Considering Buying a Business? Here’s a List of the 6 Most Frequently Asked Questions.

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 over three decades.  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 experienced 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.  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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What Do Business Brokers Do?

By William Bruce

What are business brokers and what do they doWhat do business brokers do?  Very few people know, as the profession usually operates under the radar.

Business brokers are intermediaries who facilitate the sale of small to medium size privately held businesses by working with both buyers and sellers.  There are important differences, but in some respects business brokers operate similarly to real estate agents; however their practice is limited to business entities.

Licensing

Currently there are 17 states requiring business brokers to be licensed by their state’s real estate commission.  All states require a real estate license if the business broker is handling real estate along with the sale of the business entity.  However, the majority of small to medium size businesses are in leased locations with no real property as part of the sale.

Representation

Business brokers can represent either the buyer or seller in a sale.  Historically, the broker has traditionally represented the seller, but buyer representation is becoming more common.  The representation of one party in a transaction usually creates a fiduciary duty between the broker and the party represented.  Some states allow dual agency representation of both buyer and seller if all parties agree to the arrangement.

In some states, brokers can choose to act as transaction brokers, representing neither party as an agent but working to facilitate the transaction.  In this situation, there is no fiduciary duty created and the broker deals with both parties on the same level.

Training and Qualifications

A business background from experience and/or education is essential to a successful business brokerage practice.

Training specific to business brokerage can be obtained from several professional associations or other organizations.  The American Business Brokers Association, as one example, conducts a 2-day training seminar several times each year.  A quick Google of “business broker training” will return many options.

Credentials

Both national associations of business brokers in the U.S. offer credentials to brokers who have completed a level of education and experience in the profession.

The American Business Broker Association awards the Accredited Business Intermediary (ABI) credential.  The International Business Brokers Association offers the Certified Business Intermediary (CBI) designation.

In addition, several state associations, such as Texas and California, offer their own credentials to qualified members.

Duties

Business brokers perform many duties including:

  • Pricing the business with a professional valuation.
  • Drafting an offering summary, sometimes called a confidential business review. This piece becomes one of the most important marketing tools for the offering, and is provided to prospects only after they have signed a confidentiality agreement and been qualified by the broker.
  • Marketing the business to the widest possible audience while maintaining strict confidentiality.  This is one of the important distinguishing differences between business brokers and real estate agents.  Real estate agents put a sign in front of their properties and typically without the need for confidentiality, advertise widely the specific location.  Business brokers are trained to maintain strict confidentiality.
  • Introducing prospective buyers to the business after insuring confidentiality agreements have been executed.
  • Facilitating meetings between the seller and potential buyers.
  • Writing offers to purchase the business.
  • Handling negotiations between the parties after an offer has been made.
  • Facilitating the due diligence investigation.  Offers to purchase are almost always made contingent upon a further due diligence investigation.
  • Assisting the buyer in obtaining business acquisition financing.
  • Scheduling and facilitating the closing of the transaction.

Compensation

Business brokers have traditionally been compensated by the seller with a commission only fee arrangement which is detailed in a listing agreement and paid at closing.  However, in recent years some brokers have moved to a partial up front fee which may be credited to commission at closing.  This helps the broker defray the initial expenses involved in marketing the business, and according to some brokers, also serves to identify serious sellers as opposed to those who just want “to test the waters,” which many brokers regard as a waste of their time.

The customary commission rate ranges from 8 to 12 percent, with 10 percent being the most prevalent.  In a recent survey of the profession, 59 percent of brokers reported using a 10 percent commission rate.  Generally, the smaller the business, the higher the percentage rate of commission.

Top 3 Issues Involved in a Business Transfer

Many business brokers agree that the top three issues involved in the transfer of business ownership are:

  1. Confidentiality. Confidentiality is critical to the successful transfer of a business.  If it becomes known that a business is for sale, several things start happening and none of them are beneficial for either the seller or buyer of the business.  Business brokers are keenly aware of this and are experts at maintaining confidentiality.
  2. Valuation.  The issue of valuation is of critical concern to both buyers and sellers of businesses.  Business brokers are professionals in determining the most probable selling price of a business.
  3. Financing. Business acquisition loans were difficult to obtain in the recession of a few years ago.  Currently, however, banks and the SBA are again loaning money for business acquisitions.  Business brokers stay informed as to the type and source of loans that are available from various lenders and assist buyers in arranging financing.

Asset Sale Versus Corporate Stock Sale

Most transfers of privately held businesses handled by business brokers are asset sales rather than corporate stock sales.  The selling entity (whether sole proprietorship, partnership, corporation or LLC) sells selected assets to the acquiring entity.  The selected assets are usually all assets of the business, including trade name, with the exception of cash in the bank and the accounts receivable which are usually retained by the seller.

Number of Business Brokers

Because there is no national registration or licensing of business brokers, there is not an accurate count of the total number of brokers.  Estimates run from a low of 2,500 brokers to a high of 5,000 individuals in the U.S. in the profession.  The LinkedIn discussion group of the American Business Brokers Association, which is the largest LinkedIn Group of business brokers, has a membership of over 6,700 brokers and affiliated professionals.

Additional Information

For further reading, here are additional related websites and 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 or Selling a Business: What are the Differences in an Asset and a Stock Sale?

The differences explained between corporate stock and asset sale when buying or selling a business.

The differences between the two methods of buying or selling a business can be critical.My business brokerage firm is often asked about the differences between a corporate stock (or LLC) sale versus an asset sale when buying or selling a business.  The differences between a stock and asset are huge and can be critical in the sale of small to medium-size privately held businesses.

First, let’s define each.  In an asset sale or acquisition, selected assets are bought from the selling entity by the buying entity.  Those “selected assets” usually include all of the operating assets of the business and the intangibles (trade name, goodwill, etc.).  No liabilities of the selling entity are assumed.

A corporate stock sale is just the opposite.  The buyer purchases the outstanding shares of stock in the corporation held by the seller.  The purchaser thereby assumes, through the stock acquisition, all of the assets and liabilities (known and unknown) of the company.

The same concept applies to a Limited Liability Company (LLC).  Instead of shares of stock, the buyer purchases the seller’s membership in the LLC and thereby assumes the assets and liabilities of the company.  In this article, when referring to corporate stock transactions, the same considerations apply to LLC membership transfers.

What are the advantages and disadvantages of each?

The critical advantage of an asset sale to the buyer of the business is that none of the UNKNOWN liabilities are assumed.  The potential of unknown liabilities is the real problem.

I remember from my law school days, the typical textbook example is a slip and fall accident in a business. The owner of the businesses is unaware of the incident when he/she sells the company.  A couple of years after the sale of the business, the accident victim files suit for damages.  In a corporate stock sale, the new owner of the business is on the hook for that accident.  Not so in an asset purchase.

It’s this kind of potential exposure that causes most lawyers for business buyers to strongly – very strongly – advise against a corporate stock purchase when acquiring a small to medium size privately held business.

Another advantage to the business buyer in an asset versus a corporate stock purchase is that the new owner of the business gets to set up the individual assets on a new depreciation schedule and start depreciating the assets all over again.  This provides a significant tax deduction for several years.

In the acquisition of the corporate stock of a privately held business, the buyer assumes the existing corporate depreciation schedule in which, most likely, the assets have been fully depreciated, providing little to no tax shelter in the coming years.

On the other side of the table, an advantage to the seller in a corporate stock sale is that most of the proceeds of the sale are taxed at the lower capital gains rate.

However, 90-plus percent of the small to medium size privately held business ownership transfers that my firm has been involved in have been asset sales, primarily due to the liability exposure issue.  I remember one instance when we nearly had to peel a lawyer off the ceiling when his client thought he might want to buy a business in a corporate stock acquisition!

As a practical matter, about the only time we get involved in a corporate stock sale is when the corporation holds licenses that are not transferrable. Durable medical equipment dealerships are an example with their licenses and contracts from Medicare, Medicaid and BlueCross-BlueShield.

Should you have any questions about this or other issues involved in business ownership transfers, don’t hesitate to call or email.  Please be aware that I’m neither an attorney nor an accountant, but hey, I did spend the night in a Holiday Inn Express last week!

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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 advisory 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.
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The Two Dramatically Different Definitions of “Amortization.”

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.
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What is Intellectual Property? How Do You Value It?

Valuing intellectual propertyAs a business appraiser and intermediary in the sale, merger and acquisition of privately held companies, I’m often asked about how to value 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 that 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 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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Family Businesses Are Now Less Likely to be Passed on to the Next Generation

Family businesses ownership trends are changing.

A recent survey reports some interesting results including changes in current owners’ intentions regarding ownership transfers.  The survey was done by PricewaterhouseCoopers.  The full results can be reviewed at 2017 US Family Business Survey.

According to the survey, 83 percent of family firms do not plan to change hands in the next five years.  However, the most surprising result of the survey is that among family-owned businesses contemplating a transfer of ownership within the next five years, only about half of the owners plan to pass the business on to the next generation of the family. This is down from 74 percent two years ago and is the lowest percentage in 17 years.

One possible explanation for the dramatic drop addressed in the survey is the increasing difficulty of formulating a succession plan for small to medium-sized family businesses.

The longevity of family firms depends on sound succession planning.  Companies that have made it to the third generation are much more likely to have a succession plan than younger firms.  In fact, the survey reports that 75 percent of third generation and beyond ownership have a plan for succession.

Other survey results:

  • 11 percent of family firms plan to diversify
  • 29 percent plan to expand internationally
  • 21 percent say innovation is a priority
  • 64 percent of family firms say they are more entrepreneurial than other type firms
  • 52 percent of firms say they reinvent themselves with each generation
  • 75 percent of first and second generation firms say they will give men and women equal opportunity for leadership.  With third generation and beyond, the result is 57 percent.

Our office specializes in services to family firms and offers assistance in succession planning.  Please contact us if we might be of assistance.

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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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Selling a Business: Here’s How to Successfully Meet with a Prospective Buyer.

business-meetingPrevious articles have discussed the importance of having a good reason for selling your business, getting the business ready for salesetting the right asking pricetaking your business to market and buyer acquisition financing.  In this article, we will share some advice on how to successfully hold the first face-to-face meeting with a prospective buyer of the business.

The meeting with a prospect is extremely important.  It’s your chance to put the prospect at ease and show off the business in its best light.

You will probably want to schedule the visit after hours so as not to arouse any suspicions among your employees.  Or, you can schedule the meeting in your broker’s office if for some reason you don’t want to host it in your business.  However, I think it best, if possible, to hold the meeting at your location.  It gives the prospect a better feel for your operation.  If you are using a business broker, he will arrive with the prospect, make the introductions and facilitate the meeting.

The first meeting is sort of a “look see” for both parties.  The prospect is checking out you and the business while you are sizing him up.  It’s important to remain cordial and open.

The ideal meeting will go something like this:

  • First, you welcome the prospect into your office and make sure everyone has a chair and is comfortable. (Of course, it goes without saying that you have cleaned up the place and thrown away all of the old Dominoes Pizza lunch boxes!)
  • It’s usually best after the initial get acquainted chitchat, to give the prospect a brief history of your business and a succinct description of your current operation. (You might want to even practice this presentation to make sure you cover the important points without rambling.  If you’re using a broker, he will be with you and will help guide the meeting.)
  • Remain friendly and informal, call the prospect by name often, and ask periodically if the prospect has any questions. Answer any questions openly and honestly.
  • Be enthusiastic. Point out how much fun you’ve had running the business.  Let the prospect hear and feel how he could experience the same enjoyment you have.
  • As the meeting in your office winds down, offer the prospect a tour of your facility. Give this tour some thought beforehand, so that you can address the points that you want to during the walk-thru.  Point out anything that will help clarify any points you make in the meeting in your office.
  • As the meeting ends, you say something like this, “Well thanks for coming out and taking a look. You’ll probably have some additional questions, so don’t hesitate to get back in touch with me (or Mr. Broker if you’re using one).  I know this will be a big decision for you and we have nothing to hide, so just let me know what I can do to assist you with the process.”   Put these thoughts into your own words and they will leave a favorable impression in the prospect’s mind.

From the “school of hard knocks,” I can also give you some advice on things you DON’T want to do in the initial meeting with a prospect:

  • Don’t overcomplicate your business. Simplify it.  Don’t make it sound like the management of the company is so specialized that only a brain surgeon can do it.  I’m being facetious of course, but be careful not to scare off the prospect by planting the doubt in his mind that he would not be capable of running your business.
  • Don’t hide any problems. If there are any problems with the business, get them out up front.  There is never a better time to get any problems out on the table than in the meeting.  (See discussion below.)
  • In the initial meeting, it’s usually best to stay away from price and terms. If the prospect brings it up, just say, “My broker here has all of that information and if your will, get with him on that later.”

The importance of getting any problems out in the open up front cannot be overemphasized.  It’s partly a psychological issue.  If you bring up a problem in the beginning and discuss it openly, the importance of that problem is minimized in the prospect’s mind, compared to having it pop up unexpectedly later in the process.

For example, let’s say there is a tax lien against your business for unpaid payroll withholding taxes.  If you bring it up initially by saying something like, “By the way, I do want to mention for the sake of being completely open and honest that we have a tax lien against the business which is being taken care of (or which will be taken care of at closing) so that you will buy all of the assets of the business free and clear without any liens or other encumbrances.”

When you mention it like this, you win points for honesty and openness and it minimizes the problem.  I’ve seen many transactions fall apart when such problems are not disclosed and are later discovered by the prospect.  When discovered later – as they always are – the problem will usually “torpedo” the transaction.

This is such an important point that it bears repeating: DON’T HIDE ANY PROBLEMS.  TALK ABOUT THEM IN THE BEGINNING!

Now that I’ve been overly redundant, let’s move on.  The next article will discuss how to handle written offers to purchase the business.

For further reading, here are additional related articles:

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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
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How to Use the SBA 7(a) Loan Program to Buy a Business

Information on how to use SBA 7(a) loan to buy a business.

The SBA 7(a) program is a popular loan option for buying a business.

Except for the SBA 7(a) program, banks generally do not make loans to individuals to buy a business.  This statement will surprise a lot of people.

Most people will think first of a conventional bank loan when seeking financing to buy a business.  But I can tell you from decades of experience, this just doesn’t happen often.  The bank’s advertising will lead you to believe they do, but they will usually find some reason not to make a business acquisition loan.

However, after you’ve bought the business and been operating for a while, the irony is this:  The same banker that turned you down for a loan to buy the business will come by your office soliciting your business.

Now this is a true and humorous story.  One of my clients who had been turned down by a local bank for a business acquisition loan, had the same banker visit him two years later soliciting his account after he had used other means to buy the business.  The business owner assumed a serious air and in a somber tone, replied, “Well now Mr. Banker, we’ll be happy to consider your application for our business. Let’s see, we’ll need your financial statement and a list of references and your business plan for five years into the future. Once we have your completed application, I’ll be glad to take it before my committee and let you know of our decision.”

The banker was taken aback.

But fortunately for individuals considering buying a business, participating banks have the Small Business Administration 7(a) loan program to offer.  Except for some specialized programs, the SBA does not make direct loans to borrowers.  Instead, the SBA guarantees a percentage of the principal amount that the bank loans to you.  In a practical sense, the SBA is co-signing the loan with you at your bank.

What is the 7(a) program?

It is the SBA’s most popular business loan program.  To be eligible for such a loan to buy a business, the borrower and the business must:

  • Operate for profit
  • Be small, as defined by SBA
  • Be engaged in, or propose to do business in, the United States or its possessions
  • Have reasonable invested equity
  • Have a minimum personal credit score of 660
  • Use alternative financial resources, including personal assets, before seeking financial assistance
  • Be able to demonstrate a need for the loan proceeds
  • Not be delinquent on any existing debt obligations to the U.S. government
  • An independent, third party valuation of the business must meet or exceed the agreed upon acquisition cost.

Additionally, after deducting a reasonable salary for the owner, the business being acquired must produce a net cash flow of 1.25 times debt service.

Some banks do not participate in the SBA loan programs, but fortunately many national, regional and community banks do participate.  Some banks are designated by the SBA as “Preferred Lenders” which means they have a streamlined application process and more local underwriting authority.  My experience is that you’re much better off using a Preferred Lender compared to a bank that only processes a few SBA loans per year.  The top 100 most active SBA 7(a) lenders can be found here.

Admittedly, the SBA loan application can be time consuming and sometimes frustrating.  But keep in mind, the SBA-backed loans are approved in a lot of instances where no other financing options are available.

Amount Available, Down Payment Required, Interest Rate and Collateral

The maximum amount that can be loaned under the program is $5 million. The average loan in fiscal year 2015 was $371,628.  Interest on the loans is negotiable with the SBA setting the maximum rate that a bank can charge.  As this is being written, the maximum rate for loans over $50,000 is 6.25 percent.

The down payment required is usually 20 percent of the price of the business being acquired.  Some lenders will allow a portion of this 20 percent to be covered by a seller note (ie: a note payable from the buyer of the business to the seller for a portion of the acquisition cost).  SBA restrictions on this seller note usually do not allow repayment of principal and interest for a stated period of time.

The length of the loan for business acquisition can be up to 10 years, or for real estate, the term can be up to 25 years.

There are fees involved in applying for a 7(a) business acquisition loan but in many cases, these fees can be added into the loan amount.

Banks love collateral and will usually reach out and grab whatever collateral is available; however, many lenders will approve a SBA 7(a) loan even when there is less than 100 percent available collateral coverage.  Some banks are more “cash flow lenders” than others, meaning that they will look more to the future earnings of the business being acquired as collateral for the loan rather than current hard assets.

My office stays up to date on the loan preferences and appetites of many lenders.  If you need a recommendation of a bank most suited for your particular situation, just shoot me an email at Will@WilliamBruce.org.

For further reading, here are additional related articles:

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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. 

 

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The 3 Financial Benchmarks All Small Business Owners Should Monitor.

Updated February 14, 2017.

Easy to calculate key small business financial ratios

These 3 key financial ratios should be calculated by every small business owner.

Many small to medium size business owners, including this author, get wrapped up in day to day management of their businesses to the exclusion of some important aspects of oversight.

The ultimate business benchmark is, of course, bottom-line net profit.  However, the three financial ratios discussed here don’t take long to calculate and will keep you on track for a healthy bottom line number.  These are the three that should be checked frequently to monitor the ongoing health and viability of your business:

Gross Profit Margin

Gross profit is simply your total sales (less sales tax) minus the cost of products sold.  Other expenses like rent, payroll, etc. are not considered in this calculation.  The gross profit margin is usually expressed as a percentage by dividing the gross profit by total sales.

For example, if your gross sales for last year (exclusive of sales tax) were $500,000 and the cost of the products you sold was $220,000, then your gross profit was $280,000.  Dividing your gross profit by total sales, we can calculate that your gross profit margin was 56 percent.  The rest of your expenses come out of this gross profit to compute your net profit.

Most industries have benchmarks for gross profit margins.  If yours is above your peer group, you’re doing a good job.  If lower, look for ways to improve.

Current Asset Ratio

This ratio is a measure of your company’s ability to pay its bills as they become due.  It is calculated by dividing your company’s current assets by its current liabilities.

Current assets are cash in the bank, accounts receivables and any other assets you expect to be converted into cash within the next 12 months.  Current liabilities are those obligations that will become due and payable during the next 12 months.

A ratio of two or better is considered by most analysts to be a comfortable situation.  If it’s one or lower, you’ll be waking up in the middle of the night!

Inventory Turn

This calculation measures how fast you’re selling and replacing your inventory.  Inventory turn is particularly important in retail and wholesale operations, but has application in all business categories.  It’s calculated by dividing the average inventory for the time frame being analyzed by the cost of goods sold.

Again, consult your industry benchmark for what is average in your niche.  The higher the turn, the better job you’re doing in managing your inventory level.  A low number most likely means you’re carrying too much inventory for your level of sales.

In summary, don’t be intimidated by the idea of periodically calculating these benchmarks.  It’s pretty easy.  And if you need help, ask your accountant.

Here are related articles you might find interesting.

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William Bruce is a business broker, an Accredited Business Intermediary and a business appraiser.  His practice includes consultations nationally on matters involving business valuations and transfers.  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.

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The Best and Worst Franchise Investments

Brightway Insrance is Forbes Magazine top pick for franchises costing less than $150,000.

Brightway Insrance is Forbes Magazine top pick for franchises costing less than $150,000.

As a business broker and appraiser, I’m often asked what are the best and worst franchise investments, which is why I noticed the following article.

Forbes Magazine writer Emily Inverso has just penned an interesting list of the best and worst franchises to buy.  Her rankings are based on data gathered over a five year time frame from 2009 through 2013.  Inverso’s article can be reviewed here.

The franchise offerings are ranked on several metrics including entry cost, 5-year growth rate and 5-year franchise continuity.  Franchise continuity as shown in the rankings is the percentage of franchises opened that are still in business at the end of the five year period.

The franchises are divided into three categories according to entry cost: up to $150,000, $150,000 to $500,000 and over $500,000.

The top ten in Forbes’ ranking for the under $150,000 entry cost were:

  • Brightway Insurance – sells personal and business insurance policies.
  • Maid Pro – provides residential cleaning service.
  • Right at Home – home care to seniors and disabled.
  • Discovery Map – curates quirky maps and travel guides.
  • Just Between Friends – provides consignment events for children’s and maternity clothes.
  • Seniors Helping Seniors – non-medical home care by seniors
  • BrightStar Care – homecare
  • Pop-A-Lock – locksmith services
  • Mathnasium – math tutoring
  • Weed Man – lawn care

As ranked by Forbes, the worst 10 franchises in the under $150,000 investment category were:

  • American Express Travel Services – 57% continuity for 5-year period
  • Gardsman Furniture Professionals – 47 % continuity
  • ERA Real Estate – 48% continuity
  • All Tune and Lube – 31% continuity
  • United Country – 52% continuity
  • WSI – 43% continuity
  • Handyman Connection – 31% continuity
  • Curves – 37% continuity
  • Computer Trouble Shooters – 42% continuity
  • Realty World – 29% continuity

In the mid sized investment range of $150,000 to $500,000, these were Forbes’ top 10 ranking franchises:

  • Jimmy Johns – fast food
  • Jet’s Pizza – deep dish pizza in a square pan
  • Marco’s Pizza – “authentic Italian” pizza
  • Plato’s Closet – young adult clothing
  • Dutch Bros. – drive-thru coffee shops
  • Wingstop – wings restaurants
  • Sports Clips – sports themed barber shops
  • Batteries Plus Bulbs – replacement batteries
  • Anytime Fitness – 24 hour gyms
  • Auntie Ann’s – pretzels in mall food courts

In the same size category ($150,000 to $500,00) these were Forbes worst 10 franchises to buy:

  • It’s a Grind Coffeehouse – 36 locations
  • Econo Lube N’ Brakes – 33 locations
  • Mr. Payroll – 88 locations
  • Cottman Transmissions – 67 locations
  • Chock Full o’ Nuts – 31 locations
  • Quiznos – 1,439 locations
  • Great Steak & Potato Company – 90 locations
  • Epcon Communities – 86 locations
  • Fitness Together – 207 locations
  • The Athlete’s Foot – 54 locations

For details on the above franchises and to review the ranking of franchises requiring an investment of greater than $500,000, please visit the Forbes article here.

For additional article by William Bruce on franchise risks and opportunities, please see:

Best & Worst Franchises Listed by SBA Loan Default Rates

List of Franchises Not Qualified for SBA Loans

What is a Franchise Really Worth. How to Value any Franchise.

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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 may be reached at (251) 990-5934 or by email at WilliamBruceOnline@gmail.com.  His business brokerage website may be viewed at www.WilliamBruce.net.
 
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