February, 2003 Newsletter

 
 

Our February, 2003 newsletter is entitled "Buying An Existing Business."   Our newsletters feature articles on various aspects of preparing a business plan and over time should lead you through the entire business planning process.  

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Buying An Existing Business
There are three ways to start your own business: start a new business from scratch, buy an existing business or buy a franchise. This section will focus on the advantages and disadvantages of buying an existing business.

Buying an existing business can be an exiting way to start a new venture. Existing businesses are actively bought and sold in Canada every day. However, as in all business transactions, the buyer must beware, especially since buying an existing business can be complicated. In order to ensure that you do not pay too much for a business, you should have it appraised. Business valuation is a specialized field. Be sure to get professional advise before making a deal.

Advantages of Buying an Existing Business

  • The business is already set up and running - this is called "turnkey."
  • There are existing customers, therefore there should be immediate cash flow.
  • The licensing, zoning and other matters are done for you.
  • There are supplier relationships in place. For some types of businesses, buying a business may be the only way to get into certain buying groups.
  • The business has a history of financial results that may make financial forecasting more predictable, and financing easier.
  • It is possible that the former owner has not managed the business as well as the purchaser could, therefore the new owner can help the business realize its potential.
  • It is possible that the former owner did not explore other markets to their potential.
  • It may be possible to purchase property and/or equipment at a bargain price.
  • It may be possible to use the business relationships of the former owner to obtain vendor financing.
  • The business may already have a good reputation in the community.

Disadvantages of Buying an Existing Business

  • The business reflects someone else's dream.
  • The existing setup, while turnkey, may not be what you envisioned.
  • The existing customers may not be your target market.
  • The licensing, zoning and other matters may not be done correctly.
  • The supplier relationships may not be guaranteed, or the poor payment history of the former owner may result in less than favorable terms with suppliers.
  • The customers may not want to deal with anyone else besides the former owner.
  • The price of the business may be more than the cost of the assets as the former owner may want a goodwill premium.
  • The business may have a bad reputation in the community.
  • It is complicated and costly to investigate the purchase of a new business.

How to Locate a Business for Sale
The first step in buying a business is to find one that is for sale. A motivated vendor who has made the decision to sell and has realistically appraised his business's value is an essential ingredient in completing a business purchase. In general, businesses for sale can be found from the following sources:

  • Real estate brokers - some specialize in business listings.
  • Business brokers
  • Newspaper advertisements
  • Trade journals
  • Specialty publications
  • Suppliers
  • Bankruptcy trustee sales
  • Word of mouth
  • Professionals - such as accountants, lawyers and bankers who may have clients who wish to sell.
  • The internet

What is a Good Business to Buy?
Unfortunately, there is no formula that can be used to determine a good business to buy. Here are some positive signs:

  • Positive financial trends, such as good sales growth, and improving profits
  • Reliable historical financial information
  • Well maintained equipment
  • A good reputation
  • Increasing market share
  • Reputable present owner
  • Adequate return on investment

"I've Found a Business to Buy- Now what?"
If you are buying a business, first ensure that the business is viable and that the market will support the level of sales required now and in the future. Do as much market research as you can. The business must also fit with your personal and professional lifestyle. It must be a business you understand or are capable of learning how to run.

When you have completed the market research, investigate further by answering the following questions:

What do I need to know?

  • Why is the owner selling?
  • What is the asking price, and what does the price include?
  • Will the owner stay on to assist the purchaser? For how long and at what cost?
  • Why do other people think he/she is selling?
  • What is the history of the business?
  • What is the owner's reputation?
  • Are there any lawsuits pending against the business?
  • Are there any new laws that affect the business?
  • Are there any new competitors in the business?

What Documents Do I Need to Obtain?

  • Previous years financial statements and tax returns, for at least three years previous.
  • Copies of leases.
  • Listing of equipment included in the sale.
  • Suppliers' agreements
  • Patents

The Business Investigation

Marketing Factors

  • What are the five-year historical sales?
  • Can we forecast sales for the next three years?
  • What are the market statistics for sales growth?
  • Who are the competitors? Who owns them? Have there been any recent changes in the competitors?
  • Are there any political or economic trends or technological developments that affect the business?
  • Are there untapped export potentials?
  • Beware of reliance on few customers.
  • What are the credit policies - can we change them?
  • What are the profit margins by product?

Production Factors

  • Is the equipment in good repair?
  • Is there a reasonable supplier network, or is there reliance on few suppliers?
  • Are there any material cost increases looming?
  • Is there significant exposure to changes in foreign currencies?
  • What are the annual fixed costs of the business?
  • Are any of the suppliers related to the current owner?
  • Are there any new trends or technological developments in the business?

Management Factors

  • What is the history of the previous owner? Is the business at its full potential or is there opportunity for a new buyer to increase sales?
  • Will the departure of the former owner cause some customers to leave? Beware of the "one-man/woman show".
  • Are there employees? Will they stay with you, and do you want them to?
  • Is there any back-up management?
  • Can you manage this business?
  • Are there areas of management weakness? Can you fix them?

What Price Should I Pay for My Business?

The fair market value of a business may be defined as the price that a reasonably informed buyer will pay. The value of a business is not a fixed number, but usually is a negotiated amount.

Valuing a business can be a complicated process. There are specialized professionals and Business Valuators that can be engaged to offer an independent opinion.

There are two basic methods of arriving at a price for a business, and the final value may be a result of a combination of these two methods.

Balance Sheet Method
The value consists of the book value of the equipment, inventories, cash and other assets, net of any amounts owing,

or

the value consists of the fair market value of the equipment, inventories, cash and other assets, net of any amounts owing.

Goodwill Method
The value consists of the fair market value of the equipment, inventories, cash and other assets, net of any amounts owing plus an amount that reflects the "goodwill" of the business.

The price, therefore, reflects a premium for either past or future earnings or cash flows. Often, goodwill will be calculated as the expected future annual cash flows of the business times a "multiplier". This multiplier will depend on the track record of the company, the industry it is in, and the risk factors.

The Purchase Agreement

A proper purchase agreement is essential in buying a business. Consult a qualified lawyer to protect your interests. Your lawyer will prepare a purchase agreement identifying at least the following:

  • The vendor and the purchaser
  • The closing date of the sale
  • The price and what it includes
  • How inventory will be counted and valued
  • Any agreements such as the vendor staying on to provide management advice, and the cost of such advice.
  • Representations as to the condition of the equipment and the accuracy of the financial information.
  • The allocation of the purchase price
  • A non - competition clause

Summary

Buying a business can be a wonderful opportunity, but be prepared to put considerable time into the investigation. Do not be in a hurry and be reasonably skeptical of all information presented. Most importantly, do a business plan, know why the owner is selling, and negotiate the best possible deal.

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