Buying an Exciting

Business
 How to Buy a Business
 Do not rush into a deal.
 Analyze your skills, abilities, and interests.
 Develop a list of criteria.
 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?
 How critical to your ultimate success is
experience in the business?
 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?
 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.
 What experience do you have in that
particular business?
 What is the company’s potential for
success?
 Negotiate the deal.
 How to Buy a Business
 What changes will you have to make?
 Explore financing options.
 What price and payment method are
reasonable for you?
 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.
 Competitor analysis.
 What legal aspects must I consider?
 Some Advantages for Buying a
Business
 Business may continue to be successful.
 Can use experience of previous owner.
 “Hit the ground running”.
 Business may have best location.
 Employees and suppliers are in place.
 Some Advantages for Buying a
Business
 Equipment is installed.
 Inventory is in place and trade credit
exists.
 Easier time finding financing.
 It’s a bargain.
Some Disadvantages for Buying a
Business
 It’s a loser.
 Possible “ill will” from previous owner.
 Employees may not be suitable.
 Location may be unsatisfactory.
 Equipment may be obsolete.
Some Disadvantages for Buying a
Business
 Change and innovation can be difficult.
 Inventory may be obsolete.
 Accounts receivable may be worth less
than face value.
Some Disadvantages for Buying a
Business
 Change and innovation can be difficult.
 Inventory may be obsolete.
 Accounts receivable may be worth less
than face value.
 Business may be overpriced.
 Valuing Accounts Receivable
     
Age of Probability of
Accounts Amount Collection Value
 
(days)

0-30 $40,000 .95 $38,000

31-60 $25,000 .88 $22,000
61-90 $14,000 .70 $9,800
91-120 $10,000 .40 $4,000
121-150 $7,000 .25 $1,750
151+ $5,000 .10 $500
     
Total $101,000 $76,050

       
 The Legal Aspects of
Buying a Business

 Lien - creditors’ claims against an asset.

 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.
 Ongoing legal liabilities - physical
premises, product liability, and labor
relations.
 Bulk Transfer
 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 must keep the list of creditors
and property for six months.
 Bulk Transfer

 Buyermust 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.

Variation: Adjusted Balance Sheet Technique.
 Earnings Approach
Variation 1: Excess Earnings Approach
Variation 2: Capitalized Earnings Approach
Variation 3: Discounted Future Earnings
Approach
 Market Approach.
 Balance Sheet Techniques
“ Book Value” of Net Worth = Total Assets - Total Liabilities
= $266,091 - $114,325
= $151,766

Variation: Adjusted Balance Sheet Technique:

Adjusted Net Worth = $274,638 - $114,325
= $160,313
 Earnings Approaches
 Variation 1: Excess Earnings Method

Step 1: Compute adjusted tangible net worth:

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

Step 2: Calculate opportunity costs of investing:

Investment - $160,313 X 25% = $40,078
Salary = $25,000
Total = $65,078
 Earnings Approaches
 Step 3: Project earnings for next year:
$74,000

• Step 4: Compute extra earning power

(EEP) = Project Net Earnings – Total Opp. Cost
= $ 74,000 - $ 65,078
= $ 8,922
 Earnings Approaches
 Step 5: Estimate the value of the
intangibles ("goodwill"):
Intangibles = Extra Earning Power x "Years
of Profit" Figure*
= 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:
Value = Tangible Net Worth + Value of
Intangibles
= $160,313 + 26,766 = $187,079

Estimated Value of the business = $187,079

 Capitalized Earnings Method
 Variation 2: Capitalized Earnings Method:

Value= Net Earnings (After Deducting Owner's Salary)

Rate of Return*

* Rate of return reflects what could be earned on a

similar-risk investment.

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

25%
 Discounted Future Earnings Method
Variation 3: Discounted Future Earnings
Method:

Step 1: Project earnings five years into the

future:
3 Forecasts:
Optimistic
Pessimistic
Most Likely

Compute a weighted average of the earnings:

Pessimistic + (4 x Most Likely) + Optimistic
6
 Discounted Future Earnings Method

Step 1: Project earnings five years into the

future:

Year Pess ML Opt WeightedAverage

1 $65,000 $74,000 $92,000 $75,500
2 $74,000 $90,000 $101,000 $89,167
3 $82,000 $100,000 $112,000 $99,000
4 $88,000 $109,000 $120,000 $107,333
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

(1+k)
where...
k = Rate of return on a similar risk
investment.
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 $75,500 .8000 $60,400

2 $89,167 .6400 $57,067
3 $99,000 .5120 $50,688
4 $107,333 .4096 $43,964
5 $111,667 .3277 $36,593
Total $248,712
Discounted Future Earnings Method

Step 3: Estimate the earnings stream beyond

five years:

Weighted Average
Earnings in Year 5 x 1
Rate of Return

= $111,667 x 1 = $446,668
25%
 Discounted Future Earnings Method

Step 4: Discount this estimate using the present

value factor for year 6:
$446,668 x .2622 = $117,116

Step 5: Compute the value of the business:

Value = Discounted earnings + Discounted
in years 1 through 5 earnings in years
6 through ?
= $248,712 + $117,116 = $365,828

Estimated Value of Business = $365,828

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

Company P-E Ratio

1 3.3
2 3.8 Average P-E Ratio=3.975
3 4.1
4 4.7

Step 2: Multiply the average P-E Ratio by next

year's forecasted earnings:

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

 Exit Strategies
• Straight business sale
• Family limited partnership (FLP)
• Sell controlling interest
• Restructure the company
• Use a two-step sale
• 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.
 It is likely to have an existing client base.
 The previous owners are likely to lend
support and goodwill.
 There is a tried and tested business
formula to emulate.
 Conclusion
 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.
 May require relocating your self / family.

By-
Athar A Rizvi
Roll No. 72015