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Due Diligence & Financing Strategies For Small Business Acquisition

The task of raising money for a business is not as difficult as most people seem to think. This is especially true when you have an idea or business that can provide your investors with a good return. Actually, there’s more money available for new business ventures than there are good business ideas.

A very important rule of the game to learn: Anytime you want to raise money, your first move should be to put together a proper business plan. This report covers all the key elements you need to be able to research and write a convincing business plan and raise the funds you need to acquire your new business. The report covers all the steps necessary to:

- Properly decipher the financials of the business,
- Conduct due diligence,
- Properly value the target, and
- Raise the money you need to close

>> This report was created by Phare Equity Partners which produces thoughtful, well-researched and un-biased Valuation Reports for small and mid-size businesses in all industries.

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Due Diligence & Financing Strategies For Small Business Acquisition

  1. 1. A Handbook For Analyzing Any Small Business Before Buying It
  2. 2. 2 RGL Publishing A Simple Way To Find Businesses That Can Be Flipped This section will be extremely short and straight forward. For the purpose of finding businesses that you can make an offer on and quickly flip, I would NOT use the following ways or media to find potential businesses: • Newspaper • Business Brokers • The Internet • Direct Marketing • Newspaper Advertising An extremely simply way to find businesses is to “buy” is to simply visit local businesses, preferably those businesses from which you buy goods and services. When you become a professional at flipping businesses, the location and the fact that you buy your goods and services from a business will not be important. But at the beginning, it greatly improves your chances of locking the business with an option to purchase it, while you look for a “real” buyer. So, your approach is to simply speak to owners of businesses in your town or neighboring town and court them in order to be able to have a good understanding of the business so you can make a real educated guess concerning the value and condition of the business. This allows you to control a business which you can up-sell to the real buyer. Up-selling is the difference that creates your profit margin. So, forget newspapers ads, Internet business brokers, brick-and-mortar business brokers, real estate brokers. Get to the owner yourself. That is the only way to buy and flip small businesses Finding a Business to Purchase
  3. 3. 3 profitably. Doing this will allow you to build a steady practice which you can pursue on a full time basis if you so desire later on.
  4. 4. 4 RGL Publishing Notes Here’s what you can do to gain even more: Click Here (http://rglpublishing.com/bizbrokcrse.htm) to Buy Your Own Copy Of The Printed Version of this course for the modest sum of $179.85 and get the following: A printed copy of the Business Brokerage Home Study Course in a convenient 3-ring binder for easy access (Value: $149.97) The BizVal Business Valuation Software PLUS a separate comprehensive Excel Valuation Workbook (Value: $274.95) All the Forms and Contracts you need to immediately start your practice. The forms are also in electronic format if you decide to make changes to them (Value: $59.95) Personal e-mail consultation with me, as you begin to build your practice. With these consultations, I will personally assist you while you work on your first transaction, until you close the deal and get paid (Value: Priceless) Direct answer from me to any questions you may have about the course (including questions about valuation, financials statements, due diligence, etc.) My complete lifetime guarantee. If you find out later that Business Brokerage is not for you, just send me an e-mail and I will refund your money without asking any questions (even after you’ve had the chance to review it for free!) If You Do Not Think That Business Brokerage Is For You Here is how you can help others who could benefit from this course: Send this eBook to your friends who might be interested in Business Brokerage Or better yet, send them to http://rglpublishing.com/bizbrokragefreecrse.htm so they can download their own copy of the course.
  5. 5. 5 Introduction Before embarking into the actual details of buying and selling businesses, anyone interested in buying their own business must be totally familiar with financial statements. These statements hold information that can instantly tell you a business’ strength, weakness and financial position. This section of the course covers all the key elements the student will need to be able to read and understand the three main financial statements: The Income Statement The Balance Sheet and The Cash Flow Statement Following that, we will go into the details of the actual buy/sell process. To ensure that key concepts are fully understood we will use case studies and analyze a transaction from beginning to end. The Income Statement Introduction To The Income Statement Description This section introduces the income statement and explains what it comprises and how it affects the balance sheet. Duration 25 minutes Definition of the Income Statement An Income Statement is a summary of sales and expenses over a period of time. The difference How To Analyze The Financial Statements
  6. 6. 6 between revenue and cost is equal to a company’s net income. Sections of the Income Statement The Income Statement has several sections, which list a company’s revenue and expenses. These numbers are then added and subtracted to produce the Net Income, as shown in the example below. 1998 Tuition Revenues $ 2,676,690 Other Income/(Refund) $ 376,439 Cost of Sales $ (306,094) Operating Expenses $ (2,555,850) Other Expenses $ (31,742) Net Income $ 159,443 Growth Rate (%) How Retained Earning is Affected by Net Income Net Income, which is a summary of the Income Statement, is added to the Retained Earning line item on the Balance Sheet. That means the Retained Earnings of a company fluctuate with the Net Income. This, in turn, “un-balances” the Balance Sheet (the Balance Sheet is covered later in this course). Revenues And The Income Statement Sales Does Not Equal Cash Flow A business’ cash inlay is never equal to its sales, as recorded on the Income Statement because when a sale occur, it can be for cash or credit. When a customer pays with cash, that amount is immediately recorded as cash flowing into the
  7. 7. 7 business’ registers. However, when the customer pays with a credit card, it may be weeks, and sometimes months, before cash is actually received. Sales & Account Receivable As sales are recorded, a company’s Net Income rises, which causes an increase to retained earnings and requires changes to the Balance Sheet (we will cover Balance Sheet in more details later). But when revenues increase, the resulting income may be cash or credit. In this case, credit is also called account receivable, because the cash has yet to be received (or is owed to the business), even though the sales was recorded. So an increase in sales will result in either an increase in cash or account receivable. When To Record Sales Revenue is made up of income coming from all of a company’s revenue sources, including sales, fees and residuals. These items are all displayed on the Income Statement. As we’ve seen before, due to the fact that revenues can be received as cash or credit, sales entered on the Income Statement will often not equal actual cash receipts. Expenses And The Income Statement Expense Analysis Money spent by a company usually fall in one of the two expense buckets below. COGS: Cost of Goods Sold This is what a company actually pays to either produce or acquire the products SGA: Sales, General & Administrative Costs
  8. 8. 8 These are a company’s expenses not related to the production or acquisition of the products the company sells. These expenses tend to be fixed, whereas the cost of goods sold will increase as more products are produced or procured. Note that revenues and expenses are usually paired when listed on the Income Statement. That is, when an income line is listed, an expense line follows it, so that reconciliation and analysis of the Income Statement can be conducted in an easy way. 1998 Tuition Revenues $ 2,676,690 Cost of Sales $ (306,094) Operating Expenses $ (2,555,850) Other Income/(Refund) $ 376,439 Other Expenses $ (31,742) Net Income Before Taxes $ 159,443 It is also important to note that not all expenses (insurance expense being one of them) will be paired with a revenue line item. These are funds that need to be spent whether or not a company makes money. Expenses Does Not Necessarily Equal Cash Paid Out Expenses on a company’s Income Statement do not always equal the amount of cash that actually leaves the company’s coffers. That is because a company can either use credit or cash for business expenses and insert these expenses on the Income Statement even though actual cash has not been paid out. More About The Income Statement
  9. 9. 9 When the Cost of Goods Sold (COGS) is subtracted from a company total revenue, its Net Income on the Income Statement goes down, which causes a decrease in Retained Earning. That, in turn, “un-balances” the Balance Sheet because the Assets and Liabilities sections are no longer equal. Normally, updating the Assets portion of the Balance Sheet will solve this problem. In most cases, the line item that needs to be updated in the Assets section of the Balance Sheet is Inventory. To understand this, the reader has to realize that every time COGS changes, inventory changes as well. When COGS goes up (i.e. the company is buying more goods), Inventory goes up and when COGS goes down (i.e. the company is buying less goods), Inventory goes down. Often the Income Statement includes a section or line entry labeled “Other Income.” This normally encompasses one-time income, interest income from money invested, income from the sale of an assets, etc.
  10. 10. 10 Income Statement Analysis Description This course will take you further into the income statement and its various accounts. You will learn about the difference between accounting for taxes and for shareholders. You will also be introduced to using ratios to analyze and compare companies. Length 20 min Analyzing The Income Statement Someone buying a business will look at cost of goods sold COGS, administrative costs SG&A and revenues on a company's income statement and use multiples and ratios to compare a company’s performance with respect to similar businesses. The following financial elements are usually reviewed: Gross Profit, Operating Profit, Gross Margin & Operating Margin, all of which we briefly discuss below. Element Definition Gross Profit This is a company revenue less what it spends to produces the goods that it sells it sells or COGS (see sample Income Statement below) Operating Profit Operating profit (or Operating Income), is what is left after administrative expensive are taken out of the Gross Profit (see below) Gross Margin Unlike Gross Profit and Operating Profit, gross margin is a ratio derived
  11. 11. 11 Element Definition from dividing gross profit by total sales (i.e. Gross Margin = Gross Profit / Sales). The higher the Gross Margin, the more efficiently a company is operating. Operating Margin Operating, which is also a ratio is derived by dividing Operating Profit by total sales (i.e. Operating Margin = Operating Income / Revenues). This ratio shows whether administrative costs increase or decrease when production costs (or COGS) increase. Income Statement 1998 Tuition Revenues $ 2,676,690 Cost of Sales $ (306,094) Gross Profit $ 2,370,596 Operating Expenses $ (2,555,850) Operating Income $ (185,254) Other Income/(Refund) $ 376,439 Other Expenses $ (31,742) Net Income Before Taxes $ 159,443 Interest Income and/or Expense Businesses are obligated to report all expense and income sources. Often a company may have money in CDs’ or interest bearing checking
  12. 12. 12 accounts. These have to be reported as income. In addition, when a company borrows money, it pays interests on the loans. The interest payments are considered expenses and are subtracted from total revenues. This section of the Income Statement list the details of all interest expense and income. Income Statement 1998 Tuition Revenues $ 2,676,690 Cost of Sales $ (306,094) Gross Profit $ 2,370,596 Operating Expenses $ (2,555,850) Operating Income $ (185,254) Interest Income $ 10,000 Interests Paid On Loans $ (10,000) Income Statement 1998 Other Income/(Refund) $ 376,439 Other Expenses $ (31,742) Net Income Before Taxes $ 159,443 Other Income and/or Expense This section of the Income Statement is where unusual income and expenses are listed. Unusual income may be related to the income from the sale of an assets (e.g. a truck). An unusual expense may be related to money spent to buy out a partner. Income Statement 1998 Tuition Revenues $ 2,676,690 Cost of Sales $ (306,094) Gross Profit $ 2,370,596
  13. 13. 13 Income Statement 1998 Operating Expenses $ (2,555,850) Operating Income $ (185,254) Interest Income $ 10,000 Interests Paid On Loans $ (10,000) Other Income/(Refund) $ 376,439 Other Expenses $ (31,742) Net Income Before Taxes $ 159,443 EBIT When analyzing a business with the intent of purchasing it, a buyer normally needs to make certain adjustment to the Income Statement in order to get a true sense of the business level of profitability. One of the most important financial item which is often reviewed is a company’s income before interest and taxes are paid or EBIT (or Earning Before Interest and Taxes). This number show the real bottom line on the Income Statement and reveals how much money is left to pay any debt that a business may have. That is important because the interest payments do not go on forever and when the loan is paid off, the payments are added into the company’s net profit. So, the educated business buyer will place great importance in this financial data because it depicts a better picture of the financial stability of the business being analyzed.
  14. 14. 14 The Balance Sheet Description This course will introduce you to one of accounting's fundamental documents, the balance sheet. You will learn how to read, create and maintain a balance sheet. You will also learn how a balance sheet works with other financial statements and how it fits into the annual report. Length 25 min While the Income Statement depicts a picture a company’s revenues and expenses, the Balance Sheet is a timed picture of its assets and liabilities. It is timed, because it represent the company’s position, more specifically what it owns and owes, at a very specific moment in time. Sample Balance Sheet End of Year 2000 ASSETS Checking/Savings/Employ ee Advances/Cash $ 131,860.2 Accounts Receivable $ 665,316 Inventories & Prepaid Expenses $ 17,039 Less Allowance for bad debts $ - Total Current Assests $ 814,215 Fixed Assests $ 187,578 Other Assets $ 182,770 Total Assets $ 1,184,563 LIABILITIES Current Liabilities $ 595,173 Long-Term Liabilities $ 372,456 Stockholders' Equity $ 216,935 Total Liabilities and Stockholders Equity $ 1,184,563
  15. 15. 15 Parts of the Balance Sheet The balance sheet consists of two sections. The Assets portion lists a company's assets, which represent all of a company’s possessions. The Liabilities section is where all company’s loans and debts (what is owed) are listed. Both section of the Balance Sheet must always be equal, or the Balance Sheet has to be “balanced” by adjusting specific line items from either section. Note that “Retained Earnings” is listed under the Assets section and represent a company’s profit after it has paid its taxes. Dividends, when they are paid out to investors as owners of a company, are paid from Retained Earnings. Balancing the Balance Sheet To balance the Balance Sheet, simply follow the formula below and make sure that the value of Assets section is equal to that of the Liabilities section. ASSETS = LIABILITIES + EQUITY If you increase or decrease one side, you must make the necessary change so that both sections are equal again. Sample Balance Sheet End of Year 2000 ASSETS Checking/Savings/Employe e Advances/Cash $ 131,860.2 Accounts Receivable $ 665,316 Inventories & Prepaid Expenses $ 17,039 Less Allowance for bad debts $ - Total Current Assests $ 814,215 Fixed Assests $ 187,578 Other Assets $ 182,770 Total Assets $ 1,184,563 LIABILITIES
  16. 16. 16 Sample Balance Sheet End of Year 2000 Current Liabilities $ 595,173 Long-Term Liabilities $ 372,456 Stockholders' Equity $ 216,935 Total Liabilities and Stockholders Equity $ 1,184,563 Building a Balance Sheet To build a Balance Sheet, simply list all assets that a company owns on one piece of paper (your Assets section). On another piece of paper, list all of the company’s debts and the value of the money invested by its owners or Stockholder’s Equity (your Liabilities section). Simply place the two sections side by side, with the Assets section on the left. You can also place them one above the other (as in the Balance Sheet sample above), with the Assets section placed on top. If all items have been listed under both Assets and Liabilities, the value both sections should be equal. Each time an amount is added or subtracted in one section of the balance sheet, the Balance Sheet must be rebalanced. This rebalancing may take place on either the asset side or the liability side. For example, in the Balance Sheet below, if you increase the ‘Current Liabilities’ by $100,000, you can increase ‘Fixed Assets’ by $100,000, decrease ‘StockHolders’ Equity’ by $100,000. Sample Balance Sheet End of Year 2000 ASSETS Checking/Savings/Employe e Advances/Cash $ 131,860.2 Accounts Receivable $ 665,316 Inventories & Prepaid Expenses $ 17,039 Less Allowance for bad $ -
  17. 17. 17 Sample Balance Sheet End of Year 2000 debts Total Current Assests $ 814,215 Fixed Assests $ 187,578 Other Assets $ 182,770 Total Assets $ 1,184,563 LIABILITIES Current Liabilities $ 595,173 Long-Term Liabilities $ 372,456 Stockholders' Equity $ 216,935 Total Liabilities and Stockholders Equity $ 1,184,563 Reading the Balance Sheet When reading a Balance Sheet, you will notice that the two major sections (Assets and Liabilities) are divided into sub-sections. The main sub-sections used when creating a Balance Sheet are: 1. Current Assets 2. Long-Term Assets 3. Current Liabilities 4. Long-Term Liabilities Here is a brief definition of each: Balance Sheet Item Definition Current Assets Current or short-term assets are expected to be used up or turned into cash within one year and may include cash and receivables Long-Term Assets Long-term assets will be used for more than one year and may include real estate, equipment, etc. Current Liabilities Current or short-term liabilities are expected to be paid within one year and may include payables and short-term loans
  18. 18. 18 Balance Sheet Item Definition Long-Term Liabilities These liabilities will be made up of all loans and debts for which the pay-off time is longer than one year
  19. 19. 19 Cash Flow Statement Description This course will introduce you to the different sections of the cash flow statement. You will learn why financial analysts are interested in the cash flow statement and how to compile a cash flow statement. In addition, we will introduce you to projected financial statements and calculations based on those. Length 10 min Introduction Cash Flow can be summarized as follows: The amount of actual cash that can be found in a company’s register (e.g. checking account) at the end of a period, which could a day, a week or a month. So Cash Flow is extremely important (many times more important than Net Income, because it determines whether or not a company is solvent. That is, it can pay all its bills and still have money left to continue to operate. In addition, from a buyer’s perspective, a seller can manipulate the Income Statement to make the business look good to the buyer. However, it is not possible to manipulate cash flow, because the amount of actual cash a company has can be verified by reviewing a company’s bank statements to analyze deposits and withdrawals. Sample Cash Flow Statement Cash Flows From Operating Activities New York Recast Net Income $ 513,665 Account Receivable Increase Inventory Increase Prepaid Expenses Decrease Depreciation Expense $ 114,474.00
  20. 20. 20 Cash Flows From Operating Activities New York Accounts Payable Increase Accrued Expenses Increase Income Tax Payable Decrease Cash Flow from Operating Activities $ 628,139.18 Cash Flows From Investing Activities Purchases of Property, Plant & Equipment $ - Cash Flows from Financing Activities Short-Term Debt Borrowing $ - Long-Term Debt Borrowing $ - Capital Stock Issue $ Cash Flows From Operating Activities New York - Dividends Paid to Shareholders $ - Cash Flow from Financing Activities $ - Increase (Decrease) in Cash during Year $ 628,139.18 The Cash Account Cash flow can be explained by referring back to the cash account on the balance sheet. Most items on the balance sheet are linked to cash. When making changes to the balance sheet, we are either adding or subtracting (or using) cash.
  21. 21. 21 Balance Sheet End of Year 2000 ASSETS Cash (Checking, Savings, Employee Advances, etc.) $ 131,860.2 Accounts Receivable $ 665,316 Inventories & Prepaid Expenses $ 17,039 Less Allowance for bad debts $ - Total Current Assests $ 814,215 Fixed Assests $ 187,578 Other Assets $ 182,770 Total Assets $ 1,184,563 LIABILITIES Current Liabilities $ 595,173 Long-Term Liabilities $ 372,456 Stockholders' Equity $ 216,935 Total Liabilities and Stockholders Equity $ 1,184,563 For example, if you pay $1,500 to buy inventory or make a monthly loan payment, your cash decreases. On the other hand, if you make a sale for $2,000, your cash increases by $2,000. Creating The Cash Flow Statement Since Cash Flow is the actual amount of money (or cash) left in a company’s register at the end of a period, to create a cash flow statement you simply need the company's balance sheets from the beginning and the end of the period being analyzed. You will take the difference between all Balance Sheet items affected by cash (whether an increase in cash or a decrease of it) to calculate cash flow. Balance Sheet End of Year 2000 End of Year 2001 Assets Cash (Checking, Savings, $ 70 $ 90
  22. 22. 22 Balance Sheet End of Year 2000 End of Year 2001 Employee Advances, etc.) Pre-paid Expense $ 10 $ 20 Securities $ 30 $ 20 Total Assets $ 110 $ 130 Liabilities Loans $ 110 $ 110 Total Liabilities and Stockholders Equity $ 110 $ 110 Cash Flows Statement End of Year 2001 Change in Pre-paid Exp ($10) Change in Securities $10 Change in Loans $20 Change in Cash (or Cash Flow) $20 To verify that your number is accurate, simply take the difference the two “Cash (Checking, Savings, Employee Advances, etc.)” for 2000 and 2001. That amount should be equal to the line labeled “Change in Cash (or Cash Flow)” in the example above, in our case $90 - $70 = $20. Our numbers mach, so we conclude that cash flow during the year 2001 was $20.
  23. 23. 23 Cash From Operating Activities And Investing Activities Cash From Operating Activities This section of the Cash Flow Statement tells us about a company’s cash position from its day-to- day business operations and may include money paid by clients, as well as cash paid to suppliers and employees, for example. A profitable company should have a positive cash flow from operations. How To Calculate Cash Flow From Operating Activities To calculate Cash Flow From Operating Activities, follow the directions below: Use the Balance Sheet to find all entries that are related to operating activities as show in the example below. Balance Sheet 12/00 12/01 Change Assets Account Receivables $ 200 $ 250 ($50) Inventory $ 400 $ 425 ($25) Pre-paid Expense $ 100 $ 80 $20 Other $ 60 $ 40 $20 Total Assets $ 760 $ 790 ($35) Liabilities Accounts Payable $ 100 $ 200 $100) Short-Term Loans $ 600 $ 550 ($50) Deferred Taxes $ 10 $ 50 $40 Long Term Liabilities $ 60 $ 40 ($20) Total Liabilities and Stockholders Equity $ 770 $ 840 $70
  24. 24. 24 Balance Sheet 12/00 12/01 Change Total Change in Cash From Operating Activities -$35 + $70 = $35 Cash From Investing Activities Part of the cash flow statement records the sources and uses of cash from a company's investing activities, which are activities for the purpose of purchasing assets (also known as Capital Expenditure or CAPEX) that a company will need produce the products that it sells to its customers. These activities consume cash and normally reduce a company’s cash. Cash Flow From Investing Activities also include activities related to the sale of assets that a company no longer need. These activities produce (and increase) cash that a company can use for other purposes. We illustrate how to calculate Cash Flow From Investing Activities with a simple Balance Sheet in the example below. The start and ending balances are as follows: Balance Sheet Item 12/2001 12/2002 Land $ 80,000 $ 60,000 Buildings and equipment 240,000 260,000 Accumulated depreciation- buildings and equipment 60,000 58,000 Bonds payable 50,000 45,000 Dividends payable 10,000 12,000 Common stock 30,000 40,000 Retained earnings 90,000 120,000 Investing Activities During the fiscal year:
  25. 25. 25 (1) Land worth $20,000 was sold for $47,000 (2) Equipment with a cost of $40,000 and accumulated depreciation of $12,000 was sold for a gain of $7,000 (3) A new building was bought To calculate Cash Flow From Investing Activities proceed as follows: Details for transaction (1): Cash inflow from sale of land = $47,000 Details for transaction (2): Net value of equipment sold = $40,000 - $12,000 = $28,000. Gain on sale of equipment = $7,000. Cash inflow from sale of equipment = $35,000 ($28,000 + $7,000) Details for transaction (3): Beginning balance of building and equipment + Cost of buildings and equipment purchased = Ending balance of buildings and equipment + Cost of building and equipment sold. We calculate this value as follows: Cost of new building bought = Ending balance of buildings and equipment + Cost of items sold - Beginning balance of buildings and equipment = $260,000 + $40,000 - $240,000 = $60,000 Therefore, flow of cash from investing activities is: Cash inflow from sale of land $47,000 Plus: cash inflow from sale of equipment 35,000 Less: Cash payments for new building (60,000) Cash flow from investing activities $22,000 Cash From Financing Activities And Projected Financial Statements Cash From Financing Activities
  26. 26. 26 Finally, a prospective buyer or broker analyzing a business must also include Cash Flow From Financing Activities to get a complete picture of a company’s cash position. Elements of financing cash flows include new loans and the issuance of stock (cash inflows), the payment of existing debt and dividend payouts (cash outflows). The following example uses a simple Balance Sheet to illustrate how to calculate Cash Flow From Financing Activities. Balance Sheet Items Dec-01 Dec-02 Land $ 80,000 $ 60,000 Buildings and equipment 240,000 260,000 Accumulated depreciation- buildings and equipment 60,000 58,000 Bonds payable 50,000 45,000 Dividends payable 10,000 12,000 Balance Sheet Items Dec-01 Dec-02 Common stock 30,000 40,000 Retained earnings 90,000 120,000 Financing activities during the fiscal year. Details for transaction (1): Bonds payable have decreased from $50,000 to $45,000. Hence, cash outflow to buyback bonds = $5,000 ($50,000 - $45,000) Details for transaction (2): Common stock has increased from $30,000 to $40,000. Hence, cash inflow from sale of common stock = $10,000 Dividends declared = Beginning retained earnings + Net income - Ending retained earnings = $90,000 + $45,000 - $120,000 = $15,000.
  27. 27. 27 Dividends paid = Beginning dividends payable + Dividends declared - Ending dividends payable = $10,000 + $15,000 - $12,000 = $13,000 To calculate Cash Flow From Investing Activities proceed as follows: Cash collected from sale of common stock $10,000 Less: Cash paid to buy back bonds (5,000) Less: Cash payments for dividends (13,000) Cash flow from financing activities $(8,000) Once you have calculated cash flows from operation, investment and financing activities, just add them up. The result is the company ending cash balance.
  28. 28. 28 Cash Flow Analysis Description This course will introduce you to free cash flow and net internal cash flow, methods of cash flow analysis which give a better indication of a company's financial health than simply looking at earnings, the cash flow statement, or EBITDA. Length 25 min Why Should A Buyer Analyze Cash Flow? Cash flow is scrutinized for the following reasons: To ensure that a business can repay its debts To determine the amount of cash flow coming from outside financing To compare a company’s business and financial priorities Just reviewing the standard Cash Flow Statement has serious drawbacks. Therefore, a more in- depth analysis is required. Operating Cash Flow To calculate free cash flow we first calculate operating cash flow, which is a company’s cash flow from its earnings before changes in working capital (we cover working capital later in the course).. The components of operating cash flow are net income, depreciation, amortization and all other non-cash items, which may be deferred taxes, gains or losses from the sale of assets, etc. Operating Working Capital
  29. 29. 29 After calculating operating cash flow, we now calculate the change in operating working capital, which is the change in operating assets and liabilities, or the sum of all the cash flows in the operating activities section of the cash flow statement related to receivables, inventories, other current assets, accounts payable, accrued liabilities, and other current liabilities. Scrutinizing this number is important because it shows increase in accounts receivable and inventories, which can mean that a company might run into a short-term cash crunch. Cash Flow from Operations The next step in calculating free cash flow is to get cash flow from operations, which measure a company’s cash from earnings. This is done by adding the change in operating working capital to operating cash flow. Capital Expenditures Next, we subtract capital expenditures, which come from the investing activities section of the cash flow statement Dividends The final step is to deduct the cash outflow for regular dividends that the company pays to its investors. Free Cash Flow Summary Free Cash Flow is an important measure for the business buyer. This is the cash that is left over after the payment of all cash expenses and operating investment required by a business. It is cash left in the “register.” To simplify the above discussion, you can calculate free cash flow using the following formula:
  30. 30. 30 FCF = Net Income – Taxes – Net Investment – Net Change in Working Capital (We cover Working Capital later in the course) EBITDA EBITDA or Earnings before Interest, Taxes, Depreciation, and Amortization is an approximate measure of the cash flow produced by a company’s operating activities. It is a number that many buyers review when analyzing a company’s profitability level. To calculate EBITDA, use the following formula: EBITDA = Net Income + Interest Paid + Taxes + Depreciation + Amortization The reasoning is that when the business is purchased, these expenses will no longer be on the Income Statement, which will make the business more profitable for the buyer. Working Capital Working Capital is important because it helps to: Know whether or not a company is capable of paying its bills Estimate how much money a business needs for its operations Compare operating performance of different businesses Using data on the Balance Sheet, the formula for Working Capital is as follows: Working Capital = Current Assets – Current Liabilities If a business’ Working Capital is positive, current assets are greater than current liabilities, which means that the business can cover all current
  31. 31. 31 obligations (including debts, payroll, inventory, etc.). A positive Working Capital means that the company is in good health and can continue to operate in the immediate future without any problems. Operating Working Capital Operating Working Capital, which provides a better picture of the company's actual operations, is equal to Working Capital less short-term loans, investments and cash. In order to use Operating Working Capital to compare companies of different sizes, we normally express it as a percentage of total sales as in the formula below: % of Sale = Operating Working Capital / Total Revenues
  32. 32. 32 Notes Here’s what you can do to gain even more: Click Here (http://rglpublishing.com/bizbrokcrse.htm) to Buy Your Own Copy Of The Printed Version of this course for the modest sum of $179.85 and get the following: A printed copy of the Business Brokerage Home Study Course in a convenient 3-ring binder for easy access (Value: $149.97) The BizVal Business Valuation Software PLUS a separate comprehensive Excel Valuation Workbook (Value: $274.95) All the Forms and Contracts you need to immediately start your practice. The forms are also in electronic format if you decide to make changes to them (Value: $59.95) Personal e-mail consultation with me, as you begin to build your practice. With these consultations, I will personally assist you while you work on your first transaction, until you close the deal and get paid (Value: Priceless) Direct answer from me to any questions you may have about the course (including questions about valuation, financials statements, due diligence, etc.) My complete lifetime guarantee. If you find out later that Business Brokerage is not for you, just send me an e-mail and I will refund your money without asking any questions (even after you’ve had the chance to review it for free!) If You Do Not Think That Business Brokerage Is For You Here is how you can help others who could benefit from this course: Send this eBook to your friends who might be interested in Business Brokerage Or better yet, send them to http://rglpublishing.com/bizbrokragefreecrse.htm so they can download their own copy of the course.
  33. 33. 33 Description This section of the course provides an overview of the process of buying and selling businesses. It is intended to provide the student with all the ammunitions needed to clearly understand the implications of buying and selling businesses. After reading this course, the student should feel ready to buy and/or sell any small business. The reader will learn about making the business case, performing valuation (both standalone and combined), due diligence, and negotiating the deal. The course is will also be extremely helpful for accounting and financial professionals who also want to launch their own business brokerage practice. The Basics of Buying a Business There are various ways that individuals and existing businesses can buy an operating business. The table below provides a concise summary of how an individual or other business entity can purchase a business: Applies if the Purchaser is An Individual Buyer Another Business Acquisition / Purchase X X Asset Purchase X X Merger X Consolidation X Definitions Acquisition / Purchase An acquisition is simply a term used when an entire business is The Buy / Sell Process
  34. 34. 34 Definitions purchased by another business or an individual Asset Purchase An asset purchase is a special purchase where the buyer (either an individual or business) simply purchases the assets of another business. These assets may include inventory, equipment, client list, technology. The company selling these assets may still remain in existence, unless dissolved. Merger A merger is the purchase of an entire business where the company that is sold is absorbed into the acquirer Consolidation If the entity buying and the entity being bought are both dissolved and a new entity is created, we Definitions call the transaction a consolidation Reasons for an Acquisition Applies if the Purchaser is An Individual Buyer Another Business Opportunity to buy attractive assets X X Greater economies of scale X Faster growth X Chance to diversify product lines, businesses & X X
  35. 35. 35 Applies if the Purchaser is An Individual Buyer Another Business investments Increased power in the marketplace X Increased control X X Evaluating the Purchase of a Business Buying a business is simply another form of investment. Therefore, business valuation principles should be applied in order to determine whether the investment makes sense. Buying a Business Has Its Risks and Things Can Go Wrong We all know when the merger of two public companies goes wrong, because these cases are extensively covered by the financial papers. Purchasing a private business has even more risk associated with it, because a private company is not regulated and may not have well-documented financials for the purchaser to review. In addition, because the business has no obligation to report its performance to regulators, a seller may attempt to embellish income and profits to make the business more attractive to buyers. In this course, we teach a comprehensive and systematic approach to due diligence and business valuation, which will ensure that you or your client will stay away from purchasing businesses that are bad investments. Our Fictitious Buyer For The Course NoNameBuyer is the owner of a temporary employment business that he is selling. He is scheduled to close on the sale of his business and
  36. 36. 36 is already looking for another business to buy in order to avoid retirement. Nonamebuyer has made it clear to his broker that he is only interested in a training business or a proprietary school, which is profitable and has at least $1 million in annual revenue. In addition, Nonamebuyer is very familiar with the school business because he worked with several school placement directors who used his placement services to get their students a job. Based on the fact cited above, we know that Nonamebuyer is a sophisticated business person who has ample cash to purchase a new business. We have clear specifications of the type and size of business that he want s to purchase. Our Fictitious Business For Sale Nonameschool is small proprietary school with about $3.5 million in annual sale. The school has been operating for the past 13 years. The owner, Nonameschoolowner, has decided to sell and focus on her personal coaching business where she has an office closer to her suburban home. She is asking $1.1 million, which she says is justified because the school has several licenses to sponsor foreign students plus the owner just got approval to accept student loans, federal and state student grants. That, she says can dramatically increase the company’s revenue and profit. She made it clear that she is only selling because she can continue with the long daily train commute from the suburbs. The Business Case The Process of Evaluating a Purchase The purchase of a business often represents one of the most important moments in the life of both the buyer and seller. And this is true even if the buying entity is another business.
  37. 37. 37 It may be that the buyer (whether an independent buyer or an existing business), is purchasing a business for the first time. Unfortunately, in the majority of cases, the transactions fail because: The economy may change, The market may change and the demand for the entity’s product fade Nonetheless, the educated buyer (or a smart buyer working with an educated broker) can, through an extensive due diligence process, uncover and forecast the circumstances that can make a purchase unsuccessful. Except under special circumstances, in such cases, the transaction should not pursued. To ensure that the purchase is successful, a systematic plan should be followed to thoroughly evaluate the target and ensure that the investment is a viable one. The Business Case The elements that Nonamebuyer must analyze when making the business case for the purchase are discussed below. Business Outlook From a strategic viewpoint, Nonamebuyer must consider Nonameschool’s current strategy and its impact on the long-term outlook of the school. Nonamebuyer must determine if Nonameschool can sustain its students enrollment ratio and an increase (or at least the same level) of Government contracts that it has serviced in the past. Losing government contracts can result in a substantial drop in revenue. Ultimately, even though Nonamebuyer understands the challenges of a successful purchase, he decides that from a strategic perspective, buying Nonameschool makes sense given the current momentum in the business.
  38. 38. 38 Starting a New School vs. Buying One Furthermore, Nonamebuyer must decide whether it will make more sense to start a school from scratch, given the regulatory hurdles that he will have to face. Some of the roadblocks one must overcome when starting a new school include the following: 1. securing a proprietary school license, 2. applying and waiting for immigration department approval so that foreign students can take courses at the school (foreign students currently make up a large portion of Nonameschool’s student body with approximate revenue of $1 million) 3. Being approved to bid for government contracts, which make up a large portion of Nonameschool’s annual revenue 4. Apply for Title IV status, which allows a school to accept student loan, state and federal student grants as payments (Nonameschool has received approval. It normally takes several years to even be able to apply for this right) Starting a new school is certainly not less risky than a purchase. In addition, to start a new school will probably cost more than Nonamebuyer’s initial out of pocket to purchase the business (Nonameschool’s owner is asking for $200,000 at the closing). Furthermore, there is no guarantee that in the current environment, Nonamebuyer can build a startup school that is a successful as Nonameschool. By purchasing Nonameschool, Nonamebuyer inherit an existing profitable business. With the time it would take to get the school up and running, secure all necessary licenses and get licensed to bid for government contracts, it makes more sense to purchase the school.
  39. 39. 39 Can Nonamebuyer leverage knowledge from current or past business experiences to add more value to the purchase? The placement business, which Nonamebuyer owned, is in an industry somewhat complementary to that of proprietary schools. In addition, Nonamebuyer has quite a bit of insight into the school industry because he has worked with numerous schools to help them place students into temporary and permanent jobs. Nonamebuyer is launching into a business with a substantial knowledge of the field and can use that knowledge to continue to build the business. In fact, Nonamebuyer intend to contact his former clients to offer training and placement services. As can be seen from the paragraph above, Nonamebuyer certainly has leverage capability and intends to take advantage of his knowledge and experience to make the acquisition work. Making the Business Case From our discussion above, it can be seen that the rewards for this purchase outweigh the risks. Nonamebuyer therefore concludes that it makes business sense to buy Nonameschool, although he needs to ensure that it also makes financial sense, which we cover in the valuation sections of the course. The Financial Case The previous analysis of the business case convinces Nonamebuyer that the purchase of Nonameschool makes sense. However, we must advance to the next step and analyze the purchase from a financial stand point. More specifically, we must determine how much
  40. 40. 40 Nonameschool is worth in order to get an initial value for the purchase. This initial value may change later during or after due Diligence if anything is uncovered that can make the business less attractive. For example, we may find out that Nonameschool has high level of debt. If the seller wants Nonamebuyer to assume the debt, the total purchase price may be lowered to take those debts into account. We normally use a two-step process to make the financial case. First we value the business. Valuation itself may be a two-step process, depending on the status of the buyer. If the buyer is an individual buying a business (such as in the case of Nonamebuyer), we simply value the business as a stand alone operation. If however, the buyer is another business which is making the acquisition for the purpose of expanding its operation, we must also value what will be the combined entity if/when the transaction closes. Valuing The Purchase The starting point for Nonamebuyer’s initial valuation analysis is a standalone valuation of Nonameschool, which is an estimate of the business by itself as an operating business. In our case study for this course, we will not need to value a final combined entity, because at stated above, Nonamebuyer is an individual buying a single business. However, if Nonamebuyer were another school doing the transaction for the purpose of expanding the business, once completed, the standalone value of Nonameschool would have to be adjusted to take into account all appropriate synergies of the combination of the two businesses.
  41. 41. 41 Typically, the combination of the business being purchased and the business doing the purchase results in a combined entity that is worth more than the sum of the two standalone businesses. Comparable Businesses Valuation Analysis Nonamebuyer uses a comparable businesses valuation analysis to determine the standalone value of Nonameschool. This method of analysis is appropriate for the following reasons: • It is a sound method for estimating value, is easy to derive and is very applicable to this case • Nonamebuyer can take advantage of information available on publicly traded schools when doing the analysis Before going into the actual analysis phase, it is worth mentioning that before jumping into complicated analysis, it is extremely important to think about the context of a purchase. The overall timing of a potential business purchase has to be thought through. Even if the business is a great one, a purchase at the peak of an economic down cycle may not be the right thing to do. A good business in a bad industry is definitely not recommended. Finally an analysis of the market in which a business participates needs to be performed to uncover what really drives the business. The following is a list of issues that have to be considered while the valuation analysis is being performed: Table 1 Business Analysis Table Issue to Consider Resulting Notes Business environment &
  42. 42. 42 Issue to Consider Resulting Notes government regulations Business cycle impact Geographical risk Cost structure (including material and labor) Ease of financing (for internal growth or acquisition) State of facilities and equipment Competitors & potential entrants Channels of distribution Issue to Consider Resulting Notes Customer needs and their characteristics Flexibility in pricing your product or service (e.g. can you increase the number of coins needed to use a washing machine in a Laundromat without changing the machine itself?) Your strength as the new owner, including your age and experience Technology needs Advertising and promotion needs
  43. 43. 43 Issue to Consider Resulting Notes Legal issues and potential liabilities Expansion opportunities (or lack thereof) First: Document Collection To analyze a business, we begin by collecting and reorganizing its accounting and financial statements. Below is a list of essential documents that need to be gathered and analyzed. To make this analysis worthwhile, financials statements for at least the past three years must be available, preferably on a monthly basis. We recommend buying a business that has been operating (and has been profitable) for at least three full years: Table 2 Valuation Document Collection Item No. Document Description Date Collected 1. Income statement (Profit and Loss) 2. Balance sheet (Assets and Liabilities) 3. Cash flow statement 4. Monthly bank statements 5. Equipment list with replacement value 6. List of customers and contracts (with length of time left on contracts) 7. Employee roster with description of responsibility and salary information 8. Owners’ percentage interest along with salary and benefits information (health, insurance, company car, etc) 9. Copy of lease agreement
  44. 44. 44 Item No. Document Description Date Collected 10. Lines of credit, if applicable Note that most brokers and owners will require the buyer to sign a confidentiality agreement and put down a “good-faith” (different from a down payment) deposit before you are given access to such confidential information. That is normal procedure and a serious buyer will not object to deposit at least 0.50% of the offer price (not the owner’s asking price) to a broker. This money is usually put in escrow. Some brokers use a fixed amount (e.g. $1,000). That amount is used as proof that the buyer is serious about buying the business and will either be: - Deducted from the final sale price if you buy the business, or - Refunded if the acquisition the transaction does not close Second: Reconstructing The Financials Owners of privately held businesses are very motivated to pay the least amount of taxes possible. To achieve that goal, and to the extent permitted by accounting standards, they manipulate their expense accounts in order to show on paper that the business is making the least amount of profit possible. That, in turn, lowers their tax liability on the business’ net income. To objectively value a business, its financials have to be reconstructed and re-calculated. That is, adjustments have to be made to reflect the true profit potential of that business. Such adjustments are sometimes called add backs.
  45. 45. 45 Examples of such abnormal expense items by business owners include extremely large bonuses or salaries to themselves, above-market rent space from a building that is family-owned, and company cars that are leased for personal use. Sometimes such expenses may include illegitimate items such as salaries for non-working family members, family vacations marked as business trips, and personal expenses charged to the company. This leads us to conclude that some of these expenses have to be adjusted or re-calculated in context. This adjustment will result in a noticeable increase in net profit, or a decrease in net loss, from the Income Statement. As can be seen in the case below, there is a sizable gap between the Net Income on the left and the Adjusted Earnings on the right. That adjusted number reflects a more likely income from the business’ operations if the owner did not have to minimize income in order to reduce payment of business taxes. The adjusted financials represent more objectively what the new owner (in our case Nonamebuyer) will inherit. Table 3 Nonameschool Re-Constructed Financials Re-Constructed Financials New York Addbacks 2000 1998 1999 2000 Salary/Compensation $ 250,000 Tuition Revenues $ 3,053,129 $ 3,839,729 $ 4,026,519 Repairs/Maint. $ 11,730 Other Income/(Refund) $ - $ - $ - Office Expenses $ 75,000 Cost of Sales $ (306,094) $ (239,838) $ (139,064) T&E $ 50,000 Operating Expenses $ (2,555,850) $ (3,506,446) $ (3,615,476) Automobile $ 15,000 Other Expenses $ (31,742) $ (30,869) $ (120,044) Personal Insurance $ 15,000 Net Income $ 159,443 $ 62,576 $ 151,935 Family Relations $ 25,000 Misc. Expenses $ 70,000 Adjusted Earnings $ 513,665 New Jersey Addbacks 2000 1998 1999 2000 Salary/Compensation $ 155,000 Revenues $ 522,790 $ 1,524,381 $ 1,768,876 Repairs/Maint. $ 1,000 Other Income $ 995 $ 94,472 $ (168,259) Office Expenses $ 25,000 Cost of Sales $ (58,003) $ (84,267) $ (32,744) T&E $ 368 Operating Expenses $ (465,383) $ (1,435,575) $ (1,382,834) Automobile $ 1,308 Other Expenses $ - $ - $ (33,335) Personal Insurance $ 1,500
  46. 46. 46 Re-Constructed Financials Net Income $ 399 $ 99,011 $ 151,704 Family Relations $ 15,000 Misc. Expenses $ 10,000 Adjusted Earnings $ 305,881 New York & New Jersey Total Addbacks 2000 1998 1999 2000 Salary/Compensation $ 405,000 Revenues $ 3,575,919 $ 5,364,110 $ 5,795,395 Repairs/Maint. $ 12,730 Other Income $ 995 $ 94,472 $ (168,259) Office Expenses $ 100,000 Cost of Sales $ (364,097) $ (324,105) $ (171,808) T&E $ 50,368 Operating Expenses $ (3,021,233) $ (4,942,021) $ (4,998,310) Automobile $ 16,308 Other Expenses $ (31,742) $ (30,869) $ (153,379) Personal Insurance $ 16,500 Net Income $ 159,842 $ 161,587 $ 303,640 Family Relations $ 40,000 Misc. Expenses $ 80,000 Adjusted Earnings $ 819,546 Once Nonamebuyer has constructed Nonameschool’s adjusted earning, he can go to the next step of the valuation analysis. Side Note The reader might be asking why such emphasis on the Net Income of a business as opposed to just valuing its assets. The truth is that, in addition to the fact that some businesses, such as certain service businesses, do not have any hard assets, Side Note assets do not produce cash flow, revenue and income do. Although the assets of a business are important, if they are not generating enough cash flow, they can not help the buyer cover business expenses. In addition, a business can generally find ways to generate revenues that its assets are not capable of producing. For example, a computer manufacturer may, in addition to selling computers, decide to provide computer maintenance services to its clients. Another example might be a Laundromat owner who decides to provide Dry Cleaning services by contracting out the work to a Dry Cleaning Plant. In both cases, the assets of the businesses (e.g. computers, washers and dryers) do not produce the income received. Because the buyer is acquiring the right to receive the future earnings of the business, its ability to produce cash is really what is important.
  47. 47. 47 As we can see, having your offer price dependent upon the true income (or income potential) of the business is essential. If your value is too low and you are unable to negotiate with the seller, you may be missing on a great opportunity. On the other hand, if your analysis results in overpricing the business, you will be paying too much for a business that may fail after you have invested possibly all of your life savings into it. Third: Build The Comparable Table of Publicly Traded Companies in The Same Industry Nonamebuyer then creates the comparable table listed below and populates it with sales, net income and market value information obtained freely from the Internet. The purpose of this table is to help Nonamebuyer establish a baseline for comparison. It is impossible to compare companies based on sales and net income, because some companies Financial Ratios of Comparables Companies in the Training & Education Industry (Data as of 12/2000) Computer Learning Center Learning Tree Inter Devry New Horizons Prosoft Training ITT Edu. Sylvan Apolo Grp. Franklyn Covey University of Phoenix Whitman Education Group Concorde Career Colleges Sales (million) 130.50 236.70 560.20 142.70 30.40 360.10 316.70 672.70 549.40 130.20 79.20 38.80 EBITDA (million) (16.60) 62.40 115.30 25.80 3.32 56.20 38.00 160.70 37.50 37.00 3.60 725.0K Return on assets (%) (8.56) 20.62 14.50 9.72 7.78 21.26 (0.17) 18.85 (2.46) 34.02 (1.24) (1.09) Return on equity (%) (22.49) 34.95 24.00 13.55 9.39 49.15 (0.28) 28.17 (7.52) 48.97 (3.60) (8.84) Market Value(million) 372.0K 441.30 2,390.00 114.90 62.70 783.00 625.00 3,740.00 139.40 1,640.00 35.70 7.60 EBITDA multiple n/a 7.07 20.73 4.45 18.89 13.93 16.45 23.27 3.72 44.32 9.92 0.01 Sales multiple 2.85 1.86 4.27 0.81 2.06 2.17 1.97 5.56 0.25 12.60 0.45 0.20
  48. 48. 48 may have revenues in the billions, while others will be million-dollar revenue companies. To set the stage for proper comparison, Nonamebuyer creates financial ratios for 12 publicly traded school companies to construct his table. To create the ratios Nonamebuyer use Sales, Net Income and Market Value (based on share price). From looking at the “Financial Ratios” table, you will see that Nonamebuyer uses the following ratios to perform the comparison: Return on assets (%) (from Yahoo!Finance) Return on equity (%) (from Yahoo!Finance) EBITDA multiple = Market Value / EBITDA Sales multiple = Market Value / Sales Fourth: Build Ratio Table For Nonameschool Nonamebuyer then goes on to create a table in which the he derives the same ratios used in the previous table for the 12 publicly traded companies he has chosen to use in the analysis. (Note that the EBITDA number used below is from the adjusted financials) Nonamebuyer uses EBITDA multiple to arrive at a final price estimate for Nonameschool. From the formula below, you will notice that we are missing one piece of information to derive the EBITDA Multiple. Since Nonameschool is not a public company and there is no Market Value. Therefore, Nonamebuyer use the asking price for Nonameschool as his Market Value. The formula for EBITDA Multiple is: EBITDA multiple = Asking Price / EBITDA For Nonameschool, this ratio is equal to 12.40 (see table below in the ‘Total’ column).
  49. 49. 49 As of December 2000 Nonameschool Ratios NY NJ Total Sales $ 4,190,131 $1,768,876 $ 5,959,008 EBITDA $ 675,172 $ 357,218 $ 1,032,390 Profit margin (%) 16.11 20.19 17.32 Return on equity (%) 306.88 106.71 187.90 Asking Price $12,000,000 $800,000 $12,800,000 EBITDA multiple 17.77 2.24 12.40 Sales multiple 2.86 0.45 2.15 Fifth: Perform Ratios Comparison Tor perform the comparison, Nonamebuyer takes the average EBITDA Multiple of all 12 companies used in the comparison table. In this case the Average EBITDA Multiple is 13.56. As can be seen, Nonameschool’s EBITDA Multiple is below the average, which means that the asking price is within reason (and could even be increased if needed). However, Nonamebuyer needs to take one more step, which is to Adjust Nonameschool’s valuation for lack of liquidity. Sixth: Adjust Nonameschool Value For Lack of Liquidity Before Nonamebuyer can arrive at a final estimated valuation for Nonameschool, he must take into account that Nonameschool is not a publicly-traded business and its shares can not be easily bought and sold as is the case with for companies with shares traded on an exchange. For that reason, Nonamebuyer must discount the price for Nonameschool to make up for the illiquidity, which is a drawback for all private businesses. It is not easy to sell them and any buyer takes a chance when purchasing them. Because of the risk associated with this illiquidity, Nonamebuyer
  50. 50. 50 must get a small amount discounted from the price. The discounted amount varies and will depend on how much a buyer wants to buy a business. In Nonamebuyer’s case, 10% is subtracted from Nonameschool’s asking price of $12MM for a final offer of $10.8MM. Discounted Cash Flow (DCF) In certain cases, it may be difficult, if not impossible to use the Comparable Businesses Valuation Analysis method because it may not be possible to find publicly traded company to which we can compare the entity being purchased. For example, if one were to buy a chain of Laundromats, it would probably be very difficult to find publicly-traded Laundromats. Using publicly traded service businesses would not be accurate because a service business may have several entities providing services in various sectors. In such cases, it may be more appropriate to use the Discounted Cash Flow method of analysis. We will not go into all the details involved in using this method, but will simply list all the step necessary to conduct effective valuation. Projection Horizon The first step of the DCF analysis is to choose a time horizon for projecting the cash flows of the business being valued. Although the horizon should be short enough so the cash flow estimates are reasonable, it should also be long enough to reach the point where the business is stable. A five-year time horizon is usually appropriate Calculating Free Cash Flows or FCF The second stage in conducting the Discounted Cash Flow analysis, is to calculate projected cash flows.
  51. 51. 51 In order to get an objective operational value of a business being purchased, a buyer should use the free cash flow (FCF) projections of the target. Free cash flows, as we’ve learnt, are the cash flows from operations, before any financing activities. a) Calculate EBIT as shown in the example below: Year 1 Year 2 Year 3 Year 4 Year 5 Revenue $104,911 Less Cost of goods sold 62,822 Gross Profit 52,089 Operating Expenses Depreciation 12,400 Amortization 10,498 Rsrch & Dev 11,245 Selling, Gen & Admin 33,780 Total Op. Exp 37,923 Earnings Before Interest & Taxes (EBIT) 24,166 b) Calculate Projected Free Cash Flows as shown below Year 1 Year 2 Year 3 Year 4 Year 5 Earnings Before Interest & Taxes (EBIT) $24,166 Less Taxes 15,666 Net Operating Profit After Tax (NOPAT) 18,500 Plus Non- Cash Expenses Depreciation 12,400 Amortization 10,498 Chg in Differed Taxes 10,000 Cash Flow After Non- Cash Expenses 21,398 Less Net Working Capital investment 10,150 Projected 10,000
  52. 52. 52 Year 1 Year 2 Year 3 Year 4 Year 5 Capital Expenditures Projected Free Cash Flows 21,248 c) Calculate Present Value of Free Cash Flow as in the example below: Year 1 Year 2 Year 3 Year 4 Year 5 Revenue $104,911 $27072 $134,035 $142,208 $149,606 Gross Profit (Revenue – COGS) 52,089 64292 67,424 71,584 74,805 Total Operating Expenses 37,923 44793 45,127 46,277 47,916 Earnings Before Interest & Taxes 24,166 29499 32,297 35,307 36,889 - Taxes 15,666 17,800 18,919 20,123 20,756 Net Operating Profit After Tax (NOPAT) 18,500 21699 23,378 25,184 26,134 Year 1 Year 2 Year 3 Year 4 Year 5 + Non-Cash Expense $12,898 13,918 14,118 14,118 14,418 - Net Working Capital Investment 10,150 9,021 11,234 11,458 21,329 - Projected Capital Expenditures 10,000 12,000 11,500 13,500 12,000 Projected Free Cash Flows 21,248 24,596 11,762 24,344 27,223 Present Value of Free Cash Flow 19,781 21,037 19,706 18,201 18,563 d) Calculate The Target’s Terminal Value as shown below: • Terminal Value (in Terminal year T or year 5) (000s): • TV = FCFT+1 / r or 17,223 / 0.15 or 114,820 • Present Value (PV) of Terminal Value (000s): • PV = TV / (1+rate)5 or 114,820 / (1 + 0.15)5 or 57,086
  53. 53. 53 e) Finally Derive The Target Business’ Value (000s) Sum of PV of FCF = $37,288 Plus: PV of Terminal Value = 47,066 Enterprise Value = 94,374 Less: Outstanding Debt = 4,000 Equity Value = 80,374 Additional Valuation Tips Using the method discussed above presents a very simple way to extract the value of any business after its financials have been analyzed and re-constructed. However, sometimes, it may be necessary to adjust that technique into a more specialized form of valuation, as briefly discussed below, depending on the type of business that is being purchased. To address that issue, the following sections will briefly introduce some of the details that may be involved in valuing certain types of businesses or assets. A buyer involved in any one of those businesses may first want to apply the multiple of earnings method and then apply necessary adjustments. Valuing Intangible Assets When buying a business it is very important to recognize that there may be several factors and things that contribute to the business income and profit. Among the most common items that must be taking into the analysis are: Software system Patents Trademark Copyrights Subscriptions Customers
  54. 54. 54 Contracts (both government and corporate) Brand names The above items make up a company’s Intangible Assets and must be factored into the valuation analysis because they often play an important role in revenue generation. Although there are no rules-of-thumb when valuing intangible assets, it may be pointed to the reader that these assets are usually analyzed using one of the following methods: Determining what it would cost another business to duplicate a given asset today Measuring the benefits intangible assets will bring to a business, and how long those benefits will last Predicting the life span and future financial benefits of an intangible asset Professional Practice Valuation Professional practices such as accounting, consulting, law and medical practice firms, are usually assets light. But strong relationships with their customers and highly trained employees are extremely valuable. A firm’s customers must be reviewed closely to determine how much value can be attributed to those customers. Usually the length of the relationships will be a key point as stability and longevity are two signs of lower risk, and hence higher value. Final Note about Valuation and Premiums Payments Even though this book is targeted at buyers of privately held businesses (a premium is almost always required with the acquisition of a publicly held company), we would like to mention that many times, there might be a need to add a premium to the resulting asking price from a
  55. 55. 55 valuation analysis. That is, a buyer may have to pay the seller an amount above the fair value of the business to make up for certain factors such as: Contracts (especially government contracts), Goodwill (an intrinsic value attached to the business as a running entity), Hard assets (except for real estate which is normally valued separately from the business), Patents, and Exclusivity (applicable normally to transportation or distribution businesses) In such cases, the premium to be paid will be based on industry standard, the buyer’s judgment, and his/her level of interest in the business. In addition, if the business is a really great business and the Intermediary or broker had done a good job at promoting it for the buyer, there may be more than one buyer interested in buying that business. In that case, an auction may result with the best price and most qualified buyer closing on a transaction with the seller. Combined Business Value (The Buying Entity is another Business) In our scenario for this course, we have one individual, Nonamebuyer, purchasing a business, Nonameschool. Therefore, our valuation analysis ends once we have derived a value for Nonameschool as a standalone business. However, when an existing business is buying another business, there is usually another step in the due diligence process, which is to do a pro forma analysis of the potential combined businesses. This section of the course discusses that analysis.
  56. 56. 56 Pro Forma Analysis The next step when a buyer executes the valuation analysis is a pro forma valuation. This analysis is a combined financial statement that represent the combined businesses. Acquisition Synergies Definition Table Synergy Type Effect Revenue Synergies When there are revenue-related synergies, the revenues for the combined entities is greater than the sum of the revenues for each individual business. These synergies are triggered by complimentary product mixes, cross-selling opportunities, more efficient channels of distribution, and improved marketing. Cost Synergies When there are cost-related synergies, total expense for the Synergy Type Effect merged entities are less than the sum of the expenses each business as a separate company. These synergies may include a more streamlined operations, economies of scale and staff reduction. Tax Synergies If there are tax synergies the merged businesses will pay less taxes than the sum of the amounts they would normally paid as separate businesses. The first step in deriving the pro format value is to calculate the value for revenue, cost and tax synergies. To do that, you simply analyze the financials (more specifically the Income Statements) of both businesses to determine where these synergies could be realized. Once your analysis is done, you should have a table that looks like the following:
  57. 57. 57 Synergy Estimated Amount To be Realized ($) Realized in Percent Revenue Synergies $75,000 Total Revenue / Realized Revenue Synergy Amount Cost Synergies $150,000 Total Expenses / Realized Expense Synergy Amount Tax Synergies $50,000 Total Taxes / Realized Tax Synergy Amount The next step in calculating the pro format value is to update revenue, total expense and tax, using the increase and decrease resulting from the realized synergies. Initial Amount (From Income Statement) +/- Estimated Realized Synergy Amount ($) Total Revised Revenue Total Revenue From Income Statement + Realized Revenue Synergy Total Revised Expenses Total Expenses From Income Statement - Realized Expense Synergy Total Revised Taxes Total Taxes From Income Statement - Realized Tax Synergy
  58. 58. 58 The percentage values are used to estimate these synergies in projected financials used in a discounted cash flow method of valuation. Due Diligence Letter of Intent Upon completing the preliminary valuation, Nonamebuyer submits a letter of intent (see your package for a complete set of forms and documents needed to run your practice) to purchase Nonameschool. This letter establishes Nonamebuyer’s intent to buy the business, present an offer that Nonamebuyer is willing to pay, and officially set a time period to perform due diligence and close on the transaction. Nonamebuyer is asking for a 45- day due diligence period, which Nonameschool has accepted. Sample Letter of Intent SAMPLE LETTER OF INTENT HERE Dated October 23, 2006 Outline of Business Terms for the Acquisition of [Target Business] - collectively hereinafter referred to as “Target” - (including any interests held by [Seller’s name] or other shareholders collectively hereinafter referred to as “Seller”) by [Buyer’s Name] or its designated representative(s) (hereinafter referred to as “Buyer”). Both parties hereby specifically agree that the subject purchase of [Target] does not include its [Excluded Part of Business], which shall be duly separated and retained as by Seller under [Other Entity of Target]. 1. Seller agrees that, at the Closing, it will sell, assign, transfer, and deliver One Hundred Percent (100%) of its interests in [Target Business], and Buyer agrees that it will purchase such interests. 2. Buyer and Seller agree that the business is valued at $[Sale Price] and that the Buyer will purchase 100% of the business
  59. 59. 59 Sample Letter of Intent for an amount equal to $[Sale Price]. 3. The Seller hereby agrees that the Purchase Price shall be paid and satisfied by the Buyer as follows: A. Down Payment of $[Down Pay Amount] in cash or cashier’s check due at closing B. The remaining balance of $[Balance] is to be paid over a period of [No months/years] in the amount of $[Payout Amount] each month. Such balance is to be secured by a note, mortgage/stock, pledge/security agreement. There will a two-month grace period granted to the Buyer after the closing, and such grace period will not include the month of the closing. For example, if the closing takes place on August 21 st , the first monthly payment will not be due to the Seller until November 1 st . 4. The Closing is to take place on, or around [Closing Day, Year] (a definitive date will be set upon completion of the due diligence) 5. All governmental and regulatory approvals and all consents of third parties (including for example certification agencies and landlords), and compliance with any conditions thereof, required in connection with the completion of any of the Sample Letter of Intent transactions contemplated by the definitive Agreement, the closing or the performance of any of the terms and conditions set forth in the definitive Agreement shall have been obtained and complied with on or before the Closing. 6. The definitive agreement shall incorporate an appropriate non- compete section prohibiting Seller from engaging in, directly or indirectly, any company which in any way is competing with [Target Business], in the tri-state area, within a 100-mile radius of [Target] or any of its branches or extensions wherever located, for a period of 5 years. 7. The parties shall do all things and provide all reasonable assurances as may be required to consummate the transactions contemplated by this term sheet and each party shall provide such further documents or instruments required by any other party as may be reasonably necessary or desirable to effect the purposes of this Term Sheet. 8. Expenses: • Buyer and Seller will each pay their own expenses, including legal expenses, up to the time of the closing. 9. This letter of intent is non-binding and may not be construed as an agreement on the part of any party. In the event that the parties are unable to agree on a mutually satisfactory definitive agreement providing for the
  60. 60. 60 Sample Letter of Intent transactions contemplated by this letter of intent, none of the parties shall be liable to any other party or to any other person. The conclusion of any definitive agreement will be subject to the following: • FINAL DUE DILIGENCE BY BUYER OF BUYER’S DESIGNEE • Approval of all matters relating thereto by the Seller’s and Buyer’s lawyers • Review of all business, legal, and auditing matters related to the business, the results of which are acceptable to Buyer 10. LEASE OF BUILDING SPACE: Seller has agreed to transfer the current lease to the Buyer and that all security deposit money will remain with the Landlord. 11. General and Specific Liabilities: Seller will assume all existing lines of credit. 12. Continuing Obligations: Until termination of this letter of intent, the Seller should not entertain negotiations with or make disclosures to any other party, without prior consent of Buyer. 13. Confidentiality: Both the Buyer and the Seller agree to maintain complete confidentiality regarding this transaction. Sample Letter of Intent 14. Buyer Training: In order to efficiently transition the school, Seller agrees to assist Buyer as follows: -- On a full-time basis during the first 2 weeks after the closing -- On a part-time basis (1 hour per day), during the 3 rd and 4 th weeks after the closing -- for a period of 5 months, thereafter, on an as-needed basis either by phone or in person. 15. All documents in respect to this transaction will be prepared by Buyer’s attorney, subject to such documents being reviewed by and being acceptable to the Seller’s legal counsel. 16. This Agreement shall be governed and construed in accordance with the laws of the State of [Name of State]. In witness whereof the parties have hereunto duly executed this Agreement on the date first above written. Goals of Due Diligence With the period of due diligence agreed upon, Nonamebuyer’s lawyer, banker and accountant begin to seriously work on the transaction. During the due diligence process Nonamebuyer’s team
  61. 61. 61 may find reasons to change their initial valuation of the business and reduce their offer. After due diligence, if Nonamebuyer is convinced that the purchase makes financial sense, the offer price will probably remain the same and the transaction consummated. Key Areas Examined During Due Diligence Although all of Nonameschool’s operations and financials can be inspected, Nonamebuyer will focus on the areas of the business that matter the most. These areas include the company’s foreign students recruitment efforts, government contract history and projections, and the company’s expenses, Title IV, and healthcare expansion opportunities. Further, Nonamebuyer will apply quality tests, such as quality of earnings, and expense reporting accuracy to attempt to verify how solid the numbers reported on Nonameschool’s financial statements are. Other Areas Subject to Review Nonamebuyer's review will include employee contracts (if any) and employee policies. Nonamebuyer will also take the opportunity to meet Nonameschool’s key people and begin to decide which ones of these people will efficiently contribute to the business once the transaction closes. Nonameschool’s courses and student body will be reviewed and analyzed. This review will include student drop-out rate, student placement ratio, number of students per class and instructors’ tenure. Furthermore, Nonameschool’s marketing strategy will be investigated. Finally, Nonamebuyer will complete a thorough background check of the school to uncover any legal issues that may be in progress.
  62. 62. 62 Review of Revenue Projections As Nonamebuyer’s CPA conducts a thorough review of Nonameschool’s accounting system, an important question arises. In the current year, Nonameschool has $1.9MM worth of government contracts. The question is, what guarantees that Nonameschool will receive the same amount in contracts revenue. It turns out that government contracts are never guaranteed. However, a positive performance review from the government agency that awarded the contract is the equivalent of a guarantee that if the government spends any money on education (which we know it will), Nonameschool will be awarded a portion of the available funding. Nonamebuyer needs to determine at that point whether to lower the offer price to reflect the possibility that revenue may be reduced by at least $1.9MM if Nonameschool is not awarded any contract. However, Nonamebuyer verifies that Nonameschool has performed very well on its previous year contract as attested by a letter from the state agency which awarded the contract. Furthermore, Nonamebuyer is convinced of the following: Nonameschool has been in business for over 13 years and for the past 10 years has been awarded government contracts every year. Finally, Nonameschool was just granted Tittle IV status, which the school can use t o increase revenue by accepting students payment in the form of student grants and student loans, which can increase revenue exponentially and offset the possible loss of revenue from government contracts. Given these assertions, Nonamebuyer concludes that the offer is still a fair one and the purchase still makes financial sense. Having analyzed the revenue numbers and spoken to Riverside sales managers, the team makes it decisions.
  63. 63. 63 For the non-digital revenue, the team decides that the sales manager has a sound explanation for a revenue growth rate higher than the industry rate. Therefore, those projections are left at 2.5% compound annual growth rate. However, for the new digital press product line, the team is concerned that the base case of 41% compounded annual growth is overly optimistic. The team revises this projection back to the sales team's worst-case scenario of 34% growth. Review of Expenses In addition to revising Nonameschool’s revenues, Nonamebuyer also does a thorough review of the company’s expenses. After lengthy conversations with Nonameschool’s owner, Nonamebuyer’s CPA determines that several employees will be leaving with the owner to operate a new business that the owner has been running from within Nonameschool. This will reduce the headcount and payroll and increase the bottom line by several thousand dollars monthly. After a careful analysis, Nonamebuyer’s CPA concludes that the offer need not be revised and and no revision of the financials is necessary. Both Nonamebuyer’s CPA and lawyer give the green light to proceed with a formal Purchase Contract towards closing.
  64. 64. 64 Additional Due Diligence Resources Table 4 Due Diligence Table I Due Diligence Item Item to Investigate Target Date Done (Y/N) Financials Balance Sheet, Income & Cash Flow Statements. These will be analyzed in depth in the special ‘Valuation Analysis’ section, later in this book. They are the most important documents of your Due Diligence package as they will tell you whether or not the business is growing, stagnant or failing. Usually 3 to 5 years are required in order to make a good analysis of the business. Never buy a business that is loosing money, unless you have the financial muscles and resources, as well as the expertise to turn it around. Undisclosed debts and liens against business assets by running a UCC (Uniform Commercial Code) search General Company History Overview of founding and evolution of the Company Significant events since the date of founding (e.g. previous acquisitions or subsidiary/location sale)
  65. 65. 65 Due Diligence Item Item to Investigate Target Date Done (Y/N) Rationale for selling Company (why is the owner selling?) Special aspects of the business (is it a regional or cyclical business?) Business Structure/General Legal Documents Basic legal structure (Sole proprietorship, Corporation, etc.). That will affect whether the transaction is executed as a stock or assets sale. See “Legal Issues” section Organization charts (if applicable) Certificates of incorporation Industry Growth Trends (you do not want to buy a business in a dying industry) Cyclicality of business or products (overall economy, seasonal) Future outlook Market analysis (size, trends, etc.) Barriers to entry (how easy is it for a competitor to get into this business?) Review available market research or industry analysis Competition Main competitors (by product segments, geographic,
  66. 66. 66 Due Diligence Item Item to Investigate Target Date Done (Y/N) regions, etc.) Prospective competitors Profiles of competitors Sales approach (how do your prospective competitors market their products or services compared to your seller?) Product positioning (price, technology) Competitive Advantages Source of uniqueness Market share Brand name Economies of scale Changing technologies Products Review existing products or services List major customers for each product List of major competitors for each product/service Profile potential new entrants and their new products/services Analyze nature of competition (efficacy, price, etc.) Suppliers What method is used to purchase principal items How far ahead does the company purchase inventories
  67. 67. 67 Due Diligence Item Item to Investigate Target Date Done (Y/N) Who are the major suppliers (top 10)? What is your source of materials, including contracts, any minimum purchase contracts, purchase orders for significant items of purchase and sole source suppliers? Are there any special discounts? Sales organization Structure Size Compensation (salaried vs. commission, incentives, etc.) Training Marketing strategy Types of advertising/promotional activity Pricing Trends of expenditures How does this strategy differ (or not) from competitors? Distribution Distribution mechanics Areas served Significant agreements/arrangements Outlets Types and % of volume distributed through each
  68. 68. 68 Due Diligence Item Item to Investigate Target Date Done (Y/N) (by county or region if applicable) Facilities (location and % of volume shipped from each) How does this distribution differ (or not) from competitors?
  69. 69. 69 This might look somewhat overwhelming to someone buying a business for the first time. But the prospective buyer should not proceed until satisfactory Due Diligence has been completed. And that process can take from 1 week to 3 months or more, depending on the size and complexity of the business being acquired. Even though we do not want to paralyze ourselves with analysis, reviewing the most relevant items on this list for your particular industry is highly recommended and will virtually guarantee that the business you buy is worth your invested capital. For example, if you were going to purchase a wholesale business, you would need to make sure that the following Due Diligence Items are totally investigated before finalizing your offer: Table 5 Due Diligence Table II Item To Investigate Notes Financials See Valuation Analysis in the Item To Investigate Notes following section. Industry You do not want to buy a business where technological advance or a better product is replacing the product that the target business distributes, unless you can plan to distribute or sell that new product. As discussed previously, the industry you are buying into is critical, as its prospects will determine whether you are making a long- or short-term investment. You need to be in a sector where your services will be needed for a least the next five to seven years without major industry shakeout. Although it is difficult to predict, basic research can provide the data necessary to figure out if there are any major changes under way in a particular industry. If that is the
  70. 70. 70 Item To Investigate Notes case, unless you believe that you will have the required funds to weather out the storm and make necessary changes to your operations, it is recommended that the buyer get into a business that will be more stable within the next few years, Competition You never want to buy a business without a thorough analysis of your current and possible future competitors’ strategy. Among the most important points you will need to be aware of are your competitors’ pricing levels, advertising medium, marketing channels, vendors and special promotions. You want to be able to match what they do with either a variation of what they offer, or a new and improved product or service. Item To Investigate Notes Suppliers You want to make sure that you will continue to get the products you sell from the suppliers. The worst thing that can happen to a buyer is to find out after an acquisition that the acquired business’ major supplier will no longer sell its products to the business after the new buyer take over. No one should buy a business if they can not establish a solid relationship with their future suppliers. They are part of the lifeblood of the business as they provide the owner with what the customers need. Sales The prospective buyer must confirm sales data from a seller. That can be accomplished in many ways, but can usually be verified by inspecting purchase orders and receipts from suppliers. The more
  71. 71. 71 Item To Investigate Notes products are purchased from suppliers, and the more often they are purchased, the more they are being sold. A business that has a high level of sales is always ordering new merchandise to re- stock its inventory reserves. This will be your clue as to whether sales have been stagnant, increasing, or decreasing. Of course if there is a lot of buying activities in the immediate months preceding the sale of the business, there could be ground for further investigation as the owner might have been “preparing” the business’ financials for the sale. The other important clue that can help a buyer gauge sales level is the activities in the business’ bank account. The prospective buyer Item To Investigate Notes should inspect frequency and size of deposits for several weeks prior to the Due Diligence period. Please note that it is even more important to inspect bank statements of service businesses where no inventory has to be purchased. (Dry Cleaning businesses are a good example of a service business that does not have to buy any inventory for re-sale.) Distribution Distribution is one of the most important factors that can make or break a small business, especially a small business in the wholesale industry. Items to inspect will vary from increasing distribution cost (a red flag) to actual distribution channel, like postal mail, the Internet, independent distributors, etc.
  72. 72. 72 Item To Investigate Notes If a buyer is reluctant to conduct a thorough Due Diligence, there are software packages that can help to analyze an acquisition (see the Appendix for additional resources for prospective business buyers). Or, you can simply hire the services of an expert if you have the funds to do so. However, most prospective small business buyers do not have the financial resources to do that. So, simply studying the material covered in this section and following the advice and steps outlined in this book will almost guarantee that you will not be buying a failing business. Final Valuation Estimates Final Standalone Valuation In our case study for this course (the purchase of Nonameschool by Nonamebuyer) the conclusions that came from the due diligence were that the transaction as structured is fair and there were no need for changes. However, in most transactions, things are uncovered by the buyer that result in substantial changes in valuation and final offer for the acquisition. In a case where there are changes to the valuation of the target, the standalone valuation of the target must be revised. This revised standalone valuation results to a combined valuation that always forces the buyer to reduce the price that he/she is willing to pay to close on the transaction. The buyer’s valuation team does this by modifying the appropriate sections of the valuation analysis and re-formulating the offer.
  73. 73. 73 The revision depends on the valuation methodology used. Here, we will briefly cover the Comparable Businesses. Comparable Businesses Valuation Method The table from the previous standalone valuation section must be adjusted to account for any revisions in the numbers. In this case, let us say that revenue decreases by $250K in both NNY and NJ, for a total reduction of $500K. That in turn will change EBITDA and the EBITDA multiple as shown in the original and revised tables below. Initial Table As of December 2000 Nonameschool Ratios NY NJ Total Sales $ 4,190,131 $ 1,768,876 $ 5,959,008 EBITDA $ 675,172 $ 357,218 $ 1,032,390 Profit margin (%) 16.11 20.19 17.32 Return on equity (%) 306.88 106.71 187.90 Asking Price 12,000,000 800,000 12,800,000 EBITDA multiple 17.77 2.24 12.40 Sales multiple 2.86 0.45 2.15 Revised Table (Interim) As of December 2000 Client's Ratios NY NJ Total Sales $ 3,940,131 $ 1,518,876 $ 5,459,008 EBITDA $ 425,172 $ 107,218 $ 532,390 Profit margin (%) 10.79 7.06 9.75 Return on equity (%) 191.64 28.06 94.41 Asking Price 12,000,000 800,000 12,800,000 EBITDA multiple 28.22 7.46 24.04 Sales multiple 3.05 0.53 2.34 Obviously, the EBIDTA multiple is totally distorted and far away from the 13.56 average we concluded from our publicly traded company we used for our comparison. Remember that our market value, in the case of a private business, is essentially the seller’s asking price. We must therefore adjust the asking price until our EBITDA multiple falls within acceptable value. The final revised table below shows that we’ve adjusted the asking price to $7,200,000.
  74. 74. 74 Side Note Note: In addition to you BizVal Business Valuation software, your package includes an Excel Valuation workbook with spreadsheets and formulas you need to conduct more advanced valuation analysis and scenarios. Revised Table (Final) As of December 2000 Client's Ratios NY NJ Total Sales $ 3,940,131 $ 1,518,876 $ 5,459,008 EBITDA $ 425,172 $ 107,218 $ 532,390 Profit margin (%) 10.79 7.06 9.75 Return on equity (%) 191.64 28.06 94.41 Asking Price 12,000,000 800,000 7,200,000 EBITDA multiple 28.22 7.46 13.52 Sales multiple 3.05 0.53 1.32 At this point, when due diligence has been completed and all the necessary adjustments to the projections and statements made, if the final valuation estimates is accepted by the seller, the transaction can go into contract and proceed to a closing. At that point, the lawyers on both sides will take over and the intermediary’s job simply to keep the flow of documents and information moving.
  75. 75. 75 Notes Here’s what you can do to gain even more: Click Here (http://rglpublishing.com/bizbrokcrse.htm) to Buy Your Own Copy Of The Printed Version of this course for the modest sum of $179.85 and get the following: A printed copy of the Business Brokerage Home Study Course in a convenient 3-ring binder for easy access (Value: $149.97) The BizVal Business Valuation Software PLUS a separate comprehensive Excel Valuation Workbook (Value: $274.95) All the Forms and Contracts you need to immediately start your practice. The forms are also in electronic format if you decide to make changes to them (Value: $59.95) Personal e-mail consultation with me, as you begin to build your practice. With these consultations, I will personally assist you while you work on your first transaction, until you close the deal and get paid (Value: Priceless) Direct answer from me to any questions you may have about the course (including questions about valuation, financials statements, due diligence, etc.) My complete lifetime guarantee. If you find out later that Business Brokerage is not for you, just send me an e-mail and I will refund your money without asking any questions (even after you’ve had the chance to review it for free!) If You Do Not Think That Business Brokerage Is For You Here is how you can help others who could benefit from this course: Send this eBook to your friends who might be interested in Business Brokerage Or better yet, send them to http://rglpublishing.com/bizbrokragefreecrse.htm so they can download their own copy of the course.
  76. 76. 76 For the purpose of “buying” and flipping small businesses, the legal and tax aspects are not relevant because we are actually not buying the business. When “buying” to flip, we simply use an option to acquire the rights to purchase the business. This in turn, give us time to go and look for an actual buyer for the business. As mentioned before, we are not business brokers, because we are not agents of the seller. Rather, we are a special type of buyer who is using an option to “lock” in the business for purchase. But instead of acquiring the business, we find a real buyer to whom we sell our option for a profit (the price we offered and the price the buyer will be paying). Again, as mentioned before, we sometimes simply sell the option outright to the buyer who finalizes the actual purchase with the owner. That said, the information below is important enough that we thought that it would be in the reader’s best interest to understand some of the legal and tax implications when a business changes hands. Acquisition Options Although many legal and tax issues are at play when a business is being purchased, we will not go into the details of all that can be involved. This is only because the author assumes that the reader will be engaged in a simple transaction in which the tax and legal implications are not so complex that they make these issues ground for concerns. We are also assuming that the buyer will use the services of a lawyer to effectively complete the purchase and close on the transaction. No one would think of buying real estate without a lawyer. The same should apply to buying a business, where transfer of real estate assets may be involved. Brief Overview of Legal and Tax Issues
  77. 77. 77 Assets vs. Stock Purchase The most important aspect of an acquisition when small businesses are concerned, is whether the buyer will be acquiring the stock of the business, or its assets. To make this clear, let us define a business (which we will assume is a small corporation) as a collection of assets and liabilities. Assets can be real estate, cash, contracts, receivables, equipment and machinery. Liabilities, of course, are what the business owes to its creditors, shareholders and stakeholders (such as employees). Those can be bank loans, back taxes, payroll, etc. When a buyer completes an acquisition through a stock purchase, that buyer inherits everything that makes up the business, both assets and liabilities. If a buyer simply wants to take over the assets, it has to be specified in the Letter of Intent that the transaction will be structured as an asset purchase, instead of a stock purchase, which means that the buyer will not be responsible for the company’s liabilities once the business has been acquired. Those liabilities not assumed, and which may include bank loans, among other debts, will continue to be the responsibility of the seller, even after the business has been sold. Stock sales are often used when the seller is financing the transaction under such conditions that the buyer will assume the company’s debts. However, if a buyer has some portion of the down payment and has obtained bank financing, there is no need to assume company debt, unless the asking price is reduced to reflect the assumed liability. However, if a buyer has agreed to acquire the liabilities of a business as well as its assets in a stock purchase, the Due Diligence process should be even more extensive in order to ensure that the new owner totally understands what is involved in the transaction and the extent of the debt that s/he is assuming.
  78. 78. 78 Diagram For Assets Purchase Transaction Diagram For Stock Purchase Transaction
  79. 79. 79 Notes Here’s what you can do to gain even more: Click Here (http://rglpublishing.com/bizbrokcrse.htm) to Buy Your Own Copy Of The Printed Version of this course for the modest sum of $179.85 and get the following: A printed copy of the Business Brokerage Home Study Course in a convenient 3-ring binder for easy access (Value: $149.97) The BizVal Business Valuation Software PLUS a separate comprehensive Excel Valuation Workbook (Value: $274.95) All the Forms and Contracts you need to immediately start your practice. The forms are also in electronic format if you decide to make changes to them (Value: $59.95) Personal e-mail consultation with me, as you begin to build your practice. With these consultations, I will personally assist you while you work on your first transaction, until you close the deal and get paid (Value: Priceless) Direct answer from me to any questions you may have about the course (including questions about valuation, financials statements, due diligence, etc.) My complete lifetime guarantee. If you find out later that Business Brokerage is not for you, just send me an e-mail and I will refund your money without asking any questions (even after you’ve had the chance to review it for free!) If You Do Not Think That Business Brokerage Is For You Here is how you can help others who could benefit from this course: Send this eBook to your friends who might be interested in Business Brokerage Or better yet, send them to http://rglpublishing.com/bizbrokragefreecrse.htm so they can download their own copy of the course.
  80. 80. 80 Financing The Purchase With Little Or No Money Introduction No one should allow a lack of personal funds to stop them from purchasing a business. One does not need money to make money (examples of this fact abound). The majority of the wealthy who did not inherit what they possess, started with virtually nothing. Money is an idea, and therefore one only needs good ideas and solid planning to create wealth. Actually, there is so much money available for businesses that the investment firms, whose sole purpose is to finance new ventures, regularly return funds to investors because of a lack of good investment opportunities. General Overview The task of raising money for a business is not as difficult as most people seem to think. This is especially true when you have an idea that can make you and your investors rich. Actually, there's more money available for new business ventures than there are good business ideas. A very important rule of the game to learn: Anytime you want to raise money, your first move should be to put together a proper business plan or prospectus. This prospectus should include a resume of your background, your education, training, experience and any other personal qualities that might be counted as an asset to your potential success. It's also a good idea to list the various loans you've had in the past, what they were for, and your history in paying them off. You'll have to explain in detail how the money you want is going to be used. If it's for an existing business, you'll need a profit and loss record for at Financing Strategies (How to buy a business even if you have little or money)

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  • JamieBlakeHill

    Dec. 29, 2019

The task of raising money for a business is not as difficult as most people seem to think. This is especially true when you have an idea or business that can provide your investors with a good return. Actually, there’s more money available for new business ventures than there are good business ideas. A very important rule of the game to learn: Anytime you want to raise money, your first move should be to put together a proper business plan. This report covers all the key elements you need to be able to research and write a convincing business plan and raise the funds you need to acquire your new business. The report covers all the steps necessary to: - Properly decipher the financials of the business, - Conduct due diligence, - Properly value the target, and - Raise the money you need to close >> This report was created by Phare Equity Partners which produces thoughtful, well-researched and un-biased Valuation Reports for small and mid-size businesses in all industries.

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