Buying an Exciting Business

How to Buy a Business Do not rush into a deal. Do not rush into a deal. Analyze your skills, abilities, and interests. Analyze your skills, abilities, and interests. Develop a list of criteria. Develop a list of criteria. Prepare a list of potential candidates (Remember the “hidden market”). Prepare a list of potential candidates (Remember the “hidden market”).

How to Buy a Business Is the right type of business in a market which you want to operate? Is the right type of business in a market which you want to operate? How critical to your ultimate success is experience in the business? How critical to your ultimate success is experience in the business? Will the company generate sufficient cash to pay for it self? Will the company generate sufficient cash to pay for it self?

How to Buy a Business Will the company leave you with a suitable rate of return on your investment? Will the company leave you with a suitable rate of return on your investment? Should you be starting a business and building it from the ground up rather than buying an existing one? Should you be starting a business and building it from the ground up rather than buying an existing one?

How to Buy a Business Investigate and evaluate candidate, businesses and select the best one. Investigate and evaluate candidate, businesses and select the best one. What experience do you have in that particular business? What experience do you have in that particular business? What is the company’s potential for success? What is the company’s potential for success? Negotiate the deal. Negotiate the deal.

How to Buy a Business What changes will you have to make? What changes will you have to make? Explore financing options. Explore financing options. What price and payment method are reasonable for you? What price and payment method are reasonable for you? Ensure a smooth transition. Ensure a smooth transition.

Some Critical Areas for Analyzing an Existing Business  Why does the owner want to sell.... the real reason?  What is the physical condition of the business?  What is the potential for the company's products or services?

Some Critical Areas for Analyzing an Existing Business Customer characteristics and composition. Customer characteristics and composition. Competitor analysis. Competitor analysis. What legal aspects must I consider? What legal aspects must I consider?

Some Advantages for Buying a Business Business may continue to be successful. Business may continue to be successful. Can use experience of previous owner. Can use experience of previous owner. “Hit the ground running”. “Hit the ground running”. Business may have best location. Business may have best location. Employees and suppliers are in place. Employees and suppliers are in place.

Some Advantages for Buying a Business Equipment is installed. Equipment is installed. Inventory is in place and trade credit exists. Inventory is in place and trade credit exists. Easier time finding financing. Easier time finding financing. It’s a bargain. It’s a bargain.

Some Disadvantages for Buying a Business It’s a loser. It’s a loser. Possible “ill will” from previous owner. Possible “ill will” from previous owner. Employees may not be suitable. Employees may not be suitable. Location may be unsatisfactory. Location may be unsatisfactory. Equipment may be obsolete. Equipment may be obsolete.

Some Disadvantages for Buying a Business Change and innovation can be difficult. Change and innovation can be difficult. Inventory may be obsolete. Inventory may be obsolete. Accounts receivable may be worth less than face value. Accounts receivable may be worth less than face value.

Some Disadvantages for Buying a Business Change and innovation can be difficult. Change and innovation can be difficult. Inventory may be obsolete. Inventory may be obsolete. Accounts receivable may be worth less than face value. Accounts receivable may be worth less than face value. Business may be overpriced. Business may be overpriced.

Valuing Accounts Receivable Age of Accounts (days) Amount Probability of Collection Value Total $40,000 $25,000 $14,000 $10,000 $7,000 $5,000 $101, $38,000 $22,000 $9,800 $4,000 $1,750 $500 $76,050

The Legal Aspects of Buying a Business Lien - creditors’ claims against an asset. Lien - creditors’ claims against an asset. Bulk transfer - protects business buyer from the claims unpaid creditors might have against a company’s assets. Bulk transfer - protects business buyer from the claims unpaid creditors might have against a company’s assets.

The Legal Aspects of Buying a Business Restrictive covenant - contract in which a business seller agrees not to compete with the buyer within a specific time and geographic area. Restrictive covenant - contract in which a business seller agrees not to compete with the buyer within a specific time and geographic area. Ongoing legal liabilities - physical premises, product liability, and labor relations. Ongoing legal liabilities - physical premises, product liability, and labor relations.

Bulk Transfer Seller must give the buyer a sworn list of creditors. Seller must give the buyer a sworn list of creditors. Buyer and seller must prepare a list of the property included in the sale. Buyer and seller must prepare a list of the property included in the sale. Buyer must keep the list of creditors and property for six months. Buyer must keep the list of creditors and property for six months.

Bulk Transfer Buyer must give notice of the sale to each creditor at least ten days before he takes possession of the goods or pays for them (whichever is first). Buyer must give notice of the sale to each creditor at least ten days before he takes possession of the goods or pays for them (whichever is first).

Determining the Value of a Business Balance Sheet Technique. Balance Sheet Technique. Variation: Adjusted Balance Sheet Technique. Variation: Adjusted Balance Sheet Technique. Earnings Approach Earnings Approach Variation 1: Excess Earnings Approach Variation 2: Capitalized Earnings Approach Variation 3: Discounted Future Earnings Approach Market Approach. Market Approach.

Balance Sheet Techniques “ Book Value” of Net Worth = Total Assets - Total Liabilities = $266,091 - $114,325 = $266,091 - $114,325 = $151,766 = $151,766 Variation: Adjusted Balance Sheet Technique: Adjusted Net Worth = $274,638 - $114,325 Adjusted Net Worth = $274,638 - $114,325 = $160,313 = $160,313

Earnings Approaches Variation 1: Excess Earnings Method Variation 1: Excess Earnings Method Step 1: Compute adjusted tangible net worth: Step 1: Compute adjusted tangible net worth: Adjusted Net Worth = $274,638- $114,325 Adjusted Net Worth = $274,638- $114,325 = $ 160,313 = $ 160,313 Step 2: Calculate opportunity costs of investing: Investment - $160,313 X 25% = $40,078 Investment - $160,313 X 25% = $40,078 Salary = $25,000 Salary = $25,000 Total = $65,078 Total = $65,078

Earnings Approaches Step 3: Project earnings for next year: Step 3: Project earnings for next year: $74,000 $74,000 Step 4: Compute extra earning powerStep 4: Compute extra earning power (EEP) = Project Net Earnings – Total Opp. Cost (EEP) = Project Net Earnings – Total Opp. Cost = $ 74,000 - $ 65,078 = $ 74,000 - $ 65,078 = $ 8,922 = $ 8,922

Earnings Approaches Step 5: Estimate the value of the intangibles ("goodwill"): Step 5: Estimate the value of the intangibles ("goodwill"): Intangibles = Extra Earning Power x "Years of Profit" Figure* Intangibles = Extra Earning Power x "Years of Profit" Figure* = 8,922 x 3 = $26,766 = 8,922 x 3 = $26,766 * Years of Profit Figure ranges from 1 to 7; for a normal risk business, it is 3 or 4.

Earnings Approaches Step 6: Determine the value of the business:Step 6: Determine the value of the business: Value = Tangible Net Worth + Value of Value = Tangible Net Worth + Value of Intangibles Intangibles = $160, ,766 = $187,079 = $160, ,766 = $187,079 Estimated Value of the business = $187,079

Capitalized Earnings Method Variation 2: Capitalized Earnings Method: Variation 2: Capitalized Earnings Method: Value= Net Earnings (After Deducting Owner's Salary) Value= Net Earnings (After Deducting Owner's Salary) Rate of Return* Rate of Return* * Rate of return reflects what could be earned on a * Rate of return reflects what could be earned on a similar-risk investment. similar-risk investment. Value = $74,000 - $25,000 = $196,000 Value = $74,000 - $25,000 = $196,000 25% 25%

Discounted Future Earnings Method Variation 3: Discounted Future Earnings Method: Variation 3: Discounted Future Earnings Method: Step 1: Project earnings five years into the future: Step 1: Project earnings five years into the future: 3 Forecasts: Optimistic Pessimistic Most Likely Compute a weighted average of the earnings: Compute a weighted average of the earnings: Pessimistic + (4 x Most Likely) + Optimistic Pessimistic + (4 x Most Likely) + Optimistic 6

Discounted Future Earnings Method Step 1: Project earnings five years into the Step 1: Project earnings five years into the future: future: Year Pess ML Opt WeightedAverage Year Pess ML Opt WeightedAverage 1 $65,000 $74,000 $92,000 $75,500 1 $65,000 $74,000 $92,000 $75,500 2 $74,000 $90,000 $101,000 $89,167 2 $74,000 $90,000 $101,000 $89,167 3 $82,000 $100,000 $112,000 $99,000 3 $82,000 $100,000 $112,000 $99,000 4 $88,000 $109,000 $120,000 $107,333 4 $88,000 $109,000 $120,000 $107,333 5 $88,000 $115,000 $122,000 $111,667 5 $88,000 $115,000 $122,000 $111,667

Discounted Future Earnings Method Step 2: Discount weighted average of future earnings at the appropriate present value rate: Present Value Factor = 1 Present Value Factor = 1 (1+k) (1+k) where... where... k = Rate of return on a similar risk investment. k = Rate of return on a similar risk investment. t = Time period (Year - 1, 2, 3...n). t = Time period (Year - 1, 2, 3...n).

Discounted Future Earnings Method Step 2: Discount weighted average of future earnings at the appropriate present value rate: Year Weighted Average x PV Factor = Present Value 1 $75, $60,400 1 $75, $60,400 2 $89, $57,067 2 $89, $57,067 3 $99, $50,688 3 $99, $50,688 4 $107, $43,964 4 $107, $43,964 5 $111, $36,593 5 $111, $36,593 Total $248,712 Total $248,712

Discounted Future Earnings Method Step 3: Estimate the earnings stream beyond five years: Step 3: Estimate the earnings stream beyond five years: Weighted Average Weighted Average Earnings in Year 5 x 1 Earnings in Year 5 x 1 Rate of Return Rate of Return = $111,667 x 1 = $446,668 = $111,667 x 1 = $446,668 25% 25%

Step 4: Discount this estimate using the present value factor for year 6: Step 4: Discount this estimate using the present value factor for year 6: $446,668 x.2622 = $117,116 $446,668 x.2622 = $117,116 Step 5: Compute the value of the business: Value = Discounted earnings + Discounted Value = Discounted earnings + Discounted in years 1 through 5 earnings in years 6 through ? in years 1 through 5 earnings in years 6 through ? = $248,712 + $117,116 = $365,828 = $248,712 + $117,116 = $365,828 Estimated Value of Business = $365,828 Discounted Future Earnings Method

Market Approach Step 1: Compute the average Price-Earnings (P-E) Ratio for as many similar businesses as possible: Step 1: Compute the average Price-Earnings (P-E) Ratio for as many similar businesses as possible: Company P-E Ratio Company P-E Ratio Average P-E Ratio= Average P-E Ratio= Step 2: Multiply the average P-E Ratio by next year's forecasted earnings: Step 2: Multiply the average P-E Ratio by next year's forecasted earnings: Estimated Value = x $74,000 = $294,150 Estimated Value = x $74,000 = $294,150

Exit Strategies Straight business sale Straight business sale Family limited partnership (FLP) Family limited partnership (FLP) Sell controlling interest Sell controlling interest Restructure the company Restructure the company Use a two-step sale Use a two-step sale Establish and employee stock ownership plan (ESOP) Establish and employee stock ownership plan (ESOP)

The Five Ps of Negotiating Preparation – Examine the needs of both parties and all of the relevant external factors affecting the negotiation before you sit down to talk.

Poise – Remain calm during the negotiation. Never raise your voice or lose your temper, even if the situation gets difficult or emotional. It’s better to walk away and calm down than to blow up and blow the deal.

Persuasiveness – Know what your most important positions are, articulate them, and offer support for your position.

Persistence – Don’t give in at the first sign of resistance to your position, especially if it is an issue that ranks high in your list of priorities.

Patience – Don’t be in such a hurry to close the deal that you end up giving up much of what you hoped to get. Impatience is a major weakness in a negotiation.

Conclusion The business is 'up and running' already. The business is 'up and running' already. It is likely to have an existing client base. It is likely to have an existing client base. The previous owners are likely to lend support and goodwill. The previous owners are likely to lend support and goodwill. There is a tried and tested business formula to emulate. There is a tried and tested business formula to emulate.

Conclusion Generally more chance of success than starting a similar business from scratch. Generally more chance of success than starting a similar business from scratch. A large amount of time and travel required to research the opportunities available. A large amount of time and travel required to research the opportunities available. May require relocating your self / family. May require relocating your self / family. By- By- Athar A Rizvi Athar A Rizvi Roll No Roll No