Buying an Existing

Business

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 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

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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 ?

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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

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 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

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 Buying a Business
• Advantages:
– Equipment installed and productive capacity is
known
– Inventory in place and trade credit establishes
– Easier access to financing
– High value

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 Buying a Business
• Disadvantages:
– Cash requirements
– Business is losing money
– Paying for “ill will”
– Unsuitable Employees
– Unsatisfactory location

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 Buying a Business
• Disadvantages:
– Obsolete equipment and facilities
– Change and innovation challenges
– Obsolete inventory
– Value of accounts receivable

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 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
       

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 Buying a Business
• Disadvantages
– Obsolete equipment and facilities
– Change and innovation challenges
– Obsolete inventory
– Value of accounts receivable
 Business may be overpriced

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 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

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 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

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 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

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 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)

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 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
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 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

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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?

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 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

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 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

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 Earnings Approaches
Variation 1: Excess Earnings Method

Step 1: Compute adjusted tangible net worth:

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

Step 2: Calculate opportunity costs of investing:

Investment $150,313 x 25% = $37,578
Salary $25,000
Total $62,578

Step 3: Project earnings for next year:

$74,000

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 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

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 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

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 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 - $25,000 = $196,000

25%

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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

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 Discounted Future Earnings Method
(Continued)

Step 1: Project earnings five years into the future:

Year Pess ML Opt Weighted Average

1 $65,000 $74,000 $92,000 $75,500
2 $74,000 $90,000 $101,000 $89,167
3 $82,000 $100,000 $112,000 $99,000
4 $88,000 $109,000 $120,000 $107,333
5 $88,000 $115,000 $122,000 $111,667

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 Discounted Future Earnings Method
(Continued)

Step 2: Discount weighted average of future earnings at the

appropriate present value rate:

1
Present Value Factor =
(1 +k) t
where...
k = Rate of return on a similar risk investment
t = Time period (Year - 1, 2, 3...n)

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 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
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 Discounted Future Earnings Method
(Continued)

Step 3: Estimate the earnings stream beyond five years:

Weighted Average 1
x =
Earnings in Year 5 Rate of Return

1 = $446,668
= $111,667 x
25%

Step 4: Discount this estimate using the present value factor

for year 6:
$446,668 x .2622 = $117,116

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 Discounted Future Earnings Method
(Continued)

Step 5: Compute the value of the business:

Value = Discounted earnings Discounted earnings

+
in years 1 through 5 in years
6 through ?

= $248,712 + $117,116 = $365,828

Estimated Value of Business = $365,828

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 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 = 3.975
3 4.7
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

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 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

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 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

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