The Top 3 Critical Issues in Buying or Selling a Business

Posted on April 7, 2020 by

I’m often asked what the top critical issues are in buying or selling a business.  If the top Critical issues in buying or selling a business.three issues discussed below in the sale or purchase of a business are not properly addressed, then there is a good chance the transaction will fail.

So to get to the core of the question, these are in my opinion the top three issues involved in buying or selling a business:

1. Confidentiality

Confidentiality is critical to the successful transfer of a business.  If word gets out that a business is for sale, several things start happening and none of them are good for the seller or buyer of the business.  First, key employees start looking for other jobs, fearing that a new owner may not retain them.  In the uncertainty, customers may begin shopping elsewhere.  Suppliers get nervous.  Competitors can take advantage of the situation.

This is why a prospective business buyer will be asked to sign a non-disclosure confidentiality agreement early in the process of looking at a possible business acquisition. In this agreement, the potential buyer confirms that he/she will not disclose the fact that the business is for sale except to professional advisors.

If you show that you take the need for confidentiality seriously, you will be regarded as the professional that you are.

2. Valuation

Nothing causes the buyers and sellers of businesses more anxiety than the issue of valuation. The question of selling price haunts both parties. The seller doesn’t want to price his business too low and “leave money on the table.”  On the other hand, the buyer of the business is afraid he’ll pay too much and not get the best possible price.

Formal, fully documented business appraisals are now readily available.  In addition, there are rules of thumb guidelines that can be used to quickly estimate the value of a business.  As just one example, we know that a full service restaurant with a liquor license is worth about 30% of its annual gross revenue as an ongoing business.  This assumes – big assumption – that the business is earning the average bottom line profit for its peer group.

There are rules of thumb guidelines for almost all categories of business from ice cream stands to manufacturing plants.  But again, these guidelines provide only quick estimates.  And written, fully documented business appraisals are now done by several respected national firms at a cost similar to real estate appraisals.

3. Financing

Financing is always a concern, as hardly any business buyer has the financial capacity to write a check for the purchase price of a business.  If they did, they would most likely be living off of investment income rather than buying a business.

These are five possible sources for business acquisition loans:

BANKS – Although most people seeking a loan to buy a business will think first of a traditional bank loan, I can tell you from years of business brokerage experience that banks generally do not make business acquisition loans.  There are exceptions but they’re rare.

SBA – The SBA, through its approved lenders, provides business acquisition loans.  The SBA does not make direct loans, but rather guarantees a portion of the loan that is made by the approved lender.   It’s known as the SBA 7(a) program.  Wells Fargo Bank is currently the top volume SBA lender nationally.

The SBA route for a business acquisition loan is sometimes frustrating because of the time and detail that is involved.  However, keep in mind that the SBA will approve loans that others have turned down and will usually approve them with a smaller down payment.  In most cases, it’s worth the wait.

FAMILY – Many times the older generation in a family will loan the down payment or the entire amount needed to a promising member of the family’s younger generation.  If your family is willing to loan you the money, one word of advice is in order.  Have a very clear understanding as to how the debt is to be handled and put it in writing in the form of a legal note.

THE SELLER – In a significant percentage of the business transfers that I handle as a business broker, the owner of the business finances a portion of the purchase price for the buyer.  Some sellers cannot offer owner financing for a variety of reasons, but when they can, it conveniently solves the problem of financing.

The fact that the business owner is willing to finance the sale of his company provides more than a convenient finance plan.  More importantly, it provides a strong validation of the owner’s belief that the business will support the owner and earn enough cash to pay back the loan.  You can’t get any better recommendation on the business than this.

The normal down payment for owner financing ranges generally from around 30% to 50% of the purchase price of the business.  Interest rates are generally market driven but there is more flexibility here than in other forms of financing.

401(K) FUNDS AND IRA ACCOUNTS – The use of these funds to buy a business, without tax penalty, is a fairly recent development.  Several national CPA and attorney groups have developed a plan, approved by the IRS, which allows you to use your funds for business acquisition.  There are legal and accounting fees involved, but they are a small fraction of the tax penalty that would be assessed for cashing in these accounts early.

 The above ­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­five sources of financing are not exclusive to each other.  I recently handled a transaction in which three of the five sources were used to buy the business.

It’s called creativity!

If I can assist you with any considerations involved in the transfer of ownership, please don’t hesitate to email or call me.

For further reading, here are additional related articles:

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

 
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Buying a Business? Here’s How to Write a CONTINGENT Offer.

Posted on May 18, 2020 by

Let’s say you have looked at several businesses for sale and narrowed it down to the one that you want to pursue.  You think you might want to write an offer to buy this business, but you’re not quite sure.  You have a little anxiety about the unknowns. In such a situation, writing a  CONTINGENT offer to buy the business is the answer.

The Problem

How to write a contingent offer to buy a business.

When making an offer to buy a business, be sure to make it contingent upon the due diligence investigation.

The problem, bluntly stated, is that the seller of the business does not want every Tom, Dick and Harry going through his private books and records, some of which might be very sensitive for one reason or another.

Let me ask you at this point to stand in the seller’s shoes for a moment.  He has taken the big step of putting his business up for sale.  This may have been a tough emotional decision for him.  And he probably has the same heightened level of anxiety as you do about the future transaction.

Now his business is up for sale and before long, he’s got all sorts of strangers asking him to let them look through his most private records.

As a business broker, I can verify that this is a real problem.  Some people who look at businesses have no real intention of ever buying one.  They are what we call “tire kickers.”  They will look forever and never make a purchase.  Others may have a real interest, but when push comes to shove, they lack the financial capacity to make the purchase.  Still, others may have the financial capacity but are unwilling to pay the owner anywhere near an acceptable price for his business.  There have also been instances in which a competitor sent in a stranger to check out the business.  And all of these people will demand to paw through the seller’s private books and records.

Now you may step back into your own shoes.  The brief visit to the seller’s side of the desk, I hope, gives you an understanding of the problem.

The Solution

The safe solution is to write a contingent offer to buy the business.

Simply stated, it works like this.  You, as the prospective buyer of the business, assume for the moment that the preliminary information furnished to you on the business is accurate.  You should by now have at least the annual revenue and cash flow of the business plus the other important numbers.

You then base the amount of your offer to purchase the business on those numbers, but with the following verbiage written into the contract as a condition of the offer:

This offer to purchase said business is fully contingent upon the buyer’s inspection of all the books and records of the business and the buyer’s satisfaction with the information contained therein.

This verbiage in the contract fully protects you.  If you find, during your inspection of all the books and records, including the tax returns, that the numbers furnished you were not correct, then you have the perfect right to terminate the contract and walk away with no further responsibility.  Any earnest money deposit held in trust is promptly refunded.

This procedure also protects the seller, as he knows that you are now serious about the transaction.  You and the seller have come to an agreement on price and terms – possibly after some counter offers – and you have put up an earnest money deposit.  The seller should now regard you seriously, and accordingly will open up all of his books and records for you to inspect.  This inspection phase of the transaction, by the way, is referred to as due diligence and is covered in this article.

The contingent offer to buy the business is actually a win-win situation for both parties.  It assures the seller that the buyer is serious and it protects the buyer in case the information that has been furnished is not accurate.

The Other Contingencies

There are other contingencies that you also might want to include in the contract.  For example, if you are borrowing the money with which to purchase the business, you would need to include the following language to protect yourself if you don’t already have the loan approved:

This offer is fully contingent upon the buyer obtaining satisfactory financing for the purchase of the business.

And if the business operates from leased premises, you would want to include the following proviso:

This offer is fully contingent upon the buyer’s assumption of the existing lease for the business premises or otherwise negotiating an acceptable lease with the landlord for said premises.

Other items that should be included in the purchase contract

  • The Closing Date and Place. Pick a closing date that will give you enough time to inspect the books and records of the business, get your loan approved and take care of any other issues.
  • Inventory Level. If the business carries inventory for resale, this is where you agree on the amount of inventory that must be on hand on the date of closing.  This should be the amount of inventory normally carried by the business in the normal course of doing business.  Your broker should have this figure.  The purpose of this provision is to prevent an unscrupulous seller, between the date of the agreement and the date of closing, from selling out the inventory and leaving the buyer with empty shelves.  You and the seller jointly take inventory on the day of closing.  If the inventory level, at cost, is below the figure specified in this paragraph, the purchase price of the business goes down by the amount of the shortage.  Conversely, if the inventory is over the specified level, the price of the business is adjusted upward by the amount of the surplus.  This is fair to both parties, and if the inventory discrepancy is small, the difference is usually waived, as both parties understand that it is impossible to quote an exact inventory figure in advance for any given day.  But the provision is there for protection if it needs to be invoked.
  • Training. You and the seller need to agree on the number of days training you think you will need from the seller.  Normally, this ranges anywhere from one to two months.
  • Non-Compete Agreement. You don’t want to buy Ms. Jones’s gift shop and then next month see Ms. Jones open a competing shop right down the block.  This provision prevents that possibility.  You simply agree on the distance and time limitation in this paragraph of the contract.
  • Removal of Contingencies. Remember all of the discussion above of the contingencies: inspection of the books, the lease and loan approval.  At some point, these contingencies are satisfied or waived by the buyer.  This part of the contract is where you decide how much time you’re going to need to accomplish any work needed to satisfy yourself as to these contingencies. Ten to 15 days prior to the closing date is customary.  After satisfaction of the contingencies, the contract then becomes binding on both parties, and the closing documents can be prepared.
  • Offer Deadline. This provision gives the seller a deadline for response (acceptance or counter-offer) to your offer.  If there is no response from the seller by this date and time, your offer is legally null and void and you have no further liability.  Two or three days are long enough here, unless there are unusual circumstances.

Readers can request by email a copy of William Bruce’s 67-page booklet, “How to Buy a Business in a Safe and Organized Way.”  The booklet contains a sample of an Offer to Purchase Agreement.  The email address is Will@WilliamBruce.org.

Now, take a deep breath.  It’s really not as complicated as most folks seem to think.  And we’re just getting to the fun part – the negotiations, which is covered in a separate article.

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org

His booklet “How to Buy a Business in a Safe and Organized Way” contains a sample Offer to Purchase Agreement.  You can obtain a complimentary copy by contacting William Bruce.

(C) Copyright William Bruce.  All rights reserved.

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Using Rules-of-Thumb to Quickly Estimate Business Value

Posted on May 11, 2020 by

By William BruceUsing rules-of-thumb to estimate business value

Using rule-of-thumb guidelines to estimate business value will give you a close approximation of the value of a business.

Certain situations require a formal, written, fully documented business valuation.  However, what we’re talking about here is not a formal appraisal but rather the informal methods of quickly approximating the value of a business entity by using widely accepted rules-of-thumb to estimate the value of a business.

All of the guidelines we’ll quote are based on the opinions of industry experts and averages derived from hundreds of completed transactions reported to national databases.

The Two Methods

Two commonly used methods of quickly approximating value are: (1) applying a multiple to the discretionary earnings of the business and (2) applying a percentage to the annual gross revenue of the business.

The most accurate of the two guidelines seeks to approximate the value of a business by applying a multiple to the company’s discretionary earnings.  What are discretionary earnings?  Discretionary earnings are NOT the profit or loss that you show Uncle Sam on your tax return.  To put it delicately, almost all business owners run some expenses through the business that are — a’hem — not absolutely necessary to the operation of the business.

What Are Discretionary Earnings?

Discretionary earnings are the total cash that the business generates in a year that is available to the owner after deductions for only the necessary operating expenses.  Another way to define discretionary earnings is that it is the “total owner’s benefit” derived from owning the business, regardless of how the owner takes the money out of the business.  Here’s an article explaining the subject in more detail.

The Multiple of Discretionary Earnings Method

Almost all privately held businesses will appraise for somewhere between one to five times discretionary earnings.  Exactly where in this range that a specific business falls depends on the type of business.

From the database of completed transactions, we know that an air-conditioning/heating contractor, for example, is valued at approximately 2 to 3.5 times discretionary earnings.  A retail gift shop is worth about 2.5 to 3.5 times discretionary earnings.  Home health care is 2 to 4 times; dry cleaners are 2.5 to 3.5  Wholesale distributors, in general, are valued at between 2.75 to 3.75 times discretionary earnings.  Where within these ranges by category a particular business falls depends on many factors considered by valuation experts.

The Percentage of Revenue Method

A less accurate method of estimating the value of a business is to apply a percentage to the company’s annual gross revenue.  For example, a full-service restaurant with a liquor license will be worth about 30% annual gross revenue if — big “if” — it’s earning the average bottom line profit for its peer group.

As other examples, auto service shops will be valued at 30 to 40 percent of annual gross revenue and long-haul trucking companies at approximately 40 percent.

These Items Should be Added to the Guideline Results

None of these appraisal guidelines include the value of any real estate or inventory on hand.  If the business owns real estate, the value of the realty should be added to the guideline result.  And inventory, at cost, should also be added to obtain the total estimated value of the business.

In Summary

However, you as the owner, seller or buyer of the business are the final arbiter of what the business is worth to you. Remember, these guidelines are only averages.  And the guidelines certainly don’t take into account any special considerations or any future plans that an owner might have for the business.  What a particular business might be worth to you may be more or less than it’s worth to the next person who looks at it.

One final observation:  Interestingly, there is little geographic deviation in the value of businesses.  A gift shop in Alabama with similar financial performance is worth about the same as one in California.

Here are additional articles that might be of interest: How to Analyze a Business You’re Considering Buying, How to Make a Written Offer to Buy a Business and How to Handle the Due Diligence Investigation When Buying a Business.

If you have questions about business valuation, please contact me at (251) 990-5934 or Will@WilliamBruce.org.  In addition to estimates of value using rule-of-thumb guidelines, we also produce written, fully documented business appraisals for banks, business buyers and sellers, minority / majority partners and others.

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William Bruce is a business broker, an Accredited Business Intermediary and a business valuation specialist.  He currently serves as president of the American Business Brokers Association.  His practice includes consultations nationally on matters involving business valuations and transfers.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org.

(C) Copyright William Bruce.  All rights reserved.

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Become a Business Broker with ABBA Business Broker Training

Posted on May 5, 2020 by

Do you want to become a professional business broker?  If so, there is no better option Become a business broker; business broker trainingthan the business broker training program offered by the American Business Brokers Association.

For individuals considering becoming business brokers, the business broker training seminar conducted by the American Business Brokers Association (ABBA) is held several times a year in various locations around the country.  The seminar is a very focused 2-day hands-on weekend class that is always conducted on a Saturday and Sunday.

The ABBA has been offering in-person, hands-on, independent business broker training to aspiring business brokers longer than any other organization.

After completion of the seminar, attendees are awarded the professional credential of Accredited Business Intermediary (ABI).  The program also includes unlimited on-going support afterward as individuals develop their brokerage careers.

The seminar instructor is William Bruce, president of the American Business Brokers Association and a full-time business broker.  His contact information is here.

To get an idea of what’s involved in the practice of business brokerage, please read our article entitled “What Do Business Brokers Do.”

And here’s a video produced by Business Broker Media Services in collaboration with the American Business Brokers Association with predictions for the future of the profession after the Corovavirus pandemic subsides.

For additional details on the seminar including future locations, class syllabus, and costs, please visit the website of the American Business Brokers Association.

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

 

 

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Here’s How to Value a Restaurant or Bar Business

Posted on April 14, 2020 by

By William Bruce

How to value a restaurant or bar business.

Wondering what a restaurant or bar business is worth? Here’s how to value.

As a business broker and appraiser, I’m often asked how to value a restaurant or bar business.  The valuation of a restaurant or bar business is not an exact science but there are guidelines and rules-of-thumb that can be used for a close approximation of value.

If you have a restaurant or bar business for sale or maybe you’re considering buying one, these valuation formulas will get you in the ballpark.

Certain situations require a formal business appraisal including the larger merger-acquisition transactions, SBA loan applications, management performance tracking, estate planning, divorce — or the most dreaded of all — IRS issues.  After all, a professional, fully documented appraisal certainly takes the guesswork out of the situation.

However, what we’re talking about here is not a formal appraisal but rather the informal methods of quickly approximating the value of the restaurant or bar.  All of the guidelines we’ll quote are averages derived from hundreds of completed transactions reported to regional and national databases.

There are two methods of quickly approximating the value of a business: (1) applying a multiple to the discretionary earnings of the business and (2) applying a percentage to the annual gross revenue of the business.

The most accurate of the two methods seeks to approximate the value of a business by applying a multiple to the company’s discretionary earnings.

What are discretionary earnings? It is NOT the profit or loss that you show Uncle Sam on your tax return. To put it delicately, almost all business owners run some expenses through the business that are — a’hem – not absolutely necessary to the operation of the business.

Discretionary earnings are the total cash that the business generates in a year that is available to the owner after deductions for only the necessary operating expenses. Another way to define discretionary earnings is that it is the “total owner’s benefit” derived from owning the business, regardless of how the owner takes the money out of the business. It is the amount of cash left over after only the necessary expenses that is available for (1) owner’s remuneration, (2) return on investment and (3) debt service, if any.

Here’s an article that explains the term: What are a Business Owner’s Discretionary Earnings.   If you’re not exactly sure of how to calculate, an accountant or professional business broker can compute it for you.

Almost all restaurants and bars will appraise for somewhere between 1.5 to 3.0 times discretionary earnings.  Exactly where in this range that a specific operation will fall depends on what type of bar or restaurant, size of the operation, location, revenue trends and other factors.

The second method of estimating the value of a business is less accurate.  This method applies a percentage to the operation’s annual gross revenue to approximate value.  This method of appraisal assumes the bar or restaurant is earning the average bottom line profit for its peer group.  That’s a big assumption!

But making that assumption, we know that a full-service restaurant with a liquor license will appraise for somewhere between 30 and 35 percent of gross annual revenue.  Bars will average between 35 and 45 percent of annual revenue in appraised value.  Coffee houses will appraise for about 40 percent of revenue.

A quick check of a few popular food franchises reveals the following average appraisal guidelines expressed as a percentage of gross annual revenue: Beef O’Brady’s 22%, Chick-Fil-A 65%, Dairy Queen 45%, Domino’s Pizza 52%, Panera Bread 37% and Subway at 65%.  For a more complete list of franchise valuation formulas, including many restaurants, please see our article “What is a Franchise Really Worth.”

None of these appraisal guidelines include the value of any inventory on hand or real estate.  If the business owns real estate, the value of the realty should be added to the guideline result.  And inventory, at cost (food and liquor only), should also be added to obtain the total estimated value of the business.

However, you as the owner, seller or buyer of the business are the final arbiter of what the business is worth to you.  Remember, these guidelines are only averages. And the guidelines certainly don’t take into account any special considerations or any future plans that an owner might have for the business. What a particular business might be worth to you may be more or less than it’s worth to the next person who looks at it.

Should you need advice on restaurant or bar valuation considerations, please don’t hesitate to call or email.

Here are additional related articles that might be of interest:

What is a Franchise Really Worth (includes the valuation of most food service franchises)

How to Analyze a Business You’re Considering Buying

How to Make a Written Offer to Buy a Business

How to Handle the Due Diligence Investigation When Buying a Business

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

Follow William on Twitter and LinkedIn.

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Looking at a Business That You Might Want to Buy? Here’s How to Analyze It.

Posted on April 14, 2020 by

By William Bruce

Let’s say you’re serious about buying a business and have identified an attractive business How to analyze a business to purchasethat is for sale.   You’re interested in investigating the opportunity.  What’s next?  Here’s how to analyze a business you might want to buy.

First, The Need for Confidentiality

Confidentiality is critical to the successful transfer of a business.  If word gets out that a business is for sale, several things start happening and none of them are beneficial to a prospective buyer.  First, key employees start looking for other jobs, fearing that a new owner may not retain them.  In the uncertainty, customers start looking around and begin shopping elsewhere.  Suppliers get nervous.

This is why a seller or business broker will ask you to sign a non-disclosure agreement.  It’s sometimes called a confidentiality agreement.  In this agreement, you confirm that you will not disclose the fact that the business is for sale — except to your professional advisors.  And yes, your spouse is considered a professional advisor.  After all, he/she consults with you often on a professional basis, right?  Just caution them on the need for extreme confidentiality.

If you show that you take the need for confidentiality seriously, you will be regarded as the professional that you are.

The Anonymous Customer

If you’re working with a business broker, he will probably have furnished you with a summary profile on several different businesses.  The profile will summarize all the salient points of the business including gross revenue and owner’s cash flow.  From the several profiles that your broker has given you, pick the two or three that you would like to pursue.  The first step for each business that you would like to explore is an anonymous visit posing as a customer.  We call this a reconnaissance run.

As you visit, first, note the location.  Is it appropriately located for the type of business?  As you’re driving into the parking lot, what does the business look like from the street?  What about signage and street identification?  Then as you walk to the entrance, what kind of an impression do you receive?

Once you’re inside, take a close look around.  If it’s a retail establishment, are the shelves full?  Is it clean and neat  Are there customers there?  Are the employees helpful?

What is the general feeling you received from your visit?  If you decide this is a business you want to follow up on, make a list of questions for the owner.  Make this list while your visit is fresh on your mind.  Include anything and everything you’re curious about.

It’s great if the image is good, but don’t despair if it’s not.  As one of my astute clients reminded me recently as I was lamenting the poor street image of some of my business listings, “It’s an opportunity for a new owner to make a difference.”

A word of caution:  While on this visit, don’t talk to anyone in the business about the fact that the company is for sale.  Chances are the employees don’t know it’s for sale.  And even the owner would not be free to talk about it at this point within earshot of customers and employees.  Chat pleasantly about the weather … or college football!  (‘Tis almost that time of the year, you know.)

The Meeting With the Owner

The next step in this logical sequence will be a meeting with the owner.  If you’re working with a business broker, he will set up the meeting at a time convenient with both parties.  He will go with you to the meeting and facilitate the exchange of information.

Be sure to bring your list of questions.  Ask anything you want to.  However it’s usually best, at this point, not to discuss the selling price of the business or the possibility of owner financing.  That comes later.  But ask anything else that comes to mind.  Nobody knows the business better than the owner.  If you’re meeting at the business, ask for a tour of the facility.

It’s important that this meeting remains informal and cordial.  Remember, you are both checking each other out.  If the owner is going to finance a portion of the selling price, he’s looking at you as much as you’re looking at the business.  It’s a two-way street.

At the end of the meeting, you don’t have to express any commitment.  Simply say something like:  “Well this has been very informative.  Thanks for your time.  Let me consider this new information.”  It might also be a good idea to convey to the owner that the information will be kept in the strictest of confidence.  He’ll appreciate your sensitivity to that issue.

Computing Cash Flow, Also Called Discretionary Earnings

The next step, assuming you are interested in the business, is to determine the operation’s annual cash flow.  After all is said and done, what you will be buying is the ability of the business to produce cash.

So first let’s define cash flow.  Some brokers refer to it as the owner’s discretionary earnings, which is the term I personally like.  Discretionary earnings are defined as that amount of cash left over after only the necessary operating expenses gave been paid that is available for (1) owner’s remuneration, (2) return on investment, and (3) debt service, if any.

Another way to express it is that discretionary earnings are the total owner’s benefit from owning the business regardless of how the owner takes the money out of the business.

Discretionary earnings are not the same as net profit shown on the profit and loss statement.  It’s not the same because of the bookkeeping practices of the large majority of business owners.  Simply stated, business owners do not keep books to pay income taxes.  Most business owners make strenuous efforts to reduce any taxable income.

For this reason, most business owners in an effort to reduce their taxable income run some expenses through the business that are not purely business operating expenses.  This practice reduces tax liability but it also oftentimes masks the true earnings record of a business.

As an example, take the sale of a restaurant that I recently handled.  The profit and loss statement from the business was actually showing a small loss.  However, the owner’s wife drove a Lincoln Navigator which was listed on the books of the business as a company vehicle.  The company also paid for all her gas and maintenance on the Navigator although she has no role in the operation of the restaurant.  Same for the daughter’s Honda which she drove back and forth to college.  The daughter was also on the payroll as an employee of the restaurant which furnished her with spending money at college, although she never actually worked at the restaurant.  The family ski vacation to Colorado was charged to the business because the owner attended a business meeting for a couple of hours while in Aspen.  You see where I’m heading here, don’t you?  By the time all these items plus any non-cash expenses were accounted for, the restaurant was actually producing a nice yearly cash flow for the family.

In considering a business, your challenge is to determine its true cash flow.  This process is referred to as the recasting or normalizing of income.  If you are using a business broker, he has probably already prepared a recasting worksheet on each business he presents to you.

Here another of my articles explaining more about the computation of discretionary earnings.

To Pursue or Not to Pursue

After computing the discretionary earnings of the business, the next step is to determine if the cash flow is enough for you.

To do this, you need a fairly close approximation of what your debt service will be on the amount borrowed to buy the business.  After all, it’s the amount left over after debt service that will be available for you and your family to live on.

Your broker will have amortization tables available for debt calculation.  Business loans without real estate generally run seven to 10 years.  With real estate, the term of the loan can be up to 20 years.

An increasingly popular type loan where the seller is offering financing is called the balloon loan.  It solves the problem of the seller wanting his money long before a ten or fifteen year term us up and the buyer wanting to keep his payments as low as possible.  It works this way.  After the down payment, the seller finances the sale of the business with a note from the buyer.  The payments are calculated on, say, a fifteen year amortization schedule (to keep them low) but the note calls for a payoff of the balance due (the balloon) at the end of the fifth year.  During the five years, the new owner builds up a track record and establishes a relationship with a bank.  At the end of five years, he is in a position to refinance the balloon with the bank and pay the seller.  It’s a win-win situation for both parties.

Your worksheet should show:

Annual Owner’s Discretionary Cash Flow           $____________

Less Annual Debt Service                                       $____________

Cash Left Over to for Owner’s Living Expenses $____________

It probably should be mentioned that the above calculations do not consider any increases in revenue and cash flow resulting from new ownership.  Historically, a business will experience a revenue increase of between ten and fifteen percent due solely to a change in ownership.  Nor does this calculation account for any new products and services or other changes that a new owner may plan to introduce.

Now it’s decision time.  If the business is of interest to you, and if it returns the amount of cash flow you need (or can be made to do so), and if you can envision yourself successfully running the business, then you may be ready to move on to next logical step.

If you’re ready to pursue this business, my next blog post will outline an important step: The Contingent Offer.

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

Follow William on Twitter and LinkedIn.

Posted in Franchises, Valuing, Buying or Selling a Business | Tagged , , , , , , , , , , , , , , , | 67 Comments

How to Sell a Business: First, Have a Good Reason When Selling a Business

Posted on April 8, 2020 by
Selling Your Business

Selling Your Business

By William Bruce

The decision to sell your business may not be easy.  In fact, it may be agonizingly difficult.  This is the first step in the “”How to Sell a Business” series.

You probably have an emotional attachment to the business.  Over the years, you have attracted a lot of customers and developed many friendships among them.  You have also hired and trained a talented group of employees who look to you for their very livelihoods.

And in America, people are identified by how they make their living. Your identity is directly tied to your business, so it’s no wonder that the decision to part with your business is difficult.

But things change.  And at some point in their life, most business owners decide, for good reasons, that the time has come to sell their business.

One of the motivations for writing this is that many business owners have told me the same thing.  They say that once they make the decision to sell, they don’t have a very clear idea of how to go about it.  They have spent their business lives managing their company – and in most cases doing a very good job of it – but they have never actually sold a business. It’s definitely a different “ballgame.”  Selling a business in today’s business environment is a major project fraught with many pitfalls. It can be compared to a narrow path winding through a field of landmines. The issues are numerous including pricing, confidentiality, offers, negotiations, financing, due diligence, taxes, and government regulations to name just a few.

Professional advice and assistance to guide you through the minefield is the best “insurance policy” you will ever buy.  But then, I’m prejudiced.  You see, I have one of the best jobs in the country.  In case you haven’t yet guessed, I’m a business broker!

In this series of articles, I’ll be discussing various issues involved in the sale of a business.  More will be posted later, but my first piece of advice to an owner considering selling his or her business is: “Have a good reason.”

Be able to give a good reason.

This may seem obvious.  However, it’s important to be able to give a good reason for selling your business. The very first question most prospective buyers ask is “Why is the business for sale.”

Buyers are naturally suspicious.  For most, buying a business will be the most important financial decision they will make in their lifetime, and because of it, they will have a heightened level of anxiety about the whole situation.

Some of the business buyers with whom I’ve worked in the past have expressed the thought that if a business is for sale, there must be something wrong with it.  This is not always the case, of course, and being able to answer this concern with a logical response will be of tremendous value in the sales process.

These are all good reasons

There are valid reasons that some very good privately held businesses are for sale.  The first reason most people would think of is retirement.  Another is the fact that the owner may be experiencing health problems that prevent him or her from managing the business as usual.

Other reasons may involve estate planning situations in which the owner would rather leave liquid assets that can be split more easily among several heirs than a business entity.

Still other legitimate reasons could involve friction among the owners.  This kind of situation can become particularly serious if the friction is among family members who jointly own the business.  I recently handled the sale of a business in which the real motivation to sell was to prevent further deterioration of the family relationships.  The differences among the partners were serious enough that they would surely have led eventually, if they stayed in business together, to an ugly family split-up.  The partners correctly decided that it was better to sell the business and preserve the family.  Each partner took their portion of the cash from the sale and went their separate ways.  And now they are still congenial when they get together at Thanksgiving and Christmas!

Perhaps the most common reason that a business is for sale is one that might not be readily apparent.  But as a business broker, I see it frequently.  And I’ll simply label it as “burn out.”  After an owner has operated the same business for a number of years, some just plain get burned out.  Some people are more prone to burn out than others.  It’s highly subjective but certainly understandable.

On a personal note, I experienced it in a previous business that I owned.  After 15 years, when it got to the point that I didn’t want to see customers come in the front door because I knew I’d have to spend time with them, I knew it was time to get out!  Burn out is real and I see a lot of it.

In summary

So in summary, be able to give a good reason for selling your business.  It’ll get you started off on the right foot.

In future articles, we will cover the additional issues involved in the successful sale of a business.

Readers of this blog can order the entire series of articles by requesting the 26-page booklet, “How to Sell Your Business While Avoiding Costly Mistakes.”  To request your copy, please email William Bruce at Will@WilliamBruce.org.

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

Posted in Valuing, Buying or Selling a Business | Tagged , , , , , | 7 Comments

8 Ways Business Owners Can Take Advantage of the Federal Stimulus Package

Posted on April 6, 2020 by

Thanks to Entrepreneur, this is the best list and explanation of the various financial assistance programs available to business owners during the Coronavirus pandemic.  Included are descriptions of:

  1. Stimulus Checks
  2. Economic Injury Disaster Loans (EIDL)
  3. Paycheck Protection Program (PPP)
  4. SBA Loan Forbearance
  5. Increased Access to Retirement Accounts
  6. Unemployment
  7. Paid Sick Leave
  8. Family Medical Leave (FMLA)

Read the full article by Entrepreneur here:  https://www.entrepreneur.com/article/348710.

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

 

Posted in Alabama's Economy, Gulf Coast Regional & National Economy, Mobile, Fairhope & Gulf Shores, Alabama, National economy | Leave a comment

Here’s How to Value a Retail Business

Posted on April 4, 2020 by

By William Bruce

What is retail business worthAs a business broker and appraiser, I’m often asked about how to value a retail business.  The valuation of retail businesses is not an exact science but there are guidelines and rules-of-thumb that can be used for a close approximation of value of a retail business.

Certain situations require a formal business appraisal including the larger merger-acquisition transactions, SBA loan applications, management performance tracking, estate planning, divorce — or the most dreaded of all — IRS issues. After all, a professional, fully documented appraisal certainly takes the guesswork out of the situation.

However, what we’re talking about here is not a formal appraisal but rather the informal methods of quickly approximating the value of a retail business.   The guidelines we’ll quote are averages derived from hundreds of completed transactions reported to regional and national databases.

There are two methods of quickly approximating the value of a business: (1) applying a multiple to the discretionary earnings of the business and (2) applying a percentage to the annual gross revenue of the business.

The most accurate of the two methods seeks to approximate the value of a business by applying a multiple to the company’s discretionary earnings.

What are discretionary earnings? It is NOT the profit or loss that you show Uncle Sam on your tax return. To put it delicately, almost all business owners run some expenses through the business that are not — a’hem – absolutely necessary to the operation of the business.

Discretionary earnings are the total cash that the business generates in a year that is available to the owner after deductions for only the necessary operating expenses. Another way to define discretionary earnings is that it is the “total owner’s benefit” derived from owning the business, regardless of how the owner takes the money out of the business. It is the amount of cash left over after only the necessary expenses that is available for (1) owner’s remuneration, (2) return on investment and (3) debt service, if any.

If you’re not sure of how to calculate discretionary earnings, an accountant or professional business broker can compute it for you.

Practically all retail businesses will appraise for somewhere between 1.5 to 3 times discretionary earnings plus inventory at cost. Exactly where in this range that a specific business will fall depends on the size and type of the retail shop plus its revenue trends.

The second method of estimating the value of a business is less accurate. This method applies a percentage to the operation’s annual gross revenue to approximate value. This method of appraisal assumes the business is earning the average bottom line profit for its peer group. That’s a big assumption!

But making that assumption, we know that almost all retail businesses will appraise for somewhere between 30 and 35 percent of gross annual revenue plus inventory at cost.

As indicated above, inventory for resale should be added at cost to the formula result.  If the business owns real estate, the value of the realty should also be added to the guideline result.

However, you as the owner, seller or buyer of the business are the final arbiter of what the business is worth to you.  Remember, these guidelines are only averages. And the guidelines certainly don’t take into account any special considerations or any future plans that an owner might have for the business. What a particular business might be worth to you may be more or less than it’s worth to the next person who looks at it.

Here are additional articles that might be of interest: How to Analyze a Business You’re Considering Buying, How to Make a Written Offer to Buy a Business and How to Handle the Due Diligence Investigation When Buying a Business.

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.   He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org

Follow William on Twitter and LinkedIn.

Posted in Business Valuation & Appraisal, Valuing, Buying or Selling a Business | Tagged , , , , | 10 Comments

What Are a Company’s Discretionary Earnings?

Posted on March 23, 2020 by
Cash flow and seller's discretionary earnings defined.

Cash flow and seller’s discretionary earnings defined.

By William Bruce

What are a company’s discretionary earnings, also sometimes referred to as cash flow?

It is NOT the profit or loss that you show Uncle Sam on your tax return. To put it delicately, almost all business owners run some expenses through the business that are not — a’hem – absolutely necessary to the operation of the business.

Discretionary earnings are the total cash that the business generates in a year that is available to the owner after deductions for only the necessary operating expenses.  Another way to define discretionary cash flow is that it is the “total owner’s benefit” derived from owning the business, regardless of how the owner takes the money out of the business.

More formally, it is the amount of cash left over after paying only the necessary operating  expenses that is available for (1) owner’s remuneration, including “benefits,” (2) return on investment and (3) debt service, if any.

To illustrate, let me tell you about the sale of a restaurant that I handled as a business broker several years ago.  The profit and loss statement from the business was actually showing a small loss.

However, the owner’s wife drove a Lincoln Navigator which was listed on the books of the business as a company vehicle. The company also paid for all her gas and maintenance on the Navigator although she had no role in the operation of the restaurant.  Same for the daughter’s Honda which she drove back and forth to college. The daughter was also on the payroll as an employee of the restaurant which furnished her with spending money at college, although she never actually worked at the restaurant.

The family’s ski vacation to Colorado was charged to the business because the owner attended a business meeting for a few hours while in Aspen. You see where I’m heading here, don’t you? By the time all these items plus any non-cash expenses (eg: depreciation) were accounted for, the restaurant was actually producing a nice yearly cash flow for the family.

DISCLAIMER: Hey, I’m not with the IRS and don’t render an opinion on these sort of things!

In addition to the owner perks discussed above, non cash deductions like depreciation are added back to the net profit shown Uncle Sam, as are one time expenses not likely to recur (eg: an air conditioning unit being replaced).

CPAs and business brokers often refer to the computation of discretionary cash flow as normalizing or recasting the company’s profit and loss statement.

Why is the computation of discretionary cash flow important?

It provides an accurate picture of the true cash producing ability of the business.  In effect, it uncamouflages the bookkeeping practices of most business owners.

And since many business appraisals are done based on the company’s discretionary cash flow, it’s important to be able to accurately compute the number.

If I can help with any questions or computations on this subject, don’t hesitate to contact me.

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William Bruce is an Accredited Business Intermediary (ABI) and Senior Valuation Analyst (SVA) assisting buyers and sellers of privately held businesses in the transfer of ownership.  He currently serves as president of the American Business Brokers Association.  His practice includes consulting services nationally on issues of business valuation and transfer.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org. 

Posted in Business Valuation & Appraisal, Valuing, Buying or Selling a Business | Tagged , , , , , , , , | 22 Comments