© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. CHAPTER 6 Taking Over an Existing Business

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 2 Learning Objectives Compare the advantages and disadvantages of buying an existing business Propose ways of locating a suitable business for sale Explain how to measure the condition of a business and determine why it might be offered for sale Differentiate between tangible and intangible assets, and assess the value of each

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 3 Learning Objectives Calculate the price to pay for a business Understand factors that are important when finalizing the purchase of a business Describe what makes a family business different from other types of business

6| 4 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. LO Compare the advantage and disadvantages of buying an existing business

6| 5 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Business Buyout Alternative Buy an existing business Acquire a franchised business Getting into Business Start a new business

6| 6 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Table Advantages and Disadvantages of Buying a Business

6| 7 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. LO Propose ways of locating a suitable business for sale

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 8 Sources of Locating a Business for Sale Current employer Newspaper advertising Friends and family Bankers, lawyers, and accountants SBA representatives

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 9 Sources of Locating a Business for Sale Real estate brokers Trade associations Approach a business owner Business brokers Online sources

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 10 Business Brokers Bring sellers of their businesses together with potential buyers Inspect and appraise a business establishment offered for sale before listing and advertising it Assist a buyer in financing the purchase Attempt to find a business that matches the talents

6| 11 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. LO Explain how to measure the condition of a business and determine why it might be offered for sale

6| 12 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Analyzing the Value of a Business Evaluate past performance Objectivity Requirements Predict probable future developments

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 13 Things to be Considered about a Business Before Buying HistoryInventoryTax returns for the past five yearsFinancial statements for the past five yearsSales recordsContracts and legal documentsList of liabilities, accounts receivable, and accounts payable

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 14 Things to be Considered about a Business Before Buying Sales taxesFurniture, fixtures, and equipmentMarketing and suppliersOrganizational chart of current employeesIndustry and market region trendsKey tiesSeller’s plansBuy or build

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 15 Due Diligence Fact finding to determine the total condition of a business being considered for purchase Comprises an investigation and a review of a business Initiates by addressing the overall financial health of the company

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 16 Due Diligence Trends occurring with revenues, expenses, and profit margins Identifying if products become obsolete in the future Overall Financial Health Financial statements and owner’s tax returns Existing or pending litigation or liens against the business or owners Past or current complaints at Better Business Bureau Facts to Review

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 17 Buying Out an Existing Business General Considerations Talk to the firm’s banker to verify account balances with major customers and creditors Get verbal understanding in writing from the seller Put money in escrow with trusted third party Have all papers checked by an accountant and attorney before the purchase agreement is signed Comply with UCC bulk sales provisions by issuing notices to creditors that the business is changing ownership

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 18 Reasons Behind Selling a Business Understand that the owners may not be honest about the negative prospects of the firm Discuss with the firm’s customers and suppliers Analyze the market, judge the competitive situation, and estimate the profit potential Consider and compare with list of other alternatives available for investment Check with city planners about proposed changes that would affect the viability of the business Guidelines for Prospective buyers

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 19 Financial Condition Inspect bank deposits Examine owners’ tax returns and compare them with financial statements of the firm Ascertain that all back taxes have been paid Request an independent audit to identify the condition of financial statements Compare bills and receipts with sales tax receipts Reconcile past purchases with the sales and markup claimed Consider the price at which similar businesses were sold Analysis Needed to be Conducted by the Purchaser

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 20 Indicators of a Business’s Financial Health Independent audit Identifies the condition of financial statements Gives information about legitimacy of business’s accounting practices Checks if business’s valuation of inventory, equipment, and real estate are realistic Profit trend Coveys if the sales volume is increasing or decreasing

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 21 Indicators of a Business’s Financial Health Expense ratios Calculated by trade associations Involves comparing expenses to sales Factors to be considered as other measures in financial health examination Profit ratios - Indicators of a business’s worth Working capital and the cash flow of the business Relationship between the firm’s fixed assets and the owner’s tangible net worth Firm’s debt load

6| 22 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. LO Differentiate between tangible and intangible assets, and assess the value of each

6| 23 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Buying an Existing Business Assets and earnings Factors that make the business unique Sources of Value of a Business Cash flows

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 24 Tangible Assets Owned by a business that can be seen and examined Purchaser needs to determine number of accounts that are collectible and discount them, if firm is selling its accounts receivable Aging accounts receivable - Not collecting the receivables that are 120 days or older

6| 25 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Tangible Assets Inventory Buildings Equipment Forms

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 26 Intangible Assets Assets that have value to a business but are not visible Goodwill: Allows businesses to earn a higher return

6| 27 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Intangible Assets GoodwillPatents, copyrights, and trademarks Forms Leases and other contracts

6| 28 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Figure What Should You Pay?

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 29 Other Issues in Purchasing a Business Personnel People working need to be regarded as equally important as profits and production Retention of certain key people facilitates the success of a business Seller’s personal plans Risks are reduced by writing protective clauses into contracts of sale Noncompete clause: Restricts the seller from entering the same type of business within a specified area for a certain amount of time

6| 30 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. LO Calculate the price to pay for a business

6| 31 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Determination of Purchase Price for a Business Tangible assets Market demand Intangible assets Valuation Factors Expected future earnings General condition of business

6| 32 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Methods of Business Valuation Based on a formula that applies a weighting factor to the owner- benefit figure of the previous year Factors in owner benefit Pretax Profit + Owner's Salary + Additional Owner Perks + Interest + Depreciation Multiple method Determines the value of a business based on the worth of it assets Balance sheet Determines the value of a business based on its profit potential Income statement

6| 33 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Determining Value of Tangible Assets Book value Liquidation value Factors Used Replacement value

6| 34 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Determining Value of Physical Assets Adjusted inventory Market value of buildings and property Depreciated equipment Elements Supplies Adjusted accounts receivable

6| 35 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Determining Value of Goodwill Income-statement method of valuation Establishing capitalization rate Methods Used

6| 36 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Table Calculating the Purchase Price of an Existing Business

6| 37 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. LO Understand factors that are important when finalizing the purchase of a business

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 38 Buying the Business Terms of sale Lump sum payment Payment in installments Thinning assets - Seller adjusts the assets to be manageable for the new owner by: Separating real estate ownership from business Leasing equipment and/or fixtures in the same manner as real estate Selling off excess inventory prior to purchase Factoring accounts receivable

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 39 Buying the Business Closing the deal Settlement attorney - Acts as a neutral party to draw up the necessary documents and represents the buyer and the seller Escrow settlement Buyer deposits the money, and the seller provides the bill of sale and other documents to an escrow agent Agent holds the funds and documents until proof is shown satisfying the conditions of sale

6| 40 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. LO Describe what makes a family business different from other types of business

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 41 Taking Over a Family Business Two or more members of the same family control, are involved in, and own majority of the business Family Businesses Complex interrelationships of family members interacting with one another and interacting with the business Intricate succession planning needed Differentiating Factors

6| 42 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Figure Family Business Perspectives

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 43 Difficulties in Planning Succession Reluctance to address mortality by senior family members Lack of confidence in the next generation’s commitment to the business and its success Fear in transferring control because of concern for personal long-term financial security Seniors being personally tied to the business and lacking outside interests to be attracted to retirement

6| 44 © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Figure Succession Model of Family Business

© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6| 45 Family Business Family members need to meet the same criteria and performance review standards as nonfamily employees Family members should be supervised by nonfamily employees Family members are only eligible for temporary employment, if they are under the age of 30 years No family member is allowed stay in an entry- level position permanently All positions are compensated at fair market value Family members seeking permanent employment must have a minimum of five years experience outside the company Policies