When purchasing a business, anyone can gather financials and have the business evaluated. Anyone can take a tour and speak with management. The real meat of a business acquisition, the real value of an advisor, is in the breath and depth and skill of their due diligence process. For this determines how financials are interpreted, what is focused on in a tour and during executive discussions, and what your key negotiation points will be.
The due diligence process, when done correctly, will help a prospective buyer assign value (or lack thereof) to elements of a business that are typically not accounted for in a standard business evaluation but can make or break the success of your purchase.
The following factors may have a significant impact on the value of a privately-held company, but they are normally not applicable to the value of a publicly-held firm. Most of them are stand-alone factors that have to be taken into consideration by a prospective purchaser, especially a strategic one. Most are eliminated if the subject company is acquired by a public company or a much larger company. However, when this is not the case, these factors will come into play. They should be considered and evaluated buy buyers during the due diligence process by sellers when they set the price of their business.
- Lack of access to capital. Has the company exhausted its traditional loan options with lending institutions? Has the owner fronted their own personal funds when the businesses needed it?
- Ownership structure and stock transfer restrictions. How many people in the organization have a piece of the ownership? How much of that ownership is silent? How difficult is it to transfer or purchase stock from owners? What are their obligations as stock holders?
- Company’s market share and market structure of the industry. Is this company a leader or respected player in the industry? How complicated is the industry?
- Depth and breadth of management. Is the chain of command so broad or deep it could slow down progress? Is company management left to only a few individuals that call all the shots?
- Heavy reliance on individuals especially owner(s). For each of the key company employees, ask the question, “If this person left, how would the business be affected?”
- Marketing and advertising capacity. Is marketing and advertising effective and adequately budgeted for? If not, how can it be and at what cost?
- Breadth of products and services. Does company success depend on one product? Are there too many products and services? How do you see the businesses advancing based on its current products and services?
- Purchasing power and related economies of scale. Review past purchasing agreements. How much above cost is the business buying what they need?
- Customer concentration. Is the company surviving due to a few key accounts? How easy would it be to broaden its customer base or increase sales to existing customers?
- Depth, accuracy, and timelines of accounting information and internal control. Look beyond their financials. How well is the accounting department organized? Are roles well-defined? How thorough are this department’s policies and procedures?
- Condition of facility and upcoming capital expenditure needs. What needs updating and how soon? How much will it cost?
- Ability to keep pace with technological changes. What has been the historical trend of the business with new technology? Early adopters or laggards?
- Ability to protect intellectual property. Has the company filed for or does it possess patents, copyrights, trademarks, etc. to its intellectual property? If not, how difficult and expensive would it be to do so now? Is it necessary?
- Increasing threat of foreign competition. Historically, how has the business and the industry responded to this threat? If adjustments were made, were they successful? What is the long-term outlook for this industry’s trends?
- Litigation, environmental concerns, and adverse regulatory issues. Check with legal, governmental, and regulatory bodies to see how this company is regarded and what problems it could face in the future.
Essentials of Business Acquisition
Most of us have an inherent desire to control our own destiny. We want to set our own schedules, we want unlimited earning potential, and we want to chart our own course through life. Many times, however, those who have such dreams have resigned themselves to living for the security of the next paycheck and depending on an employer for health insurance and other benefits. For others, there may come a time of decision: Remain employee for the remainder of their career or consider self-employment? Often, that decision is forced by job loss or another event that suddenly places doubt upon future job status. For those who are in the midst of such a decision, one viable option is business ownership.
Considering Business Ownership?
There are three avenues to consider for business ownership: starting your own business, buying a franchise, or buying an existing business. Of the three, starting your own business is the riskiest proposition – you need ample capital, a well-thought-out business plan, and a marketable concept. Taking risks can be both fun and fruitful. Too often however, it can be fatal. Statistics have proven that up to 80% of new business start-ups fail within the first five years of operation.
Buying a franchise can provide the thrill of a start-up business but with the risk significantly reduced. The value of the franchise is the brand name, tested and proven marketing and operating systems, and the support and training offered by the franchisor. Realize however, that any business start-up can take up to two years to yield a profit. Buying an existing business can allow the buyer to benefit from the organization put together by the previous owner, yet be creative in growing the business to reflect his personality and take advantage of new opportunities. When you buy a business, you are not just “buying a job,” you are buying a lifestyle, the chance to build your future, and the opportunity to leave your kids something of real value.
Conducting Due Diligence
Your due diligence on a business acquisition should be conducted with care and is typically divided into two stages. A preliminary due diligence is performed prior to making an offer and will include a review of general company information and detailed financial records. In your offer to purchase, you will want to list numerous contingencies allowing you an “out” if any one of the contingencies is not met. Upon acceptance of your initial offer, you will conduct a second phase of due diligence where you will be allowed to review and audit any information pertaining to the business. Obtaining help in business acquisitions and utilization of advisors, such as accountants and attorneys, is highly recommended, but you need to keep in mind that advisors are concerned about legal liability so they will most likely point out discrepancies with the business and be overly cautious about recommending a business acquisition. Your job will be to analyze their recommendations, review the data and facts pertaining to the business and determine whether the acquisition meets your own goals, options and risk factors.
Banks are leery of financing business purchases, especially for borrowers with little or no direct operating experience with the business in question. Most businesses have few hard assets that could be sold to repay the loan in the event of default. Their “worth” is in their continuous, profitable operation. The last thing the bank wants is to have to operate your business successfully in order to secure repayment. Banks are in the business of lending money – not operating small enterprises. Small Business Administration (SBA) backed loans are often available to fund start-ups and business acquisitions. However, SBA loans can be difficult to obtain due to financial, operational and collateral issues. You can investigate SBA loans through your local banker or visit the Small Business Administration web site at www.sba.gov for more information on current lending requirements. Business acquisition loans are easier to obtain if they are combined with seller financing or earnouts. Seller financing and earn-outs are common in business transfers. The structure of the financing can be designed as a traditional loan with normal repayment schedules or an earn-out with payments based upon a percentage of future revenues. Seller financing or earn-outs will provide you with some comfort that the seller now has a vested interest in your on-going success with the business.
Learning from the Previous Owner
You buy into an existing business to benefit from its income stream and the relationships that are already in place with employees, vendors, and customers. You also buy into a business to benefit from the experience of the seller. All too often, the operating knowledge gained by the owner is not documented and there are few written policies or procedures. As an essential element of your business acquisition, be sure to negotiate for the seller to remain with the business for a certain period of time to benefit from the operating experience the seller has gained. Purchasing an existing business is a big decision and one you should consider very carefully. Make sure you utilize help in business acquisitions by utilizing a Business Acquisition Advisor, conduct a thorough due diligence of the company, negotiate seller financing and try to learn as much as you can from the existing owner. Like many business owners, you should find the experience to be very rewarding!
Contact American Fortune Business Acquisition Services for expert help in business acquisitions at 502-244-0480.