2 3.8
Average P-E Ratio =
3 4.7 3.975
4 4.1

Step 2: Multiply the average P-E Ratio by

next year's forecasted earnings:
Estimated Value = 3.975 x $74,000 =
$294,150
Copyright © 2009 Pearson Education, Inc.  Publishing as Prentice Hall
 The Art of the Deal
• Establish the proper mindset
• Understand the rules of successful negotiations
• Develop a negotiating strategy
• Be creative
• Keep emotions in check
• Be patient
• Don’t become a victim

Copyright ©2009 Pearson Education,

30
Inc. Publishing as Prentice Hall
 The Five Ps of Negotiating

Preparation - Examine the needs Poise - Remain calm during the

of both parties and all of the negotiation. Never raise your voice
relevant external factors affecting or lose your temper, even if the
the negotiation before you sit situation gets difficult or emotional.
down to talk It’s better to walk away and calm
down than to blow up and blow
the deal

Patience - Don’t be in such

a hurry to close the deal that
you end up giving up much of what
you hoped to get. Impatience is
a major weakness in
a negotiation

Persuasiveness - Know what Persistence - Don’t give in at the

your most important positions are, first sign of resistance to your
articulate them, and offer support position, especially if it is an issue
for your position that ranks high in your list of priorities
 Exit Strategies
• Straight business sale
• Sell controlling interest
• Restructure the company
• Use a two-step sale
• Family limited partnership (FLP)
• Establish and employee stock ownership plan (ESOP)
• International buyer

Copyright ©2009 Pearson Education,

32
Inc. Publishing as Prentice Hall