How Much Does Escrow Cost to Close a Business Sale?

Customarily, escrow fees are split 50/50 between the buyer and the seller and vary depending on the size of the transaction. Escrow cost is less than 1% of the purchase price of the business. However, there is a minimum fee for unusually small deals. Other charges may apply to one party or the other for specific services such as lien filings, lien searches, non-standard documents, and real estate closing documents (if property is part of the sale).

The escrow agent is an independent agent who's role is to facilitate the close via a written process that is documented in an escrow agreement, or earnest money contract, that is agreed to and executed by both the seller and buyer. We all know the name of the game in business is to minimize risk; the use of an independent escrow agent substantially minimizes both the seller’s and buyer’s risk resulting from the closing process.

An independent third party escrow agent works for both the Seller and the Buyer and, as such, is in a position to be impartial.  Just as when commercial real estate or a home is transferred, a third party escrow agent is used to facilitate the close - the same should be done when you sell or buy a business. Employing an independent escrow agent to close a business sale is well worth the cost!

General Overview of Escrow Agent Services

• Holds earnest money in safe, secure escrow account pending closing.
• Coordinates with escrow attorney the drafting of all closing documents, including the bill of sale, non-compete, seller-financing loan documents, etc.
• Drafts escrow instructions according to the terms and conditions of the purchase agreement.
• Obtain a copy of all real estate leases and coordinates and confirms the lease assignments with landlord.
• Performs a UCC-1 lien and business personal property tax search on the business to make sure clear title can be conveyed.
• Submits request to Texas Comptroller for Certificate of No Sales Tax Due.
• Collects and disburses all closing funds according to escrow instructions.
• Out of the proceeds, pro-rates and pays the rent, deposits, taxes, and other expenses required.
• Insures that secured creditors are satisfied. Coordinates any necessary payoffs and handles
• UCC-3 terminations, amendments and/or releases of lien. Includes up to two payoffs and wire transfer or overnight fee for each.
• Files and records all necessary documents with the appropriate authorities.
• Obtain a Corporate Status Report form the Secretary of State of all entities involved in the transaction and confirm that the entities exist and are in good standing.
• Obtain written evidence of proper authority for an entity to sign the purchase agreement and related documents and to consummate the transaction.
• Obtain copies of all pertinent contracts and documents and review the contents of each one.
• Files UCC-1 Financing Statement with Secretary of State when Seller-financing is involved.
• Prepares separate buyers and sellers settlement statements reflecting all funds being handled through escrow.
• Provides one complete set of all closing documents executed at closing to each party. Keeps copies of all sales and closing documents.
• SBA Loan Coordination

As business brokers, we guide the entire process to facilitate a smooth closing day. Once the buyer authorizes closing activities to commence, we coordinate with the principals and their advisors, landlord, lender, and others to insure that all necessary paperwork is completed on time. The escrow attorney will conduct lien searches, prepare closing documents, such as a bill of sale, note and security agreements, closing statements, and non compete agreements prior to closing for all parties to review. Final preparations will be made for lease assignments, utility transfers, financing, merchant service accounts, inventory counts, alcohol or other special license transfers, and any other last minute preparations to make the transfer as seamless as possible. After the closing documents have been approved by the principals, a closing time is scheduled. A formal closing takes place in our office where legal documents are signed, funds are received and ownership is transferred. Voila!

Selling A Business Is All About The Process

Most business owners, have thought about selling their business a time or two. They've imagined, dreamed, and wondered what it would be like to be free of all the trappings, headaches, and burdens of running their company. They probably also wonder how cumbersome the sale process might be and what it entails.

While we can't tell what their imagination dreams up at the thought of freedom, we can tell them that selling a business requires a substantial commitment and should be a calculated decision. As with most endeavors, whatever effort is put into the process is what will come out of it.

A fundamental element to a successful sale is preparation. Knowing what to expect, understanding the motives of the most probable buyer, anticipating their questions, and vetting potential problem areas of the business that might inhibit or delay an eventual sale are key to a positive selling experience. Once business owners feel comfortable with these basics they just might stop wondering and take the leap necessary to begin living that dream.

The selling process has three distinct phases and should always be performed within the confines of Confidentiality. The anonymity of a business on the market is critical during the sale process and is important in protecting it's interests.

PHASE 1 - Message
Before this phase begins, a valuation of the business would already have been performed. Knowing the value of the business helps determine the most probable buyer, whether it be an individual, a strategic buyer, or a financial buyer. During this initial phase the business profile is compiled. It encompasses the detailed analysis (SWOT) and assessment of the business for the purpose of packaging and communicating its value, its market, its assets, its strengths, its areas that can be improved, its growth potential, and its financial history. The resulting profile is the Message that will introduce the business to the marketplace of appropriate buyers using a systematic methodology that protects confidentiality.

PHASE 2 - Action
This is the go phase where the business is launched into the marketplace. During this stage a rush of behind-the-scenes Action is taking place. Prospective buyers will be interviewed, confidentiality agreements will be signed, questions will be answered, and buyer / seller meetings will be arranged. The seller must continue to run the daily operations of the business and carry on as usual. Deviating attention away from day-to-day demands of business operations would affect employees, clients, sales, and ultimately profits -- which can mean a lower price in the marketplace. The goal of our phased, targeted marketing approach is to foster a competitive environment among interested acquirers in order to bring the highest possible price for your company.

PHASE 3 - Profit Point (Pay Day)
This is the final stretch, the closing phase of the process. It commences once a Letter of Intent is in place, or an Earnest Money Contract, for small businesses. The first step in this stage is due diligence, which is an investigation or audit of the business by the buyer. Due diligence serves to confirm all material facts in regards to the potential sale. This includes reviewing all financial records, business operations, human capital, plus anything else deemed material to the sale. Sellers should also perform a due diligence analysis on the buyer. After due diligence is performed and both parties are satisfied with the results, closing activities begin. The closing phase is the last mile that often has bumps, curves, and detours that can obstruct the way to the goal. However, these obstacles can be overcome by an expert driver who is keenly familiar with the terrain. After thousands of excursions, we know the route well and can safely guide the way to the destination...the closing table...the place where business owner can finally realize Payment due from years of hard work. They're then free to turn that dream into reality....the whole reason for the trip

SWOT Analysis



SWOT - An Analysis of a company's internal strengths and weaknesses
and its external threats and opportunities for growth.



Increase the Value of Your Business – Document Your Marketing Plan

An articulated, working marketing plan is a sign of an organized business and provides a roadmap for a new owner to follow.

A marketing plan that is tailored to reach a defined target audience instills confidence that growth can be achieved in an effective, predictable manner under new ownership. In other words, by increasing the probability that the business will continue to perform and grow into the future, the risks associated with acquiring the business are significantly reduced in the eyes of prospective buyers. Less risk means a better value. Therefore, the efficiency with which you attract customers will increase the purchase price paid for your business.

Some points to consider in developing your marketing plan that would be important to prospective buyers:

• Understand the Return On Investment (ROI) of specific marketing efforts. This is a powerful tool to achieve growth and conquer competitors. ROI Marketing is particularly powerful for small and midsized businesses that can't afford to waste money. It can increase your business "Moat." What is your marketing / advertising Return on Investment (ROI) per campagin. Where can you get the biggest bang for your buck (print, TV, radio, email, newsletters, webinars, seminars, tradeshows, on-line)?
• Document your sales process and its effectiveness.
• Develop marketing systems that improve sustainability of profits and margins
• Solidify and diversify customer base – know who your customers are – Define your target market
• Analyze and outline other marketing opportunities that could effectively grow the customer base
• Know the marketing methodologies of your competitors.
• Focus on Human Capital – people are such a crucial aspect of selling and marketing. A solid sales team and a documented hiring and training system will solidify the ongoing performance of existing and future sales staff. A trained sales team is a tool that a buyer can count on to help in transition and to ultimately increase sales in the future. 
• Keep marketing performance reports available for analysis. Can management measure and evaluate marketing efforts to verify their contributions to the bottom line? Marketing strategies are key to increasing profits and honing margins.
• Maintain a marketing calendar - keeps track of budgeting and staffing needs for promotions and events. Crystallizes focus on the value in each campaign, builds consistency, and aids in preventing marketing lapses that cause the "feast and famine" effect that many businesses experience.
• Estimate your target acquisition cost per customer.
• Understand the marketing budget necessary to achieve goals. Which tactics will best realize these goals?
• Monitor Marketing-to-Sales ratio to make sure it is in line with industry norms. Many companies spend too much on advertising without knowing how effective it is, and many advertising dollars are wasted.

Should the Owner of a Business for Sale Expect to Negotiate Price?

This is a common question asked by business owners who are thinking about putting their business on the market for sale. They want to understand the parameters of a business deal and what to expect from prospective buyers.

Negotiation may seem a daunting task, but when explained in a balanced manner, negotiation should be deemed a positive approach rather than a negative one.

When a serious qualified prospective buyer comes along, the negotiation strategy should be one that results in a winning deal for both the seller and the buyer. It's not about who strong-arms the other. Nor is it a game at which you either win or lose. It’s a complex process for sure.

A good deal is never one-sided. Both parties should work as allies since the goal of one will achieve the goal of the other. If the parties can determine the factors that are most important to each, the price and the terms of the deal can be structured to meet those needs. The short answer to the title question is that "a successful sale is not just about the price tag. The terms and structure are what make the deal."

Negotiating tips that can make a deal work:

• Resolve the toughest issues first.
• Don't get bogged down in minor details.
• Keep egos at bay.
• Focus on common interests.
• Discuss different scenarios to solve any particular problem before making a decision.

Is Now a Good Time to Buy a Business?

If you buy a business in Texas, now is a good time to buy a business.

With a roller-coaster stock market, a not-quite bottomed-out real estate market, and interest rates so low, there is nowhere else that will yield a higher return on your investment than in your own business. In what other investment can you receive a return of 25% and higher, and over which you have control?

While many areas of the country might not be faring well, business owners in Texas reported higher sales growth than the rest of the country. Texas has consistently been one of the best economic engines in the nation and ranked the Best State For Business in 2010 and 2011. Texas is popping up on a lot of radar screens as a place to relocate or expand for businesses because of its future outlook for growth.

If you are looking for stability, better predictability and control in today's economy, buying a business in Texas can offer all of these as long as you invest wisely and purchase a quality business. Leave the pitfalls of chance behind. Invest in yourself. Create your own economy. Now IS a good time to buy a business in Texas.

Three Popular Myths of Selling A Business

Over the past 38 years our firm has been involved in many discussions with business owners considering the sale of their businesses. There are a few particular myths that have repeatedly surfaced during these discussions.

Since a typical small business owner will sell a business only once in his or her life, it is not surprising that the complexity of the process is often underestimated.

Therefore, an understanding of fact vs. myth is important if an owner of a profitable small business wants to achieve a successful sale and get the best deal the market will bear.

Myth #1 – I Can Sell My Business Myself

Many owners believe they’re qualified to sell their business without professional assistance based on the skills they’ve acquired running their companies. Many owners are entrepreneurs with solid selling skills, and many function as the key salesperson for their company. However, what many don’t anticipate is that selling a business is nothing like selling a product, service or anything else they’ve sold before.

If you’re looking to sell on your own, confidentiality is immediately lost. If word of a potential sale gets out, there are definite risks. What will your competition do if they know you are for sale? They’d probably be yelling the “good news” from the rooftops. You could lose clients, employees and favorable credit terms with banks— not to mention managing potential landlord questions.

Business owners must ask themselves: is there really sufficient time to focus on running and growing the business while compiling marketing materials, advertising, screening a slew of buyers (and tire kickers), and giving tours? On top of all of this, do you have the time and wherewithal to negotiate a fair deal -- an adversarial process by nature -- plus facilitate due diligence?

When it comes time to sell your business, you should be concentrating your efforts on “the bottom line,” a key issue that matters to prospective buyers, not taking on new challenges.

Article: Why Not Sell on Your Own

Myth #2 – I Know What My Business is Worth

When self-examining the value of their business, some owners want $100,000/year for sweat equity or will base their price on what they personally need for retirement. Others utilize “industry multiples,” most often some nebulous concept of EBITDA. Yet others just pick a number out of the air.

None of these self-derived values will carry credibility with buyers nor will it help a bank provide acquisition funding at closing.

A valuation performed by a company that understands the marketplace of buyers, understands the key factors that drive business value, and has access to private industry databases for national small business sales provides a solid understanding of a company’s market worth, not some vague industry average. It’s surprising, but not uncommon, how many business owners expect a buyer to pay top dollar for their business, yet are not prepared to show them why.

Myth #3 – Selling a Business is Like Selling a House

Preparing to sell a house takes a couple weeks and then word of the sale is spread as far and wide as possible. Once a satisfactory offer is received, the keys are turned over and the seller moves on. No confidentiality, no pre-qualification, no detailed marketing and financial profile, no transition time, no seller note.

A successful business sale requires a great deal of pre-planning, valuation, cash flow recasting, SWOT analysis (strengths, weaknesses, growth opportunities, threats), and buyer evaluation, to name a few.

The average house will sell in less than four months, while the average business sale is nine months to a year.

Even after the business is sold, the seller can be expected to put in at least a few months of transition time, to help the new owner run the business successfully – thereby securing payback on the loan the seller most likely provided the new owner as part of the deal.

Selling a business is complex, to say the least. In fact, Selling a Business is Unlike Anything Else You Can Imagine.

Summary

The environment in which a business must be sold is unique. Therefore, the methods used to sell a business should also be unique. Although the sale of a business is different than the sale of essentially anything else, what occurs is straightforward. It all makes perfectly good sense and is quite logical.

Assume your business is a public company. Before attempting to attract a buyer your board of directors would first engage an investment banker to identify appropriate acquisition candidates, determine the company's worth, and package your company for presentation to the most attractive and appropriate buyers.

Essentially the same process should be used by small business owners considering a sale. Identify the characteristics of your ideal buyer. Determine what makes your company of value, to whom and for how much. Then decide to sell the company or take other actions that might be deemed more appropriate, such as make the company more attractive and valuable for a future sale.

Why Branding and Documented Systems Add Value to a Business When it's Time to Sell

A business valuation is not about what a company is worth in the current owner's hands, it's about the company's transferable value. It's about the probability that the business will sustain its profitability and continue to grow with a new owner at the helm. Therefore, the factors that contribute to the company's stability and consistency will be examined by prospective buyers to determine the risks associated with taking over the business.

A strong brand, an intangible asset and an element of goodwill, is a desirable attribute to have in the business-for-sale marketplace. Documented systems, also, is a factor that contributes to saleability. Both make the list of the TOP TEN VALUE DRIVERS that increase the sale price of a business.

If you are a small business owner, it would be worth your while to have a game plan for how you would package your business for sale. Depending on the size of your firm you may need a few things in place in order to sell the company. The first and probably the most important thing you need to do is describe how a new owner would be able to REPLACE YOU, THE CURRENT OWNER. An enterprise with infrastructure guiding its revenue-generating capacity is much more appealing than one with a singular person holding the key to the revenue engine. As the E-myth explains, the owner should be free to work "On" the business instead of "In" the business. So documenting how the business runs and how you do what you do is important.

Once the owner's role is documented and a detailed policies and procedures manual is in place, the next thing to focus on is sales. If there is no sales strategy in place that includes a well documented process for how to train and get sales staff up to speed, the company may be perceived as risky to prospective buyers. A step further would be to outline realistic opportunities for future growth that specifically illustrate the reasons why cash flow and the business itself will grow after it is acquired. This would paint the larger picture of your business and should translate into added value. This is why it is important to think about properly presenting future profitability, it's all about "show me the money."

After all systems have been documented so a new owner can step into your shoes and transition smoothly into operating the company, with the knowledge that the sales engine will continue to rev, the next step would be to think -- BRANDING. A unique brand identity that distinguishes your business from your competitors is the route to success for all companies. The better the brand position you have in the marketplace, the lower the risk of taking over the business. This translates to higher value. How is your business perceived by your target market? What unique attributes do customers and prospects associate with your business? Is your business name trademarked? Are your logos or other intellectual property protected? These all represent your brand and are valuable. As a matter of fact, McDonald’s brand does not appear on the company’s balance sheet, even though it is estimated to account for about 70 percent of the firm’s stock market value.

Just as your product or service needs intrinsic value in order to sell it to the end user, your business needs distinct attributes in order to sell it in the business-for-sale marketplace. Look at your company as a product you want to sell. How would you describe that product in an advertisement?

"If this business were split up, I would give you the land and bricks and mortar, and I would take the brands and trade marks, and I would fare better than you." — John Stuart, Chairman of Quaker (ca. 1900)

Passing Financial Due Diligence When Selling A Business

Due Diligence is the final hurdle of the business sale process. It is the time when the buyer requests from the seller any documents and materials needed to verify that all representations made by the seller are accurate and occurs after a purchase contract is signed by both parties in the transaction. The contract is contingent upon the business passing due diligence inspection by the buyer, which is usually scheduled to last about two weeks.

While there are many aspects of the business that will be explored by the buyer, such as as personnel, operational, market, and legal, it is financial due diligence that is one of the biggest reasons deals fall apart. Having proper documentation to present to a prospective buyer that proves revenues and earnings of the business is key to attaining a successful sale in a timely manner. With good financial records a prospective buyer could readily verify earnings and be able to arrange bank financing, if applicable.

On the other hand, poor financial records would not yield such a rosy outcome. First, the buyer would most likely need additional time to verify and make sense of the information, which could delay closing and require the business owner to produce additional data. Secondly, if the buyer feels the books are unsatisfactory or inconsistent, a higher risk in purchasing the business would be perceived. Consequently, depending on the risk tolerance of the buyer, s/he would either pull out of the deal or offer a lower price than originally negotiated in the contract.

There are things that may be uncovered during due diligence of which the seller may or may not have been aware that could affect the transaction. In many cases, these issues can be worked out. Small issues usually involve some give and take from both parties and the transaction will stay on track. Major findings, however, could result in a dead deal or a deal that gets renegotiated.

Due diligence preparations should be made prior to the business sale process to avoid delays and facilitate a smooth experience for everyone involved. The more expeditiously that clear and organized information that demonstrates the full financial benefits of owning the business can be made available to a prospective buyer, the more likely the business will sell as negotiated and close on time. With that in mind, the following are individual items that may be requested by a prospective buyer in order to substantiate the financial aspects of the business.

• Income statements
• Balance Sheet
• Assets on balance sheet
• Tax returns
• Texas Sales Tax and Franchise Tax up-to-date clearance (Certificate of No Tax Due)
• Customer and / or vendor contracts
• Bank statements
• Documentation of the owner’s discretionary earnings
• Inventory reports
• Asset depreciation list
• General ledgers
• Insurance policies
• Sales and backlog
• Equipment leases
• Accounts receivable and payables reports

Buying a Business with a Partner? Plan Ahead

"A friendship founded on business is a good deal better than a business founded on friendship." - John D. Rockefeller

For a variety of good reasons people partner up to purchase a business, whether it be one partner contributing the funds and the other putting in the time and knowledge or both simply deciding to split up the responsibilities.

Sometimes one person may not have all necessary skills to operate a business and needs a partner or a team to round out the required talent roster. As long as ample forethought and planning goes into the formation of a partnership it can, indeed, be a great way to achieve a business acquisition.

Since partners are liable for the business activities of the other, and a partnership is typically much easier to get into than to get out of, you'll want to achieve mutual clarity upfront. Engage a good business attorney to draft legal documents that are specifically tailored to your business circumstances. You may wish to discuss the following two documents with your attorney.

1) Shareholders or Operating Agreement - This document details the duties and responsibilities of each partner.and should establish division of labor including who'll be responsible for making purchase decisions; how much capital each will contribute; who owns what; how decisions will be made, how profits will be shared, and how disputes will be resolved.

2) Buy-Sell Agreement - This contract will outline who will be entitled to what if the partnership doesn't work out. It should address what would happen if one of the partners decides to leave the business, or if somebody gets divorced, or sick and won't be able to work, or even die.

Just like a good marriage, you believe your business partnership will last. However, circumstances and people change over time, and it's better to discuss possible solutions for problematic situations in advance.

Check out this article: 6 Steps to Finding the Perfect Business Partner

Is Lending for Business Acquisitions Back to Normal?

This is the question I get more than any other and my answer is YES, Absolutely Yes!! My answer may surprise you, and some may even want to argue, but if you have been in the lending or business brokerage industry for more than 6 or 7 years I think you will agree.

When I look back to the 1990's and early 2000's when I was asked, "What does it take to get a business acquisition loan?" I would tell them a borrower must be able to CONVINCE the lender of the following:

• The ability and willingness to pay all of their obligations on time.
• The specific experience needed to own and run the business.
• They had enough cash to make a substantial investment into the business.
• They had some tangible assets to back the loan should things go bad.
• Today when I am asked "What does it take to get a business acquisition loan?" I tell buyers and brokers exactly what I did 10 and 15 years ago.

The trouble with many individuals today is they are sitting around waiting for things to get back to the way they were in 2007. Unfortunately, the lending of 2007 is gone and most likely gone forever. SBA lending in 05, 06 and 07 was more about lender greed than it was about solid underwriting. We were able to get deals approved with a 1-2 paragraph summary and a laundry list of "add backs". Ten years ago a typical deal write up was 5-10 pages. Today, we are back to that same in depth analysis.

Just as it was in the past, it is critical that the business and the buyer be presented completely and in the "best light" possible to ensure months of hard work do not end in vain. When it comes to business lending, you really only have one chance to make a positive first impression. If the initial package does not convince the underwriter of the deals merit, your chances of ever getting the deal funded plummet.

In conclusion, having arranged funding for over 250 business acquisition loans over the past 20 years, I can honestly answer YES, business lending is back to normal!

This article was contributed by: Steve Colburn, President, Eagle Capital Advisors.

Selling Your Business is a Taxing Matter - How Much Will You Bring Home

While the first question a business owner asks is, "What kind of price can I expect in the marketplace if I sell my business," the real question is not the price paid for the business, but how much will you take home.

The Federal Tax Laws determine how much money you will actually be able to put in the bank. How your business is legally formed can be important in determining your tax status when selling your business.

For example: Is your business a corporation, partnership or proprietorship? If you are incorporated, is the business a C corporation or a sub-chapter S corporation? There are some tax rules that impact certain businesses on seller financing.

The point of this tip is that before you consider price or even selling your business, it is important that you discuss the tax implications of a sale of your business with a tax advisor that is experienced in business transfer transactions.

A business broker will be able to recognize potential problems and can refer you to tax professionals if you don't already have one that is experienced in tax issues related to business transfer transactions.

You don't want to be in the middle of a transaction with a solid buyer and discover that the tax implications of the sale are going to net you much less than you had figured. By structuring the transaction to properly address tax matters beforehand, you will not feel quite as robbed by Uncle Sam.

Passion, Purpose and Knowledge - The Attributes of a Successful Entrepreneur

Article written by Jerry Osteryoung

“Only passions, great passions can elevate the soul to great things.” ~Denis Diderot

I give many speeches every year, and in each one I always include time for questions. By far, the most frequently asked question is what attributes are needed to be successful as an entrepreneur.

After observing more than 3,000 entrepreneurs, I can tell you there are three simple keys to success: passion, purpose and knowledge. Most folks have two of these down, but you really need all three if you are going to be successful.

Passion is the burning force that keeps you going no matter what happens. Many of the entrepreneurs we deal with have cash-flow crises, but they just do not quit. Somehow they find a way to make payroll or pay that bill. Instead of getting discouraged, they just make a commitment to never end up in that situation again.

Entrepreneurs who lack passion are almost guaranteed to fail. I have seen many aspiring business owners start a company because they either got laid off or could not find a job. This is a recipe for certain disaster, because not having another option does not provide the pure and unbridled passion that you must have to be successful.

Passion alone, however, is not sufficient. You must also have purpose to be successful, because purpose is the force that focuses your passion on a specific activity or industry.

Too often, people tell me they want to start a restaurant because they are good cooks. Being passionate about being a great cook is OK, but it is the combination of passion with purpose — serving clients and making money, for instance — that makes for success.

The third piece of the entrepreneur's formula is knowledge. I cannot overstate the importance of knowledge, because this is how you are able to avoid costly mistakes.

There are three critical knowledge areas entrepreneurs must master. First, you must have a great understanding of marketing and feel comfortable promoting yourself and your business. After all, there is no better salesperson for your company than you.

The second is finance. You absolutely must be able to interpret your financial statements and have a clear understanding of the financial ramifications of your decisions.

The third and final element is knowing how to manage people effectively. All businesses need people, and being able to manage those people is a requisite to success. Knowledge takes passion and purpose and transforms that light into a laser beam for your business.

Before you start a business, make sure you have the three attributes that are vital to success: passion, purpose and knowledge. If you are unsure if you have these components, you probably do not, in which case, I would advise you to wait. If, on the other hand, you are sure, now is the time to move ahead.

Jerry Osteryoung is the Director of Outreach of the Jim Moran Institute for Global Entrepreneurship in the College of Business at Florida State University; the Jim Moran Professor Emeritus of Entrepreneurship; and Professor Emeritus of Finance. He was the founding Executive Director of the Jim Moran Institute and served in that position from 1995 through 2008. His newest book “If You Have Employees, You Really Need This Book” is an Amazon.com bestseller. View Osteryoung's past articles at www.jmi.fsu.edu/Services/Jerry-s-Articles. You can e-mail him at jerry.osteryoung@gmail.com.

Maximize Value When Selling Your Business - Get Rid of Excess Inventory

When selling a business, maximizing value is of primary importance to the business owner. One element that can drag down business value is poor inventory management in the form of excess inventory. Maintaining proper inventory levels is essential to maximizing value.

When running a business, the goal should be to tie up as little cash as possible in inventory, while having enough inventory to meet ordinary business needs. After all, a prospective buyer looking at your business as a possible acquisition would rather have fully flexible cash not less flexible inventory weighing profits down. Any additional dollar that can be found to help bottom line earnings when selling a business will be rewarded by a higher price when the business is sold.

There is a delicate balance where it begins to cost more to carry the inventory than it costs to not carry the inventory. Carrying unneeded inventory can decimate profitability and cash flow in a hurry. Not only does excess inventory tie up a lot of cash, but there are day-in and day-out costs associated with that inventory as well. From the expense of financing that inventory, to the costs of markdowns due to age and obsolescence, to the incremental payroll costs of moving it around, to the hidden costs of not being able to merchandise more productive inventory in its place, it all adds up, and hits the bottom line.

These costs affect the profitability of the business and include, but are not limited to, the following:

1. Cost of Capital - There is a cost of the capital that you have tied up in inventory which may be in the form of interest that you are paying for the financing of the inventory. With every sales transaction, cash is generated, which drives the operating cycle. Cash is used to purchase inventory and pay expenses. But when your inventory is too high, your cash is tied up in that inventory. In cases where inventory is not being converted to cash efficiently, the need for an increased line of credit is the consequence. Paying more interest on the increased debt is obviously costly when you should be generating those funds internally.
2. Storage - There is a cost for taking up space in a warehouse. You may be leasing more space than you actually need. You may also have higher utility expenses that are associated with leasing this larger space.
3. Handling - There is a cost associated with servicing and maintaining inventory such as material handlers and record keeping staff.
4. Opportunity Costs - This cost is associated with the funds you have tied up that you cannot put to use elsewhere. This cost can be determined by evaluating what you could have done with the money if you hadn't spent it on inventory. Whether it is invest in upgraded technology, equipment, staff, or something else you could have done with that money. Any higher gains that could have been achieved from those other investments is a lost opportunity and is a cost of carrying inventory.
5. Insurance and Taxes - You may be paying more taxes and higher insurance premiums than necessary to maintain excess inventory.
6. Risk of obsolescence - There is increased chance for obsolesce, deterioration, or damage when you have too much inventory.
7. Higher Selling and Advertising Costs - If you are carrying an excess level of inventory, you will incur additional and probably unplanned selling and advertising expenses in order to sell the excess merchandise.

There are other issues concerning inventory that can derail the successful sale of a business. Be sure to discuss any inventory issues you may have with your business broker prior to marketing the business for sale.

Creative Financing for Buyers Looking to Purchase a Business

The evaporation of small business capital markets and other economic factors have made creative financing the norm for today's business buyer. During these turbulent times there are a number of creative financing options that you can consider.

Seller Financing - Increasingly, buyers and lenders are looking to the seller for financing as they try to put a transaction together. In such a scenario, the seller will hold a note at an agreed upon interest rate for a specific term or amortization – generally ranging from five to 10 years. The terms of the sale may include a balloon payment three to five years after the purchase date. It’s a way of giving the buyer time to get up and running and to establish a successful track record with the business. Seller financing makes the bank more comfortable with the transaction. Lenders know they have a seller who has a vested interest in the success of the business rather than one who will take their money and run.

SBA Loans - In sales of a business, conventional loans usually aren’t available, so a buyer may want to consider going to a Small Business Administration (SBA) lender, which has a number of loan options. The SBA guarantees a portion of the loan. The buyer pays an SBA loan fee that allows them to get funding for a loan the bank couldn’t do conventionally. If an SBA guaranteed loan goes into default, the SBA will pay the lending institution up to 75 percent of any deficit left after liquidating the collateral. There have been several changes to the Small Business Administration's lending guidelines and standard operating procedures in 2009. You will want to speak with an advisor who is familiar with these recent changes.

Earnouts - Earnout financing involves a certain dollar amount agreed on by the buyer and seller to be paid to the seller based on the performance of the company after the transaction is completed. Earnouts can be structured in a variety of ways and can be based on different financial benchmarks such as a company’s revenues, gross profits or net income. Earnout financing is often used for companies that are in a turn around situation or when buyers are purchasing on potential, rather than on historical cash flow.

Mezzanine Financing - In mergers and acquisitions, mezzanine financing is another alternative for a buyer looking for capital where the financing package may include interest rates of 20 to 30 percent. The lenders in this situation are typically high net worth individuals who are expecting a larger return on their investment. They are lending in a junior lien or a position behind the bank and seller financing. The loans are typically made with limited sources of collateral, thus the request for higher interest rates. Again, this financing is often used in funding goodwill or reputation in an acquisition.

Funding Scenario - In a million dollar transaction, the buyer would be expected to have a 20 percent down payment. The seller may hold an additional 10 to 20 percent in seller financing, and the lending institution would offer a combination of conventional or SBA financing to cover the difference, depending on collateral available. A buyer and the lending institution must evaluate a company’s cash flow and determine if it is adequate to cover their debt service and provide a reasonable return on their investment. Lending institutions will also be examining whether a buyer’s coverage ratio, or excess cash flow after all debt is paid, is adequate to cover their needs.
Even if you’ve been affected by a downturn in the economy in some parts of the country, don’t let that stop you from considering your acquisition options. Creative financing tactics are becoming more common.

Talk with a business intermediary representing the company you are considering purchasing. They’ll know if the owner is willing to consider seller financing, earnouts or other creative financing ideas. Based on your available capital, the business broker should be able to tell you whether you’ll be considered for the purchase and may also provide you references to various lenders that are familiar with financing the purchase of a business.

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Should You Consider an Unsolicited Offer from a Competitor to Buy Your Business?

"A major competitor made an unsolicited offer to acquire my small business. The amount seems significant, what should my next step be?"

While the offer may sound great, the real question is whether or not it is an offer that truly reflects the value of the business you have built.

So, in order to make an informed decision, the first step is to seek an independent valuation from a firm who knows the marketplace.

Secondly, you need to educate yourself about what drives value and what motivates buyers.

The fact is that competitors usually pay the least for a business. There are other types of buyers that would probably pay more.

Each category of buyer has distinctive characteristics and motives for making an acquisition. The price each is willing to pay is directly proportional to their motive.

Should a valuation determine that your competitor's offer is less than it should be, then you should let the marketplace compete for your business in order to achieve the best possible deal.

Buying a Business - Make Your Acquisition A Good Investment

Future profit potential, and how much you can impact that future, is the most important intel you can have when purchasing a business. Future growth will ultimately be the measurement of the merits of the investment and is key to your achieving a good return.

 

One the most serious shortcomings when evaluating an enterprise is to focus only on historical performance without considering what the business might be capable of under new management. While its history provides some insight, it is what will happen to the company in the future that is key.

 

In any conventional evaluation process, the buyer will pay for what has been achieved but will buy for upside potential. Successful acquisitions are all about generating a premium on the investment. The major "determinator" in considering an acquisition should be how a new owner can improve the business. Probing for underlying growth opportunities that are ripe for exploitation will help achieve that goal.

 

Some factors to consider in gauging the company's future under your ownership that could enhance and expand the bottom line could be:

• Is there is a skill set that the current owner is lacking, that you possess. For example, a stronger marketing background or more technologically inclined.
• Are there additional markets that a new owner should pursue?
• What additional products could be delivered to existing customers?
• Where are the best profit margins realized and can they be expanded?
• Can the technology be licensed?
• Will demand for the product or service increase as population grows?
• How will enhanced marketing campaigns and sales efforts affect growth?
• Are there opportunities to grow through acquisition?
• Can growth be achieved by expanding geographically, increasing manufacturing capacity, or adding multiple locations?
• Would additional hires impact growth?
• Or, would streamlining the workforce be more beneficial?
• Is franchising feasible?
• Are there online strategies ripe for growth?
• Are there areas to explore that could decrease operating costs?
• Would the company benefit through additional workforce training and education?.

Most business pricing models have two major components: a base, usually revenue or profit, and a multiplier. To get the base you need a clear view of the revenue picture from previous years, the historical performance. The multiplier is derived from industry-specific ranges. That multiplier is actually the number of years it will take to recoup the price you just paid for the business, assuming it doesn’t grow (or shrink.) Having a clear view of the future – and how much you can impact that future – is the most powerful intelligence you can have when determining the soundness of a business investment.

 

For example, if you pay 3x earnings, and believe you can double the business in twelve months, that is a good deal. If you pay 10x earnings, and you expect 10% growth – it’s going to take a very long time to see a return on your investment. While 10x earnings is an exaggeration, it illustrates the point of return on investment.

 

Using these principles as a guide in making an acquisition decision may markedly increase the chances that your journey to profits and success will end with positive results.

Selling a Small Business is Unlike Selling Anything Else You Can Imagine!

Family and private businesses are sold in an environment that is unlike the selling environment of anything else you can imagine!

Sound surprising? After you review the following ten reasons that make selling a business different than selling anything else, perhaps you will agree.

When the decision is made to sell and the sale is properly conducted, a business is sold for the best price and terms without anyone ever having known it was for sale.


(1) Confidentiality

Making the decision to sell one's business is a difficult enough task in itself. However, once the decision is made how do you sell it without anyone knowing it's for sale? Adverse things can and do occur when people know, or think they know, a business is for sale. Confidentiality must be maintained. Here's why.

Employees get nervous and may leave for more stable employment. They believe that the "new broom will sweep clean." That may be true in public company acquisitions but is generally not true in private small business sales. Your staff represents a significant portion of your company's value. Should your key employees leave, most buyers of private companies will not buy.

Competitors may take advantage by using the information as a way to gain an advantage and pirate customers. After a recent seminar on buying, selling and pricing businesses, a businessman said to me, "I wish you had given this seminar last year. Your information would have saved me $150,000." He had decided to sell and had sent information to his competitors and others within his industry offering his company for sale. Shortly thereafter many customers stopped coming in. Apparently his competition was using the information to undermine customer confidence by saying, "I know you have done business with Joe for years but - he's selling out you know and . . ." Twelve months later business is almost back to normal. Many companies have not survived this mistake.

Suppliers extend credit to your business because of your good payment record over the years. Now they hear you are "on the block". Might they put you on COD? What impact might that have on your business?

Bankers have a healthy skepticism of small business. They want your business but they have been burned in the past by others. They know that a very high percentage of small businesses fail. What's that? Who's trying to sell his business? Might the bank decide not to renew your line of credit? Call your note(s)?

Customers may lose confidence and decide to trade elsewhere. Where are you without your customers?

IN SUMMARY, SELL IT BUT DON'T LET ANYONE KNOW IT'S FOR SALE. WHAT ELSE MUST BE SOLD UNDER THAT CONDITION?

(2) Business owners do not know what the business is worth

Essentially every business person we have worked for has confided that they really did not know what their business was worth. They admitted that although they didn't know what the business was worth, they knew what they wanted for it."

WHAT SELLER OF ANY OTHER PRODUCT DOESN'T KNOW THE PRODUCT'S WORTH?

(3) Buyers don't know what they want to buy

An overwhelming majority of buyers come to us and profess to be in search of either a light manufacturing opportunity or perhaps a distribution company. This is code for "I really don't know what I want to buy but I'd feel silly telling you that." Later, virtually all admit they really didn't know what they wanted. The odds of a person buying the business that attracted them to our offices are 1 in 500! The odds of buying a company within the industry for which they initially stated a preference, 1 in 50!

We reviewed thirty five Dry Cleaning Plant sales to determine how many were sold to persons who had responded to an advertisement for a dry cleaner. We were not surprised to find only one. The other thirty four had come to us in search of something else.

WHAT ELSE HAS TO BE SOLD TO SOMEONE WHO DOESN'T KNOW THEY WANT TO BUY IT?

(4) The major selling point is intentionally concealed

A business owner's desire to minimize taxes overrides the desire to show bottom line profits. You have to look between the lines in order to determine the real earnings of a private company.

CAN YOU THINK OF ANY OTHER SITUATION WHERE A SELLER INTENTIONALLY CONCEALS A MAJOR REASON TO PURCHASE?

(5) Everyone, yet no one, knows the value

Ask twelve buyers what a business is worth and you will get at least twelve answers. One of the twelve will offer more than the rest. Why? More on this later. Buyers, as with sellers, don't really know what a business is worth. Unlike virtually every other commodity sold, there is no public record of sale prices for private business. As a result, we have seen more than three hundred different valuation methods used by buyers, sellers and advisors to estimate a business's value.

WHAT ELSE HAS TO BE SOLD UNDER CONDITIONS WHERE NOBODY KNOWS THE REAL VALUE BUT EVERYONE HAS AN OPINION?

(6) Future value of the purchase is dependent upon who buys it

You own a business and a home. So do I. We both have profitable businesses and nice homes. Let's swap homes and businesses just for the change and variety.

It's now a year later. The value of our homes is basically the same. What about our businesses? Might one of us be in trouble, perhaps both of us? What do I know about your business? What do you know of mine?

A business is a vehicle. How fast and far it has been driven is of interest but does not predict how a new driver might fare. Will a new operator drive the business to new heights, or drive it into the ground?

WHAT ELSE IS SOLD WHERE THE FUTURE VALUE OF THE PURCHASE IS SO DEPENDENT UPON WHO BUYS IT?

(7) Third parties refuse to ratify the wisdom of the purchase

We can buy virtually anything and a third party will participate in the purchase by providing the financing. This participation essentially ratifies the wisdom of our purchase. An excellent example is the purchase of real estate. The bank appraises the property, ratifies we are not paying too much and gives us a mortgage.

Business equipment and inventories are not favorite collateral with bankers. What percentage of the asset value would they lend anyway? Which asset value would they use? Liquidation Value, Book Value, Replacement Value, Value in Place, Net Book Value - and what equity or loan to value percentage would they apply - 60%, 50%, 40%? What part of a business' value is attributable to the value of assets? Usually less than half. How much will your banker lend you on your business' assets today?

WHAT OTHER MAJOR PURCHASE CAN YOU MAKE WHERE THIRD PARTIES HAVE NO STANDARDIZED METHODOLOGY ON WHICH TO FINANCE IT?

(8) Conflict between personal desires and financial considerations

Financial considerations are important but do not drive the decision to sell. Business owners sell their businesses to gain a life-style change. They want to sell in order that they and their business can each move on to different levels. The decision is a combination of personal and financial considerations. Nothing a business owner will ever sell will have the personal attachment the business represents. Only you, the business owner, are capable of making the decision.

Buying a business is a personal and life-style decision also, not purely a financial one. Buyers are seeking independence, freedom to express themselves and their ideas, the ability to take control and not have to put up with "corporate group think" any longer. Obviously, the financial aspects of a purchase are important but financial considerations do not drive the decision to purchase. Nothing will have as great an impact on a buyer's way of life than buying a business. Only the buyer is capable of making the decision.

Both buyer and seller have to balance the imagined personal gain against uncertain financial prospects. A business opportunity, not a business guarantee, is involved.

WHAT OTHER PURCHASE OR SALE CAN YOU IMAGINE THAT INVOLVES SUCH A HIGH DEGREE OF PERSONAL INVOLVEMENT AND FINANCIAL UNCERTAINTY?

(9) Too many customers

Those who sell businesses are inundated with buyers. It seems everyone is either professing to be a buyer or knows one. Buyers are everywhere. Finding the right buyer is another story. It's always a seller's market for viable businesses. A down economy intensifies this as usually layoffs from down-sizing bring more than the usual number of buyers into the market.

CAN YOU THINK OF ANY OTHER BUSINESS WHERE PEOPLE COMPLAIN OF TOO MANY CUSTOMERS?

(10) Extremely emotional atmosphere

A business is to its owner as a child is to its parents. Your business is an extension and a reflection of you. It's your baby and you do not have to sell. You have sacrificed yourself, your family life. There have been times when you didn't take anything out, rather you put everything back into the business. All those long hours, your hopes, your dreams. . . now you are thinking of selling? Put the business up for adoption?

WHAT ELSE IS BOUGHT AND SOLD IN SUCH AN EMOTIONALLY CHARGED ATMOSPHERE?

Summary

The environment in which a business must be sold is unique. Therefore the methods used to sell a business should be unique also. Although the sale of a business is different than the sale of essentially anything else, what occurs is straightforward. It all makes perfectly good sense and is quite logical once you understand the uniqueness of what is occurring.

For an understanding of the process, assume your business is a public company. Before attempting to attract a suitor your board of directors would first engage an investment banker to identify appropriate acquisition candidates (buyers) and determine the company's worth. The investment bankers would provide the board with information as to the best acquirers and what values or strategic advantage might be achieved through a sale or merger of the firm. The board of directors would then decide if a sale or merger of the company was in the best interest of the stockholders.

Assuming the decision to sell was ratified, the investment bankers would then package your company for presentation to the most attractive and appropriate acquiror(s).

Essentially the same process should be used by small business owners considering a sale. Identify the characteristics of your ideal buyer. Determine what makes your company of value, to whom and for how much. Then decide to sell the company or take other actions that might be deemed more appropriate, such as make the company more attractive and valuable or perhaps consider some alternative to selling.

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This article is excerpted from "In & Out of Business . . . Happily," by Theodore P. Burbank.

How Can I Increase the Value of My Business Without Incurring Costs?

This is a common question from business owners who are thinking about selling. While there are many ways to increase business value without incurring costs, the following quote sums it up in a nutshell. It is relevant to any business and will spark the thought process for a DIY project.

"Every business has something that drains resources without delivering value back. This is dead weight the business is fighting against to stay afloat. Dead weight could be the rock star sales rep of three years ago that now spends more time on Farmville than rainmaking. It could be a product that never launched but is held onto for sentimental value. It could be an expensive vendor that no one takes the time to replace. The dead weight that's the hardest to recognize and drop, though, is a philosophy that no longer matches the reality of the business or its customers." -- Charlie Gilkey

A Business For Sale is More Valuable When the Owner is Replaceable

Most potential buyers would be averse to purchasing a business if the owner's shoes are too big to fill or if the owner's hand would be too difficult to unravel from the operation. When preparing to sell or build value in a business, the owner should not be so involved in the business that it would be difficult for would-be buyers to see the business as being productive under new ownership. Buyers want the owner to be replaceable.

A business is more valuable when perceived risk is low. A business is less risky when it is making money without its owner's involvement in daily operations. Three things about value:

• Value is dependent on risk
• Value is not about what the business is worth in the current owner's hands, but in someone else's.
• The more dependent the business is on its owner, the higher its risk, and the lower its value.

Therefore, to achieve a higher value, it is important to have systems running the business and an experienced staff running those systems. An enterprise with infrastructure guiding its revenue-generating capacity is much more appealing than one with a singular person holding the key to the revenue engine. The owner should be free to work "On" the business instead of "In" the business.

Systems and Procedures

Documentation of standard policies, employee records, systems, procedures and controls demonstrate that the business can be maintained profitably after the sale. Business systems include the computerized and manual procedures used in the business to generate its revenue and control expenses. It outlines the methods used to track how customers are identified and how products or services are delivered. The following are examples of business systems that enhance business value.

• Personnel recruitment, training and retention
• Human resource management (an employee manual)
• New customer identification, solicitation, and acquisition
• Product or service development and improvement
• Inventory and fixed asset control
• Product or service quality control
• Customer, vendor and employee communication
• Selection and maintenance of vendor relationships
• Business performance reports for management

Staff 

Buyers count on taking over a business with an in-place staff that can provide continuity and assist in the growth of the business. If a company’s success is reliant on capable, well-trained employees – not the owner – it means the business will not be negatively impacted under new ownership.

This is an excerpt from one of our business listings currently on the market that is a prime example of the replaceable owner.

"This well-reputed firm has long-term expert personnel, technicians, an office manager, and a bookkeeper that run daily office operations leaving an energetic new owner free to market, network, and build additional recurring revenue streams onto what has already been established in this fine enterprise."

How Long Does it Take to Sell a Business?

How long does it take to sell a business?

The average time on the market for around 82% of businesses is four to 12 months. Fewer than 10% of businesses sell more quickly, and a little over 8% are on the market for more than 12 months.

Why does it take so long to sell a business?

Price and terms are the biggest reasons. Not overpricing the business, partial owner financing, and an owner training period are factors that are attractive to prospective buyers and can lead to a more timely sale. Preparation for the information a buyer may want to review, and having answers to the questions they will ask is key to a making the process more efficient and timely. Using advisors who are transaction-experienced can also shorten the time it takes to close the sale.

These are some documents that a seller would want to gather and have available.

• Copies of  financials statements for the past three years.
• A list of furniture, fixtures and equipment included in the sale. Note: try to remove excluded items prior to the sale, or list items excluded from the deal separately.
• Copies of tax returns for the past three years.
• Sales brochures, press releases, advertisements, menus or other sales materials
• A copy of the lease and any assignments of the lease from previous sales
• A copy of the franchise agreement (if applicable) or any agreements with suppliers or vendors.
• Supporting documents for patents, copyrights, trademarks, etc.
• Customer List broken down by percentage of revenues (if applicable)
• Vendor and/or supplier lists broken down by expenditure percentage
• Accounts receivable aging report and payables ledger
• Employee list
• Growth Plan

These are Typical Buyer Questions That a Seller Should be Prepared to Address

• Is the seller willing to train a new owner at no charge?
• Is there any pending litigation?
• Are there any federal, state, or environmental issues of concern?
• Are there any copyrights, secret recipes, mailing lists, etc?
• Customer levels and concentration of customers?
• Are there any zoning or local restrictions that would impact the business?
• Are any license or permit issues involved?
• What about the employee situation? Are there key employees?
• What about major suppliers or vendors?
• What can be done to grow the business?

How are Payables and Receivables Handled When Selling or Buying a Business?

While all transactions are as unique as the parties involved, in most small business sale transactions the seller keeps the cash and outstanding receivables. They pay off the bills and any other outstanding payables and deliver the business free and clear of debt to the buyer.

In somewhat larger business sale transactions, there are many reasons why buyers consider acquiring the receivables.

• Purchasing the accounts receivable offers the buyer the advantages of having control over the collection of the receivables and continued cash flow from the business, thereby removing the need to acquire additional working capital.
• By acquiring the receivables the buyer immediately begins dealing directly with the most important element of the business - its customers.
• The sale of the accounts receivable also offers the seller a clean break from the business and the ability to cash out. This approach leaves no open-ended accounting issues after closing.
• Valuing the receivables depends on the future risk and resources necessary to collect the outstanding receivables. Therefore, the aging report of the accounts receivable would ordinarily be reviewed for history of late paying or uncollectible accounts so both buyer and seller could come to agreement on what should be paid for the outstanding receivables by the buyer.

Payables incurred prior to the transaction date is sometimes negotiated to suit the circumstances of the particular transaction, whereby the responsibility for the payables is sometimes considered by a buyer.

• By assuming the responsibility for the payables, the buyer immediately begins forming their own relationship with another key element of the company -- the suppliers, vendors, and other service providers. It puts the new owner in control of dealing with these important contacts instead of the former owner.
• The purchase price paid to the owner is reduced by the amount of accounts payable that is being assumed by the buyer. Then the buyer, as the new owner, pays the invoices as they become due. Not only would the new owner keep more money at closing -- the new owner gets a time period of 30 to 60 days of, essentially, interest-free financing for the payables.
• Capital to cover the payables as they come due would most likely be available as the receivables start rolling in and are deposited.
• An accounts payable ledger would be a tool in helping buyer and seller determine the reduction in price paid at closing by the buyer for assuming the responsibility of paying the outstanding invoices.

The Non-Compete Agreement - A Negotiated Contract in a Business Sale Transaction

Non-compete agreements are typically included as part of the terms of a business sale transaction to protect the buyer from direct or indirect competition from the seller. A buyer would not want to purchase a business if the seller could relocate down the street. For this reason, buyers usually require that this threat be eliminated.

There are two main issues about which buyers and sellers should be aware. First, a non-compete agreement has limitations on time, industry, and geographic range of competition if it is to be enforceable, and, second, there are tax implications for both the buyer and the seller.

Limitations of Non-Compete Agreements

The terms of the non-compete should not be too broad or overly burdensome on the seller. Restrictions such as scope, time, and range of competition are generally only enforceable to the extent that they are reasonable.

Among the issues usually outlined in a non-compete agreement between buyer and seller are:

• specific payment being made for a seller’s agreement not to compete
• specific time period of non-compete (3 to 5 years)
• specific geographic area
• specific industry sector 

A non-compete agreement will typically state that for a specified payment, which could be part of the sale price, the seller will promise not to go into a similar type of business, within a certain geographic area for a specified period of time. The agreement may also prohibit the seller from using confidential trade secrets or business processes that are being transferred to the buyer.

Again, keep in mind that a non-compete agreement will typically only be enforceable if it is reasonable in scope and duration. Therefore, a non-compete should only restrict the seller from working or being affiliated with a business that is similar or in the same industry as the one that is being sold. The restriction is usually limited to the same geographic area from which the customers of the business are sourced and apply for a reasonable period of time. What is reasonable will depend on the specifics of the industry, the business, and region. Standards for evaluating the reasonableness of a non-compete agreement may differ by State.

Tax Implications

Also at issue with non-compete agreements is taxation. A non-compete could have significant implications for both the seller and the buyer in a business sale transaction. Non-compete agreements are generally taxed as ordinary income to the seller, which from the seller's perspective is less than desirable. But, for a buyer, it is expensed as incurred, which is desirable for the buyer but not the seller. But in some instances, the seller may be able to achieve the preferred capital-gain taxation rate by incorporating the non-compete payments into the general goodwill of the business or a portion of the payment as personal goodwill. In these instances, the buyer would be prohibited from expensing these payments as incurred, as would be preferred, but instead amortizing them as goodwill payments.

Because of these issues, how the non-compete is structured becomes a negotiating point between buyer and seller. The buyer and seller must decide what portion of the purchase price is to be allocated to the covenant not to compete on IRS Section 1060 Form 8594, Asset Acquisition Statement.

In an asset sale transaction, assets treated as capital gains are taxed at a significantly lower rate than those treated as ordinary income. However, gains on certain intangible assets, such as a non-compete agreement, are not generally eligible for capital gains treatment. Therefore, when allocating the purchase price to the various assets of the business, the parties should keep in mind that the allocation of the purchase price attributed to the covenant not to compete could significantly lower the after-tax amount that the seller will make from the sale.

It is prudent and recommended that both parties consult a tax professional and/or an attorney to assist in defining the terms of the purchase. However, it is important that those professionals be familiar with business transfer transactions.

How Much Cash is Required to Buy a Business?

This is one of the most frequent questions we get from those who want to buy a business. Not all ask that question, however, but should.

Since most people only buy a business once in their lifetime, they do not know how much it would take to acquire a business that would fulfill their dreams.

So, how much liquid funds do you need to put a down-payment on a business and how much do you need to close on the deal?

These are the two cash requirements to think about when you start shopping for a business.

Down Payment

The amount of down payment needed to purchase a small business varies with each sale depending on the amount of tangible assets included, amount of inventory, and the buyer's financial situation. Banks are looking for hard assets to collateralize the loan, whether it be from the business or from the buyer.

As a rule, buying a business is very down-payment driven as bank financing on the cash flow of a business is a challenge in today's market. In some instances, a seller may be offering financing to a qualified buyer. Owner financing can range from 10% to 40%, depending on their own personal circumstances.

A short answer to this question is this. Businesses vary a great deal in price. The higher the amount of down payment you have, the more likely you will be able to find a business that meets your needs. It is rare that one could buy a business with much less of a down payment than $75,000.

Closing the Deal

In addition to the cash you will pay the seller for the business, there will be a host of additional demands for cash. These issues should be taken into consideration when assessing your financial capacity. Not only will this help determine the price range of businesses to target as realistic acquisition candidates, it will also help one start out on a sound financial footing.

This list is a general list of closing items and is not meant to be all-inclusive and not all may apply.

Closing costs & escrow fees
Legal filings & recording fees
Attorney's fees
Accountant's fees
Appraisal fees
Inventory counting service fees
Sales tax on equipment purchased
Vehicle registration & licensing fees
City, County, & State Business licenses & permits
Franchise license agreement transfer fee
Franchise training fee
Travel expenses associated with franchisor training
Maintenance expenses
Correction of code violation(s)
Landlord lease deposit
Utility deposit(s)
Property liability premiums
Workers compensation insurance premiums
Operating cash / working capital
Cash to fund credit sales

Would a One-Time Advertising Event be Considered an Addback When Valuing My Business?

Recapturing Profits

This question was asked by a business owner who is considering the sale of her business. An addback is an expense that is not a normal one for the business and is, therefore, taken out of the equation when performing a valuation and calculating a company's earning power.

The goal when presenting financial information to a potential buyer is to clearly represent the business earnings. This is done by Recasting the financial information into a spreadsheet that we call a "Normalized Income Statement," a reconstructed representation of the company's performance and the owner's "Discretionary Earnings" across several years.
 
The IBBA (International Business Brokers Association) defines Discretionary Earnings as follows:

"The earnings of a business enterprise prior to the following items: Income taxes, Non-operating income and expenses, Non-recurring income and expenses, Depreciation and amortization, Interest expense or income, Owner's total compensation for those services which could be provided by a sole owner/manager." 

This owner's question, by definition above, clearly qualifies as a non-recurring expense.

Question:
I did a radio spot last year that did not produce results. Would this expense be considered as a possible addback when valuing my business?

Answer:
The short answer to your specific question is yes. A marketing or advertising effort that was a one-time event that did not produce corresponding revenue can be considered as an addback since a new owner would not incur the one-time expense.

Let's consider the same one-time radio ad at a cost of $50K, resulting in one job for $10K and you will not be doing radio again. In this situation, one might make the case for adding back $40K, which is your cost for the ad, less the revenue brought in from the ad..

Most situations are not cut and dried. Every circumstance has its nuances and each would be evaluated based on its particular merits. All addbacks must be reasonably supported because buyers...and lenders...will be looking closely and judging the legitimacy of each.

Read more about addbacks in the valuation process in "Recasting Financials."

Understanding Seller Financing in a Business Sale

It has traditionally been a common practice for the sale of a privately-held small business to include some seller financing as part of the deal structure. Because of the tight credit market and lender efforts to reduce their own risks, that practice has become even more common and may be the key to getting the deal done.

Seller financing can accomplish several goals beneficial to both parties. From a buyer's perspective, most buyers feel there is a risk that the success of a small business is tied to the involvement of the owners. By having the seller finance a part of the purchase price, it can give the buyer confidence in the fact that the sellers believe that the business can thrive without them. From the seller's perspective, seller financing can help a buyer pay more for the business than if the deal were financed only through traditional financing sources.

With that in mind, it is important to remember that the purchase/sale of a business is a two-way street. Just as a buyer will conduct due diligence to determine the viability of the business, become comfortable with its financial and legal matters, and assess the opportunities for growth, a seller should be comfortable with the buyer as well, particularly if the offer includes a loan by the seller. The seller should understand the buyer's business background and qualifications, motivation for buying the business, and financial capacity to purchase and sustain the business.

Business owners who extend financing to a buyer for the purchase of their business often ask, "What happens if the purchaser defaults on the loan?" Should that happen, the seller would be able to exercise whatever rights are defined in the security agreement that is associated with the promissory note. The seller would usually have the right to get the business back, which may not always be the best scenario if the business has declined and is not performing well. In addition, if the buyer is using the business' assets to get a bank loan, the seller will have to take a second position behind the bank. A seller should try to negotiate a personal guarantee by the buyer as part of the terms of the promissory note. The seller can also require the new owner to provide periodic financial reports on the performance of the business as part of the terms of the promissory note.

While it is important for a seller to protect themselves should a default occur, keep in mind that seller financing is often required for a reason, such as lack of bank financing, risks in the business, or to bridge a value gap. In other words, seller financing may be required in order to get the deal done.

Regarding the interest rate to be paid for the seller note, if the seller note is in conjuction with a bank note, it is hard to substantiate a rate much higher than the bank since a buyer is generally utilizing seller financing as a "bridge" mechanism to help the seller attain his or her price.

In the course of due diligence on the buyer, it is acceptable to ask for their credit record, particularly if the buyer is an individual. Personal credit records are available through several outside services, as long as written authorization is given by the individual being checked out. There are standardized forms that can be used whereby the buyer grants permission for the seller to obtain credit reports from specific consumer reporting agencies. Many of these credit companies can be queried via the Internet, such as Equifax, Experian, and TransUnion. If a fee is charged to obtain the reports, the buyer can be asked to cover it. The seller may also ask the buyer for a list of financial and business references.

Seller financing can accomplish the goals of, and be beneficial to, both parties as long as each feels confidence in the other.