Buying an Exciting

8/8/2019 Buying an Exciting

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Buying an ExcitingBuying an Exciting

BusinessBusiness


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How to Buy a BusinessHow 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 ofcriteria.Develop a list ofcriteria. Prepare a list ofpotential candidatesPrepare a list ofpotential candidates

(Remember the hidden market).(Remember the hidden market).


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Is the right type ofbusiness in a marketIs the right type ofbusiness in a market

which you want tooperate?which you want tooperate?

How critical to your ultimate success isHow critical to your ultimate success isexperience in the business?experience in the business?

Will the company generate sufficient cashWill the company generate sufficient cash

topay for it self?topay for it self?


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Will the company leave you with a suitableWill the company leave you with a suitable

rate ofreturn on your investment?rate ofreturn on your investment?

Should you be starting a business andShould you be starting a business andbuilding it from the ground up rather thanbuilding it from the ground up rather than

buying an existing one?buying an existing one?


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Investigate and evaluate candidate,Investigate and evaluate candidate,

businesses and select the best one.businesses and select the best one.

What experience do you have in thatWhat experience do you have in thatparticular business?particular business?

What is the companys potential forWhat is the companys potential for

success?success?

Negotiate the deal.Negotiate the deal.


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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 areWhat price and payment method arereasonable for you?reasonable for you?

Ensure a smooth transition.Ensure a smooth transition.


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Some Critical Areas for Analyzing anSome Critical Areas for Analyzing an

Existing BusinessExisting Business

Why does the ownerwant to sell....Why does the ownerwant to sell....

thethe realrealreason?reason?

What is the physical condition of theWhat is the physical condition of thebusiness?business?

What is the potential for theWhat is the potential for the

company's products or services?company's products or services?


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SomeSome CriticalCriticalAreas for Analyzing anAreas for Analyzing an

Existing BusinessExisting Business

Customer characteristics andCustomer characteristics and

compositioncomposition..Competitor analysis.Competitor analysis.

What legal aspects must I consider?What legal aspects must I consider?


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SomeSome AdvantagesAdvantages for Buying afor Buying a

BusinessBusiness Business may continue to be successful.Business may continue to be successful.

Can use experience ofprevious owner.Can use experience ofprevious 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.


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SomeSome AdvantagesAdvantages for Buying afor Buying a

BusinessBusiness Equipment is installed.Equipment is installed.

Inventory is in place and trade creditInventory is in place and trade credit

exists.exists. Easier time finding financing.Easier time finding financing.

Its a bargain.Its a bargain.


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SomeSome DisadvantagesDisadvantages for Buyingfor Buying

a Businessa Business Its a loser.Its 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.


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a Businessa 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 lessAccounts receivable may be worth lessthan face value.than face value.


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a Businessa 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 lessAccounts receivable may be worth lessthan face value.than face value.

Business may be overpriced.Business may be overpriced.


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Valuing Accounts ReceivableValuing Accounts Receivable

Age ofAccounts

(days)Amount

ProbabilityofCollection Value

0-3031-6061-9091-120121-150

151+

Total

$40,000$25,000$14,000$10,000$7,000$5,000

$101,000

.95

.88

.70

.40

.25

.10

$38,000$22,000$9,800$4,000$1,750$500

$76,050


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The Legal Aspects ofThe Legal Aspects of

Buying a BusinessBuying a Business

LienLien -- creditors claims against an asset.creditors claims against an asset.

Bulk transferBulk transfer -- protects business buyerprotects business buyerfrom the claims unpaid creditors mightfrom the claims unpaid creditors might

have against a companys assets.have against a companys assets.


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The Legal Aspects ofThe Legal Aspects of

Buying a BusinessBuying a Business Restrictive covenantRestrictive covenant -- contract in which acontract in which a

business seller agrees not to compete withbusiness seller agrees not to compete with

the buyerwithin a specific time andthe buyerwithin a specific time andgeographic area.geographic area.

Ongoing legal liabilitiesOngoing legal liabilities -- physicalphysical

premises, product liability, and laborpremises, product liability, and laborrelations.relations.


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Bulk TransferBulk Transfer

Seller must give the buyer a sworn listSeller must give the buyer a sworn list

ofcreditors.ofcreditors.

Buyer and seller must prepare a list ofBuyer and seller must prepare a list ofthe property included in the sale.the property included in the sale.

Buyer must keep the list ofcreditorsBuyer must keep the list ofcreditors

and property for six months.and property for six months.


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Bulk TransferBulk Transfer

Buyer must give notice of the sale toBuyer must give notice of the sale to

each creditor at least ten days beforeeach creditor at least ten days before

he takes possession of the goods orhe takes possession of the goods orpays for them (whichever is first).pays for them (whichever is first).


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Determining theDetermining the ValueValue ofa Businessofa Business

Balance Sheet Technique.Balance Sheet Technique.

Variation: AdjustedBalance Sheet TechniqueVariation: AdjustedBalance Sheet Technique..

Earnings ApproachEarnings ApproachVariation 1: Excess Earnings ApproachVariation 1: Excess Earnings Approach

Variation 2: Capitalized Earnings ApproachVariation 2: Capitalized Earnings Approach

Variation 3: Discounted Future EarningsVariation 3: Discounted Future Earnings

ApproachApproach

Market ApproachMarket Approach..


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Balance Sheet TechniquesBalance Sheet Techniques

Book Value of Net Worth = Total Assets Book Value of Net Worth = Total Assets -- Total LiabilitiesTotal Liabilities

= $266,091= $266,091 -- $114,325$114,325

= $151,766= $151,766

Variation:Variation: Adjusted Balance Sheet Technique:Adjusted Balance Sheet Technique:

Adjusted Net Worth = $274,638Adjusted Net Worth = $274,638 -- $114,325$114,325

= $160,313= $160,313


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EarningsEarningsApproachesApproaches

Variation 1: Excess Earnings MethodVariation 1: Excess Earnings Method

Step 1: Compute adjusted tangible net worth:Step 1: Compute adjusted tangible net worth:

Adjusted Net Worth = $274,638Adjusted Net Worth = $274,638-- $114,325$114,325= $ 160,313= $ 160,313

Step 2: Calculate opportunity costs of investing:Step 2: Calculate opportunity costs of investing:

InvestmentInvestment -- $160,313 X 25% = $40,078$160,313 X 25% = $40,078

SalarySalary = $25,000= $25,000

TotalTotal = $65,078= $65,078


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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(EEP) = Project Net Earnings Total Opp. CostTotal Opp. Cost

= $ 74,000= $ 74,000 -- $ 65,078$ 65,078

= $ 8,922= $ 8,922


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Step 5Step 5: Estimate the value of the: Estimate the value of theintangibles ("goodwill"):intangibles ("goodwill"):

Intangibles = Extra Earning Power x "YearsIntangibles = Extra Earning Power x "Years

of Profit" Figure*of Profit" Figure*= 8,922 x 3 == 8,922 x 3 = $26,766$26,766

* Years of Profit Figure ranges from 1 to 7; for* Years of Profit Figure ranges from 1 to 7; for

a normal risk business, it is 3 or 4.a normal risk business, it is 3 or 4.


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Step 6Step 6: Determine the value of the: Determine the value of thebusiness:business:

Value =Value = TangibleTangible Net Worth + Value ofNet Worth + Value of

IntangiblesIntangibles

= $160,313 + 26,766 == $160,313 + 26,766 = $187,079$187,079

Estimated Value of the business = $187,079Estimated Value of the business = $187,079


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Capitalized Earnings MethodCapitalized Earnings Method

Variation 2: Capitalized Earnings Method:Variation 2: Capitalized Earnings Method:

Value=Value= Net Earnings (Net Earnings (AfterAfterDeducting Owner's Salary)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

similarsimilar--risk investment.risk investment.

Value =Value = $74,000$74,000 -- $25,000$25,000 == $196,000$196,000

25%25%


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Discounted Future Earnings MethodDiscounted Future Earnings Method

Variation 3: Discounted Future EarningsVariation 3: Discounted Future EarningsMethod:Method:

Step 1Step 1: Project earnings five years into the: Project earnings five years into the

future:future:3 Forecasts:OptimisticPessimisticMost Likely

Compute aCompute a weighted averageweighted average of the earnings:of the earnings:

Pessimistic + (4 x Most Likely) + OptimisticPessimistic + (4 x Most Likely) + Optimistic66


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Step 1Step 1: Project earnings five years into the: Project earnings five years into the

future:future:

Year Pess ML Opt WeightedAverageYear Pess ML Opt WeightedAverage1 $65,000 $74,000 $92,000 $75,5001 $65,000 $74,000 $92,000 $75,500

2 $74,000 $90,000 $101,000 $89,1672 $74,000 $90,000 $101,000 $89,167

3 $82,000 $100,000 $112,000 $99,0003 $82,000 $100,000 $112,000 $99,000

4 $88,000 $109,000 $120,000 $107,3334 $88,000 $109,000 $120,000 $107,333

5 $88,000 $115,000 $122,000 $111,6675 $88,000 $115,000 $122,000 $111,667


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Step 2Step 2: Discount weighted average of future: Discount weighted average of future

earnings at the appropriate present value rate:earnings at the appropriate present value rate:

Present Value Factor = 1Present Value Factor = 1(1+k)(1+k)

where...where...

k = Rate of return on a similar riskk = Rate of return on a similar risk

investment.investment.t = Time period (Yeart = Time period (Year -- 1, 2, 3...n).1, 2, 3...n).


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Step 2Step 2: Discount weighted average of future: Discount weighted average of future

earnings at the appropriate present value rate:earnings at the appropriate present value rate:

Year Weighted Average x PV Factor = Present Value

Year Weighted Average x PV Factor = Present Value

1 $75,500 .8000 $60,4001 $75,500 .8000 $60,400

2 $89,167 .6400 $57,0672 $89,167 .6400 $57,067

3 $99,000 .5120 $50,6883 $99,000 .5120 $50,688

4 $107,333 .4096 $43,9644 $107,333 .4096 $43,964

5 $111,667 .32775 $111,667 .3277 $36,593$36,593

TotalTotal $248,712$248,712


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Step 3Step 3: Estimate the earnings stream: Estimate the earnings streambeyond five years:beyond five years:

Weighted AverageWeighted AverageEarnings in Year 5 x 1Earnings in Year 5 x 1

Rate of ReturnRate of Return

= $111,667 x 1 = $446,668= $111,667 x 1 = $446,66825%25%


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Step 4Step 4: Discount this estimate using the present: Discount this estimate using the presentvalue factor for year 6:value factor for year 6:

$446,668 x .2622 =$446,668 x .2622 = $117,116$117,116

Step 5Step 5: Compute the value of the business:: Compute the value of the business:

Value = Discounted earnings + DiscountedValue = Discounted earnings + Discounted

in years 1 through 5 earnings in yearsin years 1 through 5 earnings in years

6 through ?6 through ?= $248,712 + $117,116 == $248,712 + $117,116 = $365,828$365,828

Estimated Value of Business = $365,828Estimated Value of Business = $365,828



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Market ApproachMarket Approach

Step 1Step 1: Compute the average Price: Compute the average Price--Earnings (PEarnings (P--E)E)Ratio for as many similar businesses as possible:Ratio for as many similar businesses as possible:

Company PCompany P--E RatioE Ratio

1 3.31 3.32 3.8 Average P2 3.8 Average P--E Ratio=3.975E Ratio=3.975

3 4.13 4.1

4 4.74 4.7

Step 2Step 2: Multiply the average P: Multiply the average P--E Ratio by nextE Ratio by nextyear's forecasted earnings:year's forecasted earnings:

Estimated Value = 3.975 x $74,000 =Estimated Value = 3.975 x $74,000 = $294,150$294,150


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The Five Ps of NegotiatingThe Five Ps of Negotiating

Preparation

Examine the needs of both partiesand all of the relevant externalfactors affecting the negotiation

before you sit down to talk.


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Poise Remain calm during the negotiation.Never raise your voice or lose yourtemper, even if the situation gets

difficult or emotional.Its better to walk away and calm

down than to blow up and blow thedeal.


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Persuasiveness

Know what your most importantpositions are, articulate them, andoffer support for your position.


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Persistence

Dont give in at the first sign of

resistance to your position, especiallyif it is an issue that ranks high in yourlist of priorities.


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Patience Dont be in such a hurry to close thedeal that you end up giving up muchof what you hoped to get. Impatience

is a major weakness ina negotiation.


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ConclusionConclusion

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 lendThe previous owners are likely to lendsupport and goodwill.support and goodwill.

There is a tried and tested businessThere is a tried and tested business

formula to emulate.formula to emulate.


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ConclusionConclusion

Generally more chance ofsuccess thanGenerally more chance ofsuccess thanstarting a similar business from scratch.starting a similar business from scratch.

A large amount of time and travel requiredA large amount of time and travel required

to research the opportunities available.to research the opportunities available. May require relocating your self / family.May require relocating your self / family.

ByBy--AtharA RizviAtharA Rizvi

Roll No. 72015Roll No. 72015

Buying an Exciting

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