Top 3 Issues Involved When Buying or Selling a Business

Posted on November 7, 2010 by

Updated January 2, 2018

By William Bruce

America is a nation of small business owners.  In fact, there are over 22 million of us.

Why do people want to go into business for themselves?  In surveys done several years ago, the number one response was the potential for higher income.  But now in the most recent survey, the top reason was “control of one’s own destiny.”  The change is most likely a reaction to the recent economic times.

More and more individuals are now viewing small business ownership as a viable alternative to the vagaries of corporate America.  As a friend said recently, “There is no more job security.  The only job security you’ve got nowadays is the person looking at you in the mirror.”

As a business broker, I’m often asked about the issues involved in buying or selling an existing business.  In my opinion, these are the top three issues:

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 problem 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 rule 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 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 rule 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 buyers have 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 the majority 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!

For further reading, here are additional related articles:

And the businesses offered for sale by William Bruce may be viewed at www.WilliamBruce.net.

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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.  His practice includes consulting services nationally on issues of business valuation and transfer.  He currently serves as president of the American Business Brokers Association.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org.  His website listing businesses for sale may be viewed at www.WilliamBruce.net.
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Considering Buying a Business of Your Own? Here’s a List of the Most Frequently Asked Questions and Responses by William Bruce.

Posted on January 7, 2019 by

If you’re considering buying a business of your own, it’s natural that you would have lots of questions about the process.

William Bruce, President
American Business Brokers Association

I’ve been a business broker for many years.  During these enjoyable times, I’ve had the opportunity of assisting many individuals in achieving their goal of owning a business of their own.

In this work, I’ve found that many buyers of businesses have the same questions.  So I thought I’d list those questions that I’m most frequently asked along with my responses.

Why would a good business be for sale?

Answer by William Bruce: “I have found that some buyers think that if a business is for sale, there must be something wrong with it.  This is sometimes true, but most businesses are for sale for legitimate reasons including retirement, health problems, family issues and burnout.  Burnout after many years of operating a business is real.  I suffered from it years ago after owning a heavy equipment dealership for almost 20 years.

How will I know if the asking price of the business is reasonable?

Answer by William Bruce:  This is a very good question.  There are fairly simple guidelines for closely estimating the value of many types of small to medium size businesses.  These rules-of-thumb vary by category of business, but usually seek to estimate value (1) by applying a percentage to gross annual revenue of the business or (2) applying a multiple to the discretionary earnings of the business.

For example, we know that a full-service restaurant will most likely be valued at around 30 percent of gross annual revenue, assuming that the bottom line earnings support that appraisal number.

We also know that the majority of businesses will appraise for somewhere in the range of 2 to 3.5 times discretionary earnings.  As just two examples, a convenience store will appraise at approximately 2.25 times discretionary earnings plus inventory at cost, and a lawn maintenance service valuation will average about 2.75 times discretionary earnings.

Written and fully documented business valuations are also available for a reasonable cost from several highly respected national business valuation firms.

For further reading on this issue, please see this article.

What are discretionary earnings?  Is it the same as cash flow?

Answer by William Bruce:  The terms “discretionary earnings” and “cash flow” are used interchangeably by business buyers, sellers and brokers to refer to the total owner’s benefit from owning the business, regardless of how the owner takes the money out of the business (salary, draws, perks, etc.).  It’s the cash left over after only the necessary operating expenses of the business are paid.

CPAs sometimes refer to the process of computing discretionary earnings as “normalizing” the profit and loss statement.  The computation removes the camouflage from the bookkeeping practices of most business owners.

For an article on how to compute discretionary earnings, please see this article.

 How do I finance the acquisition of a business?

Answer by William Bruce:  There are five possible sources of financing for buying a business including (1) banks, (2) SBA-guaranteed loans, (3) the seller of the business, (4) family and (5) in recent years a new program that allows you to use your 401(k) or IRA funds to buy a business without an early withdrawal penalty.

For a discussion of the pros and cons of each of these options, please see this article.

How much down payment do I need?

Answer by William Bruce:  It depends on several things but between 25 and 35 percent should suffice in most situations.  You should also have in reserve for working capital about two months operating expenses of the business to get you comfortably over the initial timeframe.

What is due diligence?

Answer by William Bruce:  Due diligence is a fancy term.  In practical use, it can be summarized as that phase in the purchase of a business when you have access to all the books and records of the business (1) to verify the accuracy of the information that you’ve previously been furnished and (2) to make sure that there are no serious, undisclosed problems with the business.  It’s customarily done after a buyer and seller have agreed upon price and terms, with the completion of the transaction fully contingent upon a satisfactory due diligence investigation.

For a more thorough explanation, please see this article.

For a comprehensive discussion of these and other issues involved in buying a business, you can order William Bruce’s free 62-page booklet “How to Buy a Business in a Safe & Organized Way.”  The booklet walks you through step-by-step the process of buying a business to make sure you get what you pay for.  To order, please click here.

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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.  His practice includes consulting services nationally on issues of business valuation and transfer.  He currently serves as president of the American Business Brokers Association.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org.  His website listing businesses for sale may be viewed at www.WilliamBruce.net.
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Small Businesses Selling for Record Prices

Posted on October 16, 2018 by

2018 Q3 Small Businesses Sale Price vs Asking PriceBizBuySell.com, the Internet’s largest business-for-sale marketplace, recently reported that sale prices of businesses sold in the third quarter of 2018 reached new highs. The record prices are directly related to higher earnings which also hit new levels in the third quarter.

With buyers able to offset increasing prices by acquiring healthier businesses, the result is a well-balanced market. While owners are getting top dollar for their business, buyers are acquiring businesses with a better financial footing.

Average selling prices in the third quarter of 2018 were up 10.7 percent as compared to the same quarter last year, setting an all-time record since the firm started collecting data in 2007.

2018 Q3 Key Financials for Sold Small Businesses

“Locally, here across the Southeast which is where my business brokerage practice is centered, our activity reflects the national trends,” said William Bruce, president of the American Business Brokers Association and a mergers and acquisitions specialists.

“The strong bottom line earnings,” Bruce continued “are giving business buyers an excellent investment opportunity.  And it’s giving business sellers, many of whom are at retirement age, a fair price for a business they’ve nurtured and grown over the years.”

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William Bruce is a business broker, an Accredited Business Intermediary and a business appraiser.  He currently serves as president of the American Business Brokers Association.  His practice includes consultations 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.
Posted in Business Valuation & Appraisal, Buying or Selling a Business, National economy | Tagged , , , | 2 Comments

Small Business Optimism Reaches All Time High

Posted on September 17, 2018 by

The Small Business Optimism Index as measured by the National Federation of Independent Businesses soared in August to a new record in the survey’s 45-year history.  According to the NFIB, the record-breaking figure is driven by the changes in the nation’s economic policies.

The August survey showed:

  • Job creation plans and unfilled job openings both set new records.
  • The percentage of small business owners saying it is a good time to expand tied the May 2018 all-time high.
  • Inventory investment plans were the strongest since 2005 and capital spending plans the highest since 2007.

“Today’s groundbreaking numbers are demonstrative of what I’m hearing every day from small business owners – that business is booming. As the tax and regulatory landscape changed, so did small business expectations and plans,” said NFIB President and CEO Juanita D. Duggan. “We’re now seeing the tangible results of those plans as small businesses report historically high, some record-breaking, levels of increased sales, investment, earnings, and hiring.”

August is the ninth consecutive strong month of reported sales gains after years of low or negative numbers. The net percent of owners planning to build inventories rose six points to a record net 10 percent.  The frequency of reports of positive profit trends rose to the second highest reading in the survey’s 45-year history.

“At the beginning of this historic run, Index gains were dominated by expectations: good time to expand, expected real sales, inventory satisfaction, expected credit conditions, and expected business conditions,” said NFIB Chief Economist Bill Dunkelberg.“Now the Index is dominated by real business activity that makes GDP grow: job creation plans, job openings, strong capital spending plans, record inventory investment plans, and earnings. Small business is clearly helping to drive that four percent growth in the domestic economy.”

As reported in last week’s NFIB’s monthly jobs report, 38 percent of owners reported job openings they could not fill in the current period, a survey high. Sixty-two percent of owners reported trying to hire, with 89 percent of those owners reporting few or no qualified applications for their open positions.

A record 25 percent of owners cited the difficulty of finding qualified workers as their Single Most Important Business Problem, up two points from last month.

The report concludes, “As a leading indicator of economic activity, the Index turned up sharply late in November 2016 and headed to readings in the top 5 percent of the Index history in December, never looking back. Three months later, economic activity soared, rising from 1.5 percent GDP growth to over 3 percent. Profits are driving the stock indices for ‘small’ firms to record levels, mirroring the record levels of profit gains for NFIB firms.”

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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.  His practice includes consulting services nationally on issues of business valuation and transfer.  He currently serves as president of the American Business Brokers Association.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org.  His website offering profitable businesses for sale may be viewed at www.WilliamBruce.net.

 

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Small Business Earnings and Confidence Are Setting Records. How Long Can It Last?

Posted on May 15, 2018 by

by William Bruce

Small business earnings are the highest in decades and business confidence is spiking.

According to results of a recent National Federation of Independent Businesses (NFIB) survey, small business earnings rose in April to the highest levels in at least 45 years.

The NFIB said that small business earnings were the highest in the history of its surveys, which began in 1973, and also noted that small business optimism increased in April to a level in the top 95th percentile of its all-time average.

“Never in the history of this survey have we seen profit trends so high”, said CEO Juanita Duggan. “The optimism small businesses owners have about the economy is turning into new job creation, increased wages and benefits, and investment.”

Summarizing reasons for the soaring optimism, NFIB Chief Economist Bill Dunkelberg said, “Consumer spending, the new tax law, and lower regulatory barriers are all supporting the surge in optimism across all small business industry sectors.”

Another national survey done by the U.S. Chamber of Commerce confirms much of the above.  The Chamber’s first quarter Small Business Confidence Index shows the largest quarterly jump for the first quarter of 2018 in the history of the index.  Nine out of 10 business owners surveyed are expecting 2018 to be a good year.

However, the Chamber’s index did reflect some caution among small business owners.  The Chamber reported that “Although optimistic, small businesses are still taking a cautious approach. While anticipating a strong year, small businesses plan on spending conservatively, with more small businesses expecting to save profit (51%) rather than invest profit (39%),”  perhaps attributable to the memory among business owners of the Great Recession of 10 years ago.

Interestingly, the index also spotlighted some regional differences.  The southern states had the most optimistic outlook with the western states reporting the least optimistic.  The eastern and midwestern states were in the middle of the range.  But all were very high compared to the historical averages.

And yet another survey by the outplacement firm of Challenger Gray & Christmas, Inc. reveals that a relatively high percentage of their job seeking clients have chosen to start their own businesses rather than remaining in the job market.  An average of eight percent of job seekers started a business in the first quarter, the highest percentage in 5 years.  The results were obtained from a quarterly survey of over 3,000 job seekers nationwide.

A confirming report by one of the nation’s largest business-for-sale websites validates this entrepreneurial enthusiasm.  The firm’s 2018 first-quarter report showed a record-breaking quarter in the business-for-sale marketplace for both the valuation of small businesses and the number of completed transactions.

So how long will this activity and optimism last?  Predicting such things is akin to sprinkling salt on a sparrow’s tail.  It’s inherently difficult.

But consider these interrelated thoughts:

  • The Federal Reserve is doing a better job of managing the macroeconomy versus a few years ago. The Fed “went to school” on the Great Recession.
  • Gross Domestic Product is expected to grow by three percent this year compared to two percent last year.
  • Inflation, currently running under three percent, is not a pressing concern.
  • Interest rates are still low enough to make a lot of business transactions workable.
  • Core business spending on fixed assets in 2018 will be up by about seven percent. That will be on top of last year’s solid five percent increase.
  • Consumer confidence and spending are at high levels.

Developments that might slow or end the growth include:

  • The start of a significant trade war.
  • A major terrorist initiative by Iran or other rogue groups.
  • Micky Mouse announcing that he is divorcing Minnie. (Hey — just want to make sure you were still awake!  Discussing the economy for most folks works better than Ambien.)

So what do you think about the economic outlook?  Please let me have your thoughts.

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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.  His practice includes consulting services nationally on issues of business valuation and transfer.  He currently serves as president of the American Business Brokers Association.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org.  His website offering profitable businesses for sale may be viewed at www.WilliamBruce.net.

 

 

 

 

 

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The Two Dramatically Different Definitions of “Amortization.”

Posted on February 13, 2018 by

The two distinctly different definitions of “amortization” explained.

The term amortization has two distinctly different meanings.  And both definitions are used in the financial world, adding to the confusion.

Most folks will think of amortization as a loan repayment table for a car or home loan, and that is the most frequent usage of the term.

If you’ve bought a car or home with an installment or mortgage loan, you’ve most likely got somewhere in your files an amortization schedule which breaks down each monthly payments between interest expense and the amount applied to the loan principal.  The amounts allocated to interest and loan principal vary each month as the principal balance due on the loan declines.

The other usage of the term amortization has no relation to the above.

Before moving into a discussion of the other meaning of the word amortization, let’s back up a moment and talk about the term depreciation.  Depreciation is the yearly write-down on financial statements of tangible business assets, usually buildings, furniture, fixtures and equipment.  This write-down of tangible assets is allowed by the IRS as an expense deduction on the profit and loss statement.

Now, let’s move back to the term amortization.  Amortization in this second meaning is a first cousin to depreciation.  It’s the write-down of intangible assets as opposed to the depreciation of tangible assets.  Intangible assets can be the value of a patent, a trademark, a copyright or business goodwill.  Intangible business assets are sometimes referred to as intellectual property.

If you see amortization listed on a profit and loss statement or tax return as an expense line item, you know that it’s this second meaning and therefore a write-down of intangible assets.  If you see a chart or table filled with columns and rows of numbers, it’s an amortization table breaking down a loan repayment schedule into the amounts allocated monthly to principal and interest.

It’s confusing to have such distinctly different meanings attributed to the same word, with both being used in the financial world.  We hope this article helps a bit to clear up the misunderstanding we frequently encounter in our mergers and acquisitions practice.

For further reading, here are additional articles that may be of interest:

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William Bruce is an Accredited Business Broker and Appraiser assisting buyers and sellers of privately held businesses in the transfer of ownership.  His practice includes consulting services nationally on issues of business valuation and transfer.  He currently serves as president of the American Business Brokers Association.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org.  His business brokerage website may be viewed at www.WilliamBruce.net.
Posted in Business Valuation & Appraisal, Buying or Selling a Business | Tagged , , , , , | 2 Comments

Small Business Ownership Transfers Set a Record in 2017

Posted on January 16, 2018 by

BizBuySell.com, the Internet’s largest business-for-sale marketplace, reported recently that the number of small business transfers reached a record high in 2017, exceeding the previous high set in 2016 by 27 percent. BizBuySell.com aggregates statistics from business-for-sale transactions reported by participating business brokers nationwide.

This year’s increase marks a noteworthy upward shift in the number of small businesses changing hands across America. For several years after the 2008-2009 Great Recession, sales volume remained low as small businesses struggled financially and capital for financing remained tight. Beginning in 2013, as the economy recovered, closed transactions have steadily increased. But 2017 represents a significant increase, with 9,919 closed transactions reported compared to the 7,842 in 2016.

The median revenue of sold businesses grew 5.8 percent in 2017 compared to 2016. Median cash flow also increased almost 7 percent.

The selling price of the reported businesses, expressed as a multiple of discretionary earnings (sometimes referred to as cash flow), was approximately 2.7.  Expressed as a percentage of gross revenue, the transactions averaged about 60 percent.

The highest priced businesses stated by a multiple of discretionary earnings were in Buffalo, New York and Dayton, Ohio.  The lowest were in Hartford, Connecticut and Las Vegas, Nevada.

Arkansas business broker Richard Roberts confirmed the active market conditions.  “This is the strongest market for privately held businesses that I’ve seen,” said Roberts.  “Quality businesses are coming to market and buyers are finding acquisition financing readily available for profitable businesses.”  Roberts is an Accredited Business Intermediary and Managing Broker at Aegis Business Advisors in Fayetteville.

The Dow Jones stock market index at an all-time high.  Additionally, the National Federation of Independent Businesses reports that their Business Optimism Index is in record territory.  With high business confidence, strong profits and the availability of acquisition financing, it appears that 2018 and beyond will be a favorable timeframe for small business owners and buyers.

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William Bruce is an Accredited Business Intermediary and Appraiser assisting buyers and sellers of privately held businesses in the transfer of ownership.  His practice includes consulting services nationally on issues of business valuation and transfer.  He currently serves as president of the American Business Brokers Association.  He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org.  His business brokerage website may be viewed at www.WilliamBruce.net.
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What is Business Intellectual Property? How Do You Value It?

Posted on July 3, 2017 by

As a business appraiser and intermediary in the sale, merger and acquisition of privately held companies, I’m often asked about intellectual property.

Intellectual property is something originally created in the mind.  Among other things, it can be an invention, a  written manuscript, a piece of art or a company logo including words, phrases and images used in business.

Some experts in intellectual property break it down into four categories: copyrights, trademarks, patents and trade secrets.

A copyright is a person’s or company’s exclusive right to reproduce, publish, or sell his or her original work of authorship (as a literary, musical, dramatic, artistic, or architectural work).  The ownership right is protected by law.

A trademark is a distinctive design, graphics, logo, symbols, words, or any combination of these that uniquely identifies a company and gives the owner the legal rights to prevent its unauthorized use.

A patent is a right granted to an inventor by the federal government that permits the inventor to exclude others from making, selling or using the invention for a period of time.

In general, a trade secret is any confidential business information which gives a company a competitive edge.  Legal protection for owners of trade secrets is available but murkier than for the other categories.

How do you place a value on intellectual property?

It’s not easy but I’ll tell you how I do it to get fairly close.  When I’m appraising an on-going business entity, I’ll determine the total market value of the business by using industry-specific valuation formulas, sold comparables and other methods.  Then I’ll subtract from that total market value the (1) inventory at cost, (2) the furniture, fixtures and equipment at used replacement value, and (3) the value of any other tangible assets.

The remaining balance is the company’s goodwill value which may include intellectual property.  However, be aware that goodwill can include other items in addition to the intellectual property.  Such things as company reputation, trained employees and a loyal customer base are also part of the goodwill of the business.  For an article explaining goodwill in more detail, please see “What is Business Goodwill.”

For further reading, here are additional articles that may be of interest:

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