Chapter ppt_07.pptx

Section 2:
The Entrepreneurial Journey Begins
Copyright © 2019, 2016, 2014 Pearson Education, Inc. All Rights Reserved

Copyright © 2019, 2016, 2014 Pearson Education, Inc. All Rights Reserved.
Essentials of Entrepreneurship and Small
Business Management
Ninth Edition
Chapter 7
Buying an Existing Business

Learning Objectives (1 of 2)
1. Describe the advantages and disadvantages of buying an
existing business.
2. Explain the five stages in acquiring a business: search, due
diligence, valuation, deal, and transition.
3. Explain the three steps in the search stage of buying a
business.

Learning Objectives (2 of 2)
4. Describe the four areas involved in conducting due diligence
on a business: the seller’s motivation, asset valuation, legal
issues, and financial condition.
5. Explain the various methods used to estimate the value of a
business.
6. Describe the basic principles of negotiating a deal to buy a
business and structuring the deal.
7. Understand how to manage the transition stage when a deal is
done.

Buying an Existing Business (1 of 2)
• Before you buy, ask:
– Is the right type of business for sale in a market in
which you want to operate?
– What experience do you have in this particular
business and the industry in which it operates? How
critical to your ultimate success is experience in the
business?
– What is the company’s potential for success?
– What changes will you have to make – and how
extensive will they be – to realize the business’s full
potential?

Buying an Existing Business (2 of 2)
– What price and payment method are reasonable for
you and acceptable to the seller?
– Is the seller willing to finance part of the purchase
price?
– Will the company generate sufficient cash to pay for
itself and leave you with a suitable rate of return on
your investment?
– Should you be starting a business and building it from
the ground up rather than buying an existing one?

Types of Business Buyers
Figure 7.1 Types of Business Buyers
Source: “Meet the Buyers,” by Darren Dahl, Inc., April 1, 2008, pp. 98–99. © 2008 by Inc. Magazine.
Reprinted with permission.

The Advantages of Buying an Existing
Business (1 of 2)
• Successful existing businesses often continue to be
successful.
• Superior location.
• Employees and suppliers are in place.
• Installed equipment with known production capacity.
• Inventory in place.

The Advantages of Buying an Existing
Business (2 of 2)
• Trade credit is established.
• The turnkey business.
• The new owner can use the experience of the previous
owner.
• Easier access to financing.
• High value.

The Disadvantages of Buying an Existing
Business (1 of 2)
• Cash requirements.
• The business is losing money.
• Paying for ill will.
• Employees inherited with the business may not be
suitable.
• Unsatisfactory location.

The Disadvantages of Buying an Existing
Business (2 of 2)
• Obsolete or inefficient equipment and facilities.
• The challenge of implementing change.
• Obsolete inventory.
• Valuing accounts receivable.
• The business may be overpriced.

The Stages in Acquiring a Business
Figure 7.2 The Acquisition Process
Sources: Based on Buying and Selling: A Company Handbook (New York: Price Waterhouse, 1993), pp. 38–42;
Charles F. Claeys, “The Intent to Buy,” Small Business Reports, May 1994, pp. 44–47.

The Five Stages of
Buying a Business
Figure 7.3 The Five Stages of
Buying a Business

The Search Stage
• There are three steps in conducting an effective search for
the right business to buy:
1. Conduct a self-inventory, objectively analyzing skills,
abilities, and personal interests to determine the
type(s) of business that offer the best fit.
2. Develop a list of the criteria that define the “ideal
business” for you.
3. Prepare a list of potential candidates that meet your
criteria.

Step 1: Self-Inventory (1 of 2)
• What business activities do you enjoy most? Least? Why?
• Which industries or markets offer the greatest potential for
growth?
• Which industries interest you most? Least? Why?
• What kind of business would you enjoy running?
• What kinds of businesses do you want to avoid?
• What do you expect to get out of the business?
• How much time, energy, and money can you put into the
business?

Step 1: Self-Inventory (2 of 2)
• What business skills and experience do you have? Which
ones do you lack?
• How easily can you transfer your skills and experience to
other types of businesses? In what kinds of businesses
would that transfer be easiest?
• How much risk are you willing to take?
• Are you willing and able to turn around a struggling business?
• What size company do you want to buy?
• Is there a particular geographic location you desire? What
business skills and experience do you have? Which ones do
you lack?

Step 2: Develop a List of Criteria
• The goal is to identify the characteristics of the “ideal
business” for you so that you can focus on the most viable
candidates as you wade through a multitude of business
opportunities.
• These criteria will provide specific parameters against
which you can evaluate potential acquisition candidates.

Step 3: Prepare a List of Potential
Candidates
• Many businesses that can be purchased are not publicly
advertised but are available either through the owners
themselves or through business brokers and other
professionals.
– Hidden market: low-profile companies that might be
for sale but are not advertised as such.

Business Purchases
by Type of Business
Figure 7.4 Business
Purchases by Type of
Business
Source: Based on data from “BizBuySell’s 2016 Report: Why Buying or Selling a Business Is Becoming a Big Deal,”
BizBuySell, 2017, http://www.bizbuysell.com/htmlmail/2017/content/BizBuySell-Small-Business-Infographic-
2016.pdf?utm_source=bizbuysell&utm_medium=blog&utm_campaign=infographicarticle021417.

The Due Diligence Stage (1 of 2)
• Once you have a list of prospective companies, ask:
– What are the company’s strengths? Weaknesses?
– Is the company profitable? What is its overall financial
condition?
– What is its cash flow cycle? How much cash will the
company generate?
– Who are its major competitors?
– How large is the customer base? Is it growing or
shrinking?

The Due Diligence Stage (2 of 2)
– Are the current employees suitable? Will they stay?
– What is the physical condition of the business, its
equipment, and its inventory?
– What new skills must you learn to be able to manage
this business successfully?

The Due Diligence Process
• Due diligence: the process of studying, reviewing, and
verifying all the relevant information concerning an
acquisition.
1. Motivation. Why does the owner want to sell?
2. Asset valuation. What is the real value of the
company’s assets?
3. Legal issues. What legal aspects of the business are
known or hidden risks?
4. Financial condition. Is the business financially sound?

Motivation
• Why does the owner want to sell?
– The most common reasons business owners give for
selling their businesses are:
 Planned retirement (40%)
 Burnout (21%)
 Desire to own a bigger business (20%)

Asset Valuation
• What is the true nature of the firm’s assets?
– Are the assets really useful, or are they obsolete?
– Will the assets require replacement soon?
– Do the assets operate efficiently?
• Investigate:
– Accounts recievable
– Lease arrangements
– Business records
– Intangible assets
– Location and apperance

Legal Issues (1 of 2)
• Liens: claims by creditors against a company’s assets.
• Due-on-sale clause: a clause that requires the buyer to
pay the full amount of the remaining loan balance or to
finance the balance at prevailing interest rates, thus
preventing the buyer from assuming the seller’s loan at a
lower interest rate.

Legal Issues (2 of 2)
• Covenant not to compete (or restrictive covenant): an
agreement tied to the sale of a business in which the seller
agrees not to open a competing business within a specific
time period and geographic area of the existing one.
• Product liability lawsuit: a lawsuit which claims that a
company is liable for damages and injuries caused by the
products or services it sells.

Financial Condition
• Is the business financially sound?
– Examine:
 Income statements and balance sheets for at least
three years
 Income tax returns for at least three years
 Cash flow

The Valuation Stage
• Non-disclosure agreement (NDA): a legal contract that
requires a prospective buyer to maintain the confidentiality
of the business, its owner, and any information, financial
and otherwise, that the buyer sees as part of the due
diligence process.
• Methods for Determining the Value of a Business
– Business valuation is partly an art and partly a science.
 Balance sheet method
 Earnings approach
 Market approach

Balance Sheet Method
• Net worth (or owner’s equity):
– Net worth = Assets − Liabilities

Earnings Approach (1 of 2)
• Excess earnings method: a business valuation method that
combines both the value of a company’s existing assets (less
its liabilities) and an estimate of its future earnings potential to
determine the selling price for the business.
– Goodwill: the difference between an established,
successful business and one that has yet to prove itself
that is based on the company’s reputation and its ability to
attract and retain customers.
– Opportunity cost: the cost of forgoing a choice; the cost
of the next best alternative.
– Extra earning power: the difference between a
company’s forecasted earnings and the total opportunity
costs of investing in that company.

Earnings Approach (2 of 2)
• Capitalized earnings approach: a business valuation
method that involves dividing a company’s estimated net
earnings (after subtracting a reasonable salary for the
owner) by the rate of return that reflects the risk level of
investing in the business.
• Discounted future earnings approach: a business
valuation method that involves estimating a company’s net
income for several years into the future and then discounts
these future earnings back to their present value, which
provides an estimate of the company’s worth.

Market Approach
• Market (or price/earnings) approach: a business
valuation method that involves using the price/earnings
ratios of similar publicly traded businesses to estimate the
value of a company.

The Best Method?
Figure 7.7 Business Valuation Methods
Source: Based on data from Craig R. Everett, 2017 Private Capital Markets Report, Pepperdine
University, March 15, 2017, p. 55.

The Deal Stage
• The structure of the deal – the terms and conditions of
payment—is more important than the price the seller
agrees to pay.
– The “art of the deal”
– The buyer’s goals
– The seller’s goals

The “Art of the Deal” (1 of 3)
• Don’t confuse price with value.
– Value is what a business actually is worth; price is what
the buyer agrees to pay for it.
• The bargaining process may eventually lead both parties
into the bargaining zone: the area within which the two
parties can reach agreement.
– It extends from above the lowest price the seller is
willing to take to below the maximum price the buyer is
willing to pay.

Identifying the Bargaining Zone
Figure 7.8 Identifying the Bargaining Zone

• Negotiating tips:
– Establish the proper mind-set.
– Know what you want to have when you walk away from
the table.
– Develop a negotiating strategy.
– Recognize the other party’s needs.
– Be an empathetic listener.
– Focus on the issue, not on the person.

• Avoid seeing the other side as “the enemy.”
• Educate; don’t intimidate.
• Be creative.
• Keep emotions in check.
• Be patient.
• Don’t become a victim.
• Remember that “no deal” is an option.

The Buyer’s Goals
• The buyer seeks to realize the following goals:
– Get the business at the lowest price possible.
– Negotiate favorable payment terms, preferably over
time.
– Get assurances that he is buying the business he
thinks it is.
– Avoid enabling the seller to open a competing
business.
– Minimize the amount of cash paid up front.

The Seller’s Goals
• The seller of the business is looking to accomplish the
following goals:
– Get the highest price possible for the company.
– Sever all responsibility for the company’s liabilities.
– Avoid unreasonable contract terms that might limit
future opportunities.
– Maximize the cash from the deal.
– Minimize the tax burden from the sale.
– Make sure the buyer will make all future payments.

The Structure of the Deal
• Typical ways that parties structure business sales.
– Straight business sale
– Two-step sale
– Employee stock ownership plan (ESOP)

Straight Business Sale
• Disadvantages:
– Usually the most expensive way to sell a business.
– Could result in a significant ax burden.
– Unattractive for owners who want to surrender control
gradually.
• May involve seller financing.

Two-Step Sale
• One option is an earn-out an agreement:
– The seller agrees to accept a percentage of the sales
price and stays on to manage the business for a few
more years under the new owner; the remaining
portion of the price is contingent on the company’s
performance; the more profit the company generates
during the earn-out period, the greater the payout to
the seller.

Employee Stock Ownership Plan
• Employee stock ownership plan (ESOP):
– A type of employee benefit plan in which a trust that is
created for employees purchases their employer’s
stock; employees do not make any out-of-pocket
payments but over time become owners in the
company that employs them, are entitled to share in its
profits, and receive sizable retirement benefits.

A Typical ESOP
Figure 7.9 A Typical Employee Stock Ownership Plan

Letter of Intent
• Letter of intent:
– A document that represents a firm commitment by both
sides that they are ready to move toward closing the
sale of a business.

The Transition Stage (1 of 4)
• Closing documents include:
– Asset purchase agreement – the formal agreement of
the deal
– Bill of sale – transfers ownership
– Asset list – all assets that are included in the sale,
including tangible assets and intellectual property
– Buyer’s disclosure statement
– Allocation of purchase price – a formal document that
must be filed with the Internal Revenue Service at the
end of the tax year that allocates the price among the
various assets

– Non-compete agreement
– Consulting/training agreement
– Transfer of subsidiaries associated with the business
– Transfer of utilities
– Transfer of Web sites, social media addresses, and
phone numbers
– Documentation of the new entity that will own the
business and documentation of the new bank account
for that business
– Transfer of merchant accounts
– Notice to creditors

– Lease assignments
– Financing documents, security agreement, promissory
note, and UCC financing statement, if seller is
financing all or part of the sale
– Sales tax and payroll tax clearance
– Escrow instructions
– Closing adjustments/proration
– Transfer of any third-party contracts
– Corporate resolution authorizing sale of the corporate
assets

• To ensure a smooth transition:
– Concentrate on communicating with employees.
– Be honest with employees.
– Listen to employees.
– Devote time to selling the vision for the company to its
key stakeholders, including major customers, suppliers,
bankers, and others.
– Consider asking the seller to serve as a consultant until
the transition is complete. The previous owner can be a
valuable resource.

Conclusion
• The five stages of buying a business are:
1. The search stage
2. The due diligence stage
3. The valuation stage
4. The deal stage
5. The transition stage

Copyright

Chapter ppt_07.pptx

More Related Content

What's hot

Similar to Chapter ppt_07.pptx

More from FrankieSneeze2

Chapter ppt_07.pptx

Editor's Notes