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Seller Financing: It Makes Dollars and Sense

When contemplating the sale of a business, an important option to consider is seller financing. Many potential buyers don't have the necessary capital or lender resources to pay cash. Even if they do, they are often reluctant to put such a hefty sum of cash into what, for them, is a new and untried venture.

Why the hesitation? The typical buyer feels that, if the business is really all that it's "advertised" to be, it should pay for itself. Buyers often interpret the seller's insistence on all cash as a lack of confidence--in the business, in the buyer's chances to succeed, or both.

The buyer's interpretation has some basis in fact. The primary reason sellers shy away from offering terms is their fear that the buyer will be unsuccessful. If the buyer should cease payments--for any reason--the seller would be forced either to take back the business or forfeit the balance of the note.

The seller who operates under the influence of this fear should take a hard look at the upside of seller financing. Statistics show that sellers receive a significantly higher purchase price if they decide to accept terms. On average, a seller who sells for all cash receives approximately 70 percent of the asking price. This adds up to approximately 16 percent difference on a business listed for $150,000, meaning that the seller who is willing to accept terms will receive approximately $24,000 more than the seller who is asking for all cash.

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What Is Burnout?

Burnout can come with a business that's successful as well as with one that's failing to grow. The right time to sell is before the syndrome becomes a threat to the effective management of a business. What are the warning signs of burnout?

• That isolated feeling. The burnt-out owner has been "chief cook and bottle washer" for such an extended period of time that even routine acts of decision-making and action-taking seem like Sisyphean tasks. These owners have been shouldering the burdens alone too long.

• Fuzzy perspective. Burnt-out owners are so close to their work that they lose perspective. Prioritizing becomes a major daily challenge, and problem-solving sometimes goes no further than the application of business Band-Aids that cost money in the long run rather than increase profits.

• No more fun. Of course, owning a business is hard work, but it should also include an element of enjoyment. The owner who drags himself or herself through every day, with a sense of dread – or boredom – should consider moving on to a fresh challenge elsewhere.

• Just plain tired. Simply put, many business owners burn out from the demands placed on them to keep their companies operating day after day, year after year. The schedule is not for everyone; in fact, statistics show that it\'s hardly for anyone, long-term.

The important point here is for business owners to recognize the signs and take action before burnout begins to hinder the growth – or sheer survival – of the business. Many of today\'s independent business owners feel they\'ve worked hard, made their money and sense that now is a good time to "cash-out" and move on.

Expanding Your Business

The term “growing the business” seems to be the term of choice for business people who discuss expansion. Unfortunately, in too many cases, this growing never goes beyond the seedling stage. Business people also talk about “thinking outside the box.” Again, that concept encompasses so much – what box? How far outside? – that it really can be an unfocused way of planning. So many random ideas can come out of such discussions and thinking that nothing really gets accomplished.

It might be a much better idea to focus on one small thing that would increase business. For example, you feel strongly that mailing a circular to your existing customer base or to the immediate neighborhood would increase business, but you never seem to have the time to do it. Why not plan on mailing 1,000 circulars to possible customers over the next 30 days? This means devoting about one hour, two or three times a week, to take this project to fruition. Don’t worry about next month – take one month at a time.

Since it’s said to take about 21 days to create a habit, several months should set the stage for the rest of the year. This will also help predict whether a mailing will indeed increase business. If it doesn’t, take the same time you did to work on the mailing and come up with another idea. What you have done is to “bank” the time you created for the mailing program so that it’s there for you to develop and implement the next plan.

A caveat: don’t work on something that you know you won’t finish, no matter how great the idea. For example, calling all the prospects for your product or service may be a great idea and one that would most likely expand the business. However, you know that is not what you like to do – so, forget it.

Implementing just one plan at a time and staying focused on it is the key. It may be easier to come up with 25 ideas outside the box, but if none ever get implemented, they might as well have stayed inside the box and never have been exposed to the light of day. Work on what you consider to be the best idea, and spend the same time you did on the mailing and develop it. It’s the habit of spending the one hour for two to three times a week that is critical. This creates time for a true growing of the business.

Happy Employees Can Increase Profits...and Value

Happy employees mean happy customers and clients. An unhappy employee can mean loss of business or worse. How does a business owner create happy and contented employees? It all starts with the hiring process – hiring positive people to start with certainly helps. Offering as many benefits as your business can afford is also a plus.

However, one of the big keys is simply for the business owner to treat employees well, and appreciate their contributions. Some owners expect their employees to have the same dedication to the business as they do. They are not owners and don’t have the same privileges as an owner does. In most cases, the business is an owner’s life, whereas the employee has a life outside of the business. It is important that the owner understands this difference.

In the long run, positive and happy owners have happy employees. But if being a good role model doesn’t do the job with workers who remain negative, your only recourse is to get rid of them. Reward your people with praise, and every once in a while give them a dinner gift certificate for two – or their birthday off – anything to let them know you appreciate their work. It’s an inexpensive way to increase profits and subsequently the value of the business. When a potential buyer checks the business, and they will, being waited on by a happy employee can seal the deal.

Take a Look at Your Lease

If your business is not location-sensitive, that is, if your business location is immaterial to its success, then the following may not be important. However, lease information is usually helpful no matter what the situation. The business owner whose business is very dependent on its current location should certainly read on.

If your business is location-sensitive, which is almost always true for a restaurant, a retail operation, or, in fact, any business that depends on customers finding you (or coming upon you, as is often the case with a well-located gift shop) – the lease is critical. It may be too late if you already have executed it, but the following might be helpful in your next lease negotiation.

Obviously, a very important factor is the length of the lease, usually the longer the better. If the property ever becomes available – do whatever it takes to purchase it. However, if you are negotiating a lease for a new business, you might want to make sure you can get out of the lease if the business is not successful. A one-year lease with a long option period might be an idea. Keep in mind that you might want to sell the business at some point – see if the landlord will outline his or her requirements for transfer of the lease.

If you’re in a shopping center, insist on being the only tenant that does what your business does. If you have a high-end gift store, a “dollar” type of store might not hurt, but its inclusion as a business neighbor should be your decision. Also, if the center has an anchor store as a draw, what happens if it closes? The same is true if the center starts losing businesses. Your rent should be commensurate with how well the center meets your needs.

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Selling Your Business? Expect the Unexpected!

According to the experts, a business owner should lay the groundwork for selling at about the same time as he or she first opens the door for business. Great advice, but it rarely happens. Most sales of businesses are event-driven; i.e., an event or circumstance such as partnership problems, divorce, health, or just plain burn-out pushes the business owner into selling. The business owner now becomes a seller without considering the unexpected issues that almost always occur. Here are some questions that need answering before selling:

How much is your time worth?
Business owners have a business to run, and they are generally the mainstay of the operation. If they are too busy trying to meet with prospective buyers, answering their questions and getting necessary data to them, the business may play second fiddle. Buyers can be very demanding and ignoring them may not only kill a possible sale, but will also reduce the purchase price. Using the services of a business broker is a great time saver. In addition to all of the other duties they will handle, they will make sure that the owners meet only with qualified prospects and at a time convenient for the owner.

How involved do you need to be?
Some business owners feel that they need to know every detail of a buyer’s visit to the business. They want to be involved in this, and in every other detail of the process. This takes away from running the business. Owners must realize that prospective buyers assume that the business will continue to run successfully during the sales process and through the closing. Micromanaging the sales process takes time from the business. This is another reason to use the services of a business broker. They can handle the details of the selling process, and they will keep sellers informed every step of the way – leaving the owner with the time necessary to run the business. However, they are well aware that it is the seller’s business and that the seller makes the decisions.

Are there any other decision makers?
Sellers sometimes forget that they have a silent partner, or that they put their spouse’s name on the liquor license, or that they sold some stock to their brother-in-law in exchange for some operating capital. These part-owners might very well come out of the woodwork and create issues that can thwart a sale. A silent partner ceases to be silent and expects a much bigger slice of the pie than the seller is willing to give. The answer is for the seller to gather approvals of all the parties in writing prior to going to market.

How important is confidentiality?

This is always an important issue. Leaks can occur. The more active the selling process (which benefits the seller and greatly increases the chance of a higher price), the more likely the word will get out. Sellers should have a back-up plan in case confidentiality is breached. Business brokers are experienced in maintaining confidentiality and can be a big help in this area.

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Do You Know Your Customers?

It’s always nice, when eating at a nice restaurant, for the owner to come up and ask how everything was. That personal contact goes a long way in keeping customers happy – and returning. It seems that customer service is now handled by making a potential customer or client wait on a telephone for what seems forever, listening to a recording saying that the call will be handled in 10 minutes. Small businesses are usually built around personal customer service. When is the last time you “worked the floor” or handled the phone, or had lunch with a good customer? Customers and clients like to do business with the owner. Even a friendly “hello” or “nice to see you again” goes a long way in customer relations and service.

The importance of knowing your customers and/or clients could actually be extended to suppliers, vendors, and others connected with your business. When is the last time you visited with your banker, accountant, or legal advisor? A friendly call to your biggest supplier(s) can go a long way in building relationships. A call to one of these people thanking them for prompt delivery can pay big dividends if and when a problem really develops.

Owning and operating your own business is not a “backroom” or “hide behind the business plan” business. It is a “front-room” business. Go out and meet the customers – and anyone else who has an interest in your business.

Selling A Business: How Long Does it Take?

A recent survey revealed the following about the length of time that selling a business requires:

Average time from putting the business on the market to time of sale:

Time Period % of Businesses Sold in This Time Period
1 to 3 Months 9.7 %
4 to 6 Months 28.3%
7 to 9 Months 38.0%
10 to 12 Months 15.9%
13 to 18 Months 7.6%
19 + Months 0.7%

It took from four to 12 months to sell approximately 82 percent of businesses, with 38 percent falling into the seven- to nine-month range. Certainly some businesses sell more quickly, but at the other end of the spectrum, over eight percent are on the market for over 12 months.

Why does it take so long to sell a business? Price and terms are the biggest reasons. Not over-pricing the business at the beginning of the sales process is a big plus, as well as a transaction structured to include a reasonable down payment with the seller carrying the balance. Having all of the necessary information right from the beginning can also greatly reduce the time period. Being prepared for the information a buyer may want to review or having the answers available for the questions a buyer may want answered is the key.

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Why Sell Your Company?

Selling one's business can be a traumatic and emotional event. In fact, "seller's remorse" is one of the major reasons that deals don't close. The business may have been in the family for generations. The owner may have built it from scratch or bought it and made it very successful. However, there are times when selling is the best course to take. Here are a few of them.

Burnout - This is a major reason, according to industry experts, why owners consider selling their business. The long hours and 7-day workweeks can take their toll. In other cases, the business may just become boring - the challenge gone. Losing interest in one's business usually indicates that it is time to sell.
No one to take over - Sons and daughters can be disenchanted with the family business by the time it's their turn to take over. Family members often wish to move on to their own lives and careers.
Personal problems - Events such as illness, divorce, and partnership issues do occur and many times force the sale of a company. Unfortunately, one cannot predict such events, and too many times, a forced sale does not bring maximum value. Proper planning and documentation can preclude an emergency sale.
Cashing-out - Many company owners have much of their personal net worth invested in their business. This can present a lack of liquidity. Other than borrowing against the assets of the business, an owner's only option is to sell it. They have spent years building, and now it's time to cash-in.
Outside pressure - Successful businesses create competition. It may be building to the point where it is easier to join it, than to fight it. A business may be standing still, while larger companies are moving in.
An offer from "out of the blue" - The business may not even be on the market, but someone or some other company may see an opportunity. An owner answers the telephone and the voice on the other end says, "We would like to buy your company."
There are obviously many other reasons why businesses are sold. The paramount issue is that they should not be placed on the market if the owner or principals are not convinced it's time. And consider an old law that says, "The time to prepare to sell is the day you start or take over the business."

Who Is The Buyer?

Buyers buy a business for many of the same reasons that sellers sell businesses. It is important that the buyer is as serious as the seller when it comes time to purchase a business. If the buyer is not serious, the sale will never close. Here are just a few of the reasons that buyers buy businesses:

Laid-off, fired, being transferred (or about to be any of them)
Early retirement (forced or not)
Job dissatisfaction
Desire for more control over their lives
Desire to do their own thing
A Buyer Profile

Here is a look at the make-up of the average individual buyer looking to replace a lost job or wanting to get out of an uncomfortable job situation. The chances are he is a male (however, more and more women are going into business for themselves, so this is rapidly changing). Almost 50 percent will have less than $100,000 in which to invest in the purchase of a business. In many cases the funds, or part of them, will come from personal savings followed by financial assistance from family members. The buyer will never have owned a business before, and most likely will buy a business he or she had never considered until being introduced to it.

Their primary reason for going into business is to get out of their present situation, be it unemployment or job disagreement (or discouragement). Prospective buyers want to do their own thing, be in charge of their own destiny, and they don't want to work for anyone. Money is important, but it's not at the top of the list, in fact, it probably is in fourth or fifth place in the overall list. In order to pursue the dream of owning one's own business, buyers must be able to make that "leap of faith" necessary to take the risk of purchasing and operating their own business.

Buyers who want to go into business strictly for the money usually are not realistic buyers for small businesses. Keep in mind the following traits of a willing buyer:

The desire to buy a business
The need and urgency to buy a business
The financial resources
The ability to make his or her own decisions
Reasonable expectations of what business ownership can do for him or her

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First Impressions Can Make or Break Your Deal

Life is full of second chances, but when it comes to mergers and acquisitions, the maxim “you have only one chance to make a first impression” usually is true. The first time prospective sellers sit down with prospective buyers is a critical moment — one that may determine whether the deal will go forward and prosper, or get stopped in its tracks. If you’re selling a business, you naturally want to
impress your buyers at this initial meeting. Your success — or failure — will come down to preparation and attention to details, including the attendees, location and agenda. Choosing your reps One of the first decisions you’ll need to make is
who will attend the meeting. Do you want to keep it small and confidential, including only your owner or CEO and your M&A advisors? Or do you wish to invite senior managers representing your company’s various departments? Each configuration offers certain pros and cons. A meeting limited to owners and CEOs will likely
move faster and be more candid. But its success will rely on the impression made by only one or two individuals. Involving a team of managers, on the other hand, enables you to provide more information and expertise. But it also increases the
chance that the meeting will get bogged down with too many — or even mixed — messages. You’ll also want to consider whether your prospective buyer is sending an army of officials or only a few key decision-makers. Your M&A advisor can help you decide what’s appropriate under the circumstances.

Mapping a location Although it may seem like a minor detail, your meeting’s location can have major repercussions. A third-party site such as a hotel conference room is
ideal because it eliminates the “home field advantage” for either party and helps both concentrate on the issues without distraction. However, it’s likely that your potential buyers will want to meet at your office so they can look around and get a feel for your operations and business culture. If this is the case, be sure your facilities are clean and organized and that employees are on notice to dress and act appropriately. If you’re concerned about fueling the employee rumor mill, consider holding your meeting after-hours.
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Crush Financing Roadblocks with a Mezzanine Loan

When business buyers don’t have the cash to make an acquisition, they traditionally turn to banks for help. But the credit crunch of the past few years means that these types of loans are extremely hard to come by. If you’ve struck out with primary lenders (or they’re willing to give you only a portion of the amount you need) and your target has already rejected the idea of seller financing, it’s time to consider mezzanine debt. This type of financing gives companies the opportunity to obtain the capital they need and avoid some of the drawbacks associated with traditional debt or equity financing. Layered loans Mezzanine financing works by layering a junior loan atop a senior (or primary) loan. It combines aspects of senior secured debt from a bank and equity obtained from direct investors. Sources of mezzanine financing can include private equity groups, insurance companies and buyout firms.
Unlike bank loans, mezzanine debt typically is unsecured, so the cost of obtaining financing is higher than that of a senior loan. The cost, however, generally is lower than what’s required for an equity investment, which, to compensate investors for increased risk, must offer the potential for higher gains. Structurally speaking
The primary advantage of mezzanine financing is that it can provide capital when you can’t obtain it elsewhere. That doesn’t mean mezzanine debt is an option of last resort, though. Many companies prefer it because it offers flexible structures. If, for example, you’re uncomfortable giving up any equity interest (and partial control of your company), you can choose to pay a higher interest rate instead. Although structures vary, most mezzanine instruments share the following characteristics:Term of between five and 10 years. During the loan’s term, you repay only interest. Repayment of principal typically is deferred, based on your financing needs and cash flow projections. High interest rate. Rates generally range between 10% and 15%.
Investor participation. Most mezzanine instruments allow the lender to participate in your company’s success — or failure. Generally, the lower your interest rate, the more equity you have to offer. Lender participation usually takes the form of warrants with put options, which enables the lender to purchase a certain amount of ownership at a relatively low price. At the end of the loan term, you may be required to repurchase the lender’s stock. Mezzanine financing has some disadvantages, however. Primary among them is the higher expense. And although some lenders are relatively hands-off, they retain the right to a significant say in
company operations. What’s more, mezzanine financing can make an M&A deal more complicated because it introduces an extra interested party to the negotiation table.
Exploring your options Mezzanine loans aren’t for every company contemplating an acquisition, but high-growth companies with strong earnings potential and
proven management typically make the best candidates. If you’re having trouble getting bank financing and prefer not to dilute your equity, talk to your M&A advisor about this option.

SUNBELT INDIANA BUSINESS BROKERS RECEIVE CMSBB DESIGNATION

INDIANAPOLIS, IN August 19, 2010 – Dave Gorman, Gary Stehle and Tim Koger, Business Intermediaries at Sunbelt Indiana Business Resource in Indianapolis, IN, have earned the prestigious Certified Mainstreet Business Broker (CMSBB) designation. Dave, Gary and Tim successfully passed the CMSBB exam administered by the national Sunbelt Network of business brokers. Business brokers are the intermediaries for owners who want to sell their business.

Business broker transactions – mainly geared to brokering sales of mid-sized and small businesses – are valued at more than $1.5 billion per year and affect the economic well-being of thousands of communities in the United States and around the world.

Gorman, Stehle and Koger were awarded the CMSBB designation after demonstrating a superior knowledge about the functions and applications of business broker services, participating in a rigorous 10 week curriculum of courses, and passing a comprehensive examination. They are to be awarded a plaque certifying the designation by the Sunbelt Network this month and will undoubtedly be lauded by their peers for their significant professional accomplishment. This designation identifies them among America’s highly qualified and credentialed business intermediaries, and sets them apart in their profession.

As the world’s largest business brokerage firm, Sunbelt has over 250 licensed locations in the US with over 1400 brokers handling over 3000 business sales transactions annually. Sunbelt sponsors national education programs for its brokers and are members in good standing of the International Business Brokers Association (IBBA). Sunbelt awards the designation “Certified Mainstreet Business Broker (CMSBB)” to members who demonstrate professional excellence through their broker experience and education, and pass a comprehensive examination.

Additional information is available from Dave Gorman by telephoning 317-218-8626, Gary Stehle at 317-218-8620, and Tim Koger at 317-218-8628. They are available to the news media on a continuing basis as a source of information and comment about the transfer of business ownership, strategic exit planning, business valuation, or current economic trends and how they affect the local business community.

Are you sure you’re ready to sell?

You may have decided it’s time to sell, but
before you begin the M&A process, you need to
take a good, hard look at what you plan to put
on the block. Just because you’re ready doesn’t
mean buyers will be interested — particularly if
this is the first time you’ve thought about
preparing your business for sale. Prospective
buyers won’t just scrutinize your business, but
they’ll also compare it to other opportunities in
the marketplace.
Asking tough questions
With the help of your M&A advisors, go over your
company with a fine-tooth comb,
just as a buyer will during the due
diligence stage. Evaluate
everything from debt levels to
personnel to customer
relationships and address any
issues that are likely to give
potential buyers pause, such as
too much business concentration
in only a few customers.
As an owner, you probably value
your business and its sale
prospects highly. But to understand its actual
market value, you need to think like a buyer and
ask the kinds of questions buyers will. These
include:
Is it financially sound? Is your balance sheet
strong relative to those of your competitors,
particularly when it comes to debt? Do you have
good growth prospects or has your company’s
growth plateaued? If buyers sense financial
distress or little growth opportunity, they’ll
undervalue your business or, more likely, move on.
Is it unique? Identify what gives you a leg up on
the competition. Do you make a niche product
essential to the business of other manufacturers?
Do you own a valuable patent, trademark or brand?
Do you have an exclusive client or customer list?
Such assets can increase your company’s value in
the eyes of the right buyer.
Is it an easy fit? Buyers look for businesses with
strong leaders, similar corporate cultures and the
prospect of smooth integration. Do you have an
experienced management team capable of easing
the company through a merger transition? Have
you provided incentives for good employees to
stay?

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Tax Advantage - Section 338(h)(10) can help S corp buyers and sellers

If you’re planning to sell a business arranged as
a subchapter S corporation, a provision of the
federal tax code can make you a more
appealing target for buyers. Even better, it
could boost your sale price.
Why buyers like the code
S corporations don’t pay income taxes. Instead, the
company’s income or losses are
distributed through its
shareholders, who in turn report
income or losses on their
individual income tax returns. This
fact can potentially complicate the
sale of an S corporation.
Internal Revenue Code Section
338(h)(10), however, enables a
stock sale of an S corporation to
be taxed as if the transaction were
an asset sale. Asset sales offer
several advantages. For one, the buyer can take a
“stepped-up” tax basis, which means it can
significantly raise the stated value of the seller’s
assets. Greater asset value, in turn, enables a
buyer to claim more depreciation on its to-beacquired
assets and, therefore, take a larger,
current tax deduction.
What’s in it for sellers
This advantageous tax situation puts selling S
corporations in an excellent negotiating position.
Buyers must obtain the approval of the selling
company’s shareholders to structure a deal that
includes a 338(h)(10) election. And buyers typically
are willing to agree to a higher purchase price in
exchange for shareholder cooperation.
In a 2005 study analyzing S corporations, Merle
Erickson, an accounting professor at the University
of Chicago’s Booth School of Business, and Shiingwu
Wang, a professor at the University of Southern California’s Marshall School of Business, estimated
that the tax benefits of S corporation acquisitions
total, on average, approximately 12% to 17% of the
deal’s value.
For example, when Coca-Cola Enterprises
acquired the S corporation Herb Coca-Cola Inc. in
2001, it paid Herb’s shareholders an extra $100
million to approve the 338(h)(10) election.
Coca Cola reportedly valued the tax
benefits of the election at $145 million,
thus paying Herb shareholders 70% of
the total tax benefits.
Despite these kinds of benefits, many S
corporation sellers are unaware of or illinformed
about the tax code provision.
Unfortunately, sometimes buyers use
seller ignorance to take the deduction
without offering a higher acquisition price
in return.
Know your advantage
Realizing the tax advantages of Section 338(h)(10)
is a complex process. So it’s essential to work with
experienced advisors who are knowledgeable
about tax issues. They can help you determine if
your business is eligible and ensure you get an
equitable share of any tax benefits a buyer derives
from the acquisition.

Turning to Earnouts - A potential solution for negotiation stalemates

Sometimes merger and acquisition negotiations reach
an impasse — even when both parties are committed
to making the deal succeed. When buyers and sellers
are at loggerheads over pricing, all of the transaction’s
benefits can fall to the wayside.
There may, however, be an alternative: an earnout.
With an earnout agreement, the seller might remain
with the company to operate it after it has been sold.
The buyer agrees to make periodic payments to the
seller if the company meets specific performance goals.
Incentives for everyone
An earnout can be a particularly effective way to bridge
the gap when the buyer and seller disagree about the
value of the company. The promise of future payments
can assuage seller concerns that they’re settling for a
price that undervalues their business. And, assuming
the seller remains in control of operations after the
sale, earnouts help reassure the buyer that the seller
will work hard to maintain the company’s performance.
Keep in mind that earnouts are far more effective for
sellers when, postmerger, the selling company
continues to operate as a stand-alone subsidiary or the
seller continues to manage it as a division of the
acquiring company. If a target is intended to be
immediately absorbed by the buyer, earnouts may not
make sense. Sellers will have little control over the newly
merged company’s performance. Negotiating the details
Although earnouts often provide a solution to difficult
price negotiations, the process of agreeing on an earnout
structure can prove challenging as well. The parties need to
discuss the form that seller payments will take as early
as possible, because this decision can have other ramifications. If, for example, a seller wants to be paid
in stock, the parties must decide whether the stock will
be valued as of the deal closing date, at some other
date or by another measure.
The parties also must agree on the objectives that must
be reached to trigger earnout payments and an
acceptable accounting method (typically, Generally
Accepted Accounting Principles) by which to measure
achievement of these objectives.
Earnout objectives could include:
Sales. Often, sellers prefer that performance be
measured by gross sales, because they provide a clear
goal that management can directly influence.
EBITDA. If performance is measured by EBITDA
(earnings before interest, taxes, depreciation and
amortization), the seller will need to show that it’s
achieving a certain level of pretax cash flow. Earnout
payments typically are a percentage or multiple of the
amount by which the seller division’s results exceed a
set EBITDA figure.
Annual performance. The parties may agree to set an
annual performance threshold based on revenues.

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Exit planning: Prepare for an out while you’re still in

Running a successful business is time
consuming, leaving you little time to plan what
may seem like distant succession issues. It’s
important, however, to outline an exit plan and
make succession decisions as early as
possible. Evaluating and grooming possible
successors or preparing for an outside sale can
take years. And it’s never too early to make
retirement and estate plans.
Take stock
Before determining where you want to be when
you’re ready to retire, assess where you and your
business are financially today. Prepare a detailed
financial analysis of your business with the help of
a valuation professional. This expert will review
historical data to determine its current value.
Also examine all contracts and agreements to
make sure your business is transferable. Transfer
restrictions, such as professional license
restrictions, government contracts, franchise
agreements, lending agreements, shareholder
agreements or other types of contracts, can slow
down the process significantly.
Transfer or sell?
Next, develop a succession plan that outlines how
your business will be sold or transferred. If you
have business partners, they will most likely be
able to buy your ownership interests according to
the terms of your company’s shareholder or other
agreements.
You might choose to groom a family member to
eventually take the helm. Or consider selling the
business to a key employee or group of employees.
Employee buyers may have several financing
options, including private equity partners, bank loans and Employee Stock Ownership Plans
(ESOPs).
If none of these succession options seem viable —
or attractive — you’ll likely want to sell your
business to an outside party. Competitors or those
in related industries might view your business as a
good expansion vehicle. To protect confidentiality,
you should consider working with an M&A advisor
to identify potential strategic buyers.
At the same time, consider whether the company
would likely generate more proceeds if sold intact
or broken down by segments. Liquidating or
divesting your assets might be your best option if
you have equipment or real estate, or particularly
valuable profit centers, and it seems unlikely you’ll
be able to sell the business outright because of
weak financials or a changing marketplace.

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Hard times? Now may actually be a good time to sell a business

Given the state of the financial markets and general
economy, now may seem like an unlikely time to sell a
company. But selling in the current market can actually be
less challenging than you think — and may even provide
benefits you haven’t considered.
Determining whether to sell is always a difficult and complex
decision, involving many considerations specific to your plans
and business. For example, how urgent is your exit plan and
how much do you hope to realize from the sale? Although the
current economic environment may factor into your decision,
it shouldn’t be your primary consideration.
Bad news, good news
To sell your company at a fair price, you need only one buyer
that really wants to acquire it. A global credit crunch means
that some buyers have limited financing options right now
and may not be looking for targets. That’s the bad news. The
good news is that many of the buyers shut out of the current
market are financial buyers — companies seeking
opportunistic, short-term investments — such as private
equity and hedge funds. The majority of those remaining are
strategic buyers seeking synergies and other long-term
advantages of an acquisition. These buyers may be willing
to pay more for a target that meets their specific needs.
What’s more, companies that are profitable and not highly
leveraged are regarded as attractive acquisition targets
regardless of market conditions. Stable earnings and low
risk are particularly prized in poor economies, and private companies immune to day-to-day
stock fluctuations enjoy an additional advantage.
Owners of larger companies might want to explore whether
selling their business in pieces — by division, subsidiary or
asset — rather than as a whole is a favorable option. Partial
acquisitions can be attractive to buyers who want a specific
product line, hard asset such as a production facility or
human resources such as a software development group.
Shaping up
As long as your company isn’t financially distressed and
doesn’t have significant liabilities that may necessitate
compromise, you should remain confident in its appraised
value. Several strategies, however, can help improve your
chances of selling well.
Reducing short-term debt, if at all possible, is near the top of
that list. If you have outstanding loans or upcoming loan or
bond financings, ensure that you’re current on payments.
Few buyers will be interested in assuming additional debt
from a prospective acquisition — particularly debt with
onerous rates and terms.
A current business valuation that takes into account your
company’s long-term performance is also essential. Buyers
may try to get a reduced deal price by arguing that any recent
performance declines due to a poor economy make your
business a less viable acquisition. So you need to be prepared
to show that historical earnings are solid and explain to
buyers that they provide a better forecast for future
performance.
Opportunities remain
If you put your company on the market only to encounter
unappealing bids or even deafening silence, your effort isn’t
in vain. Entertaining offers helps you understand what buyers
are looking for. What’s more, displaying your strengths can
put you on the radar of buyers that are financially
constrained now but plan to make acquisitions once
conditions improve.
With the assistance of experienced M&A advisors, you are
very likely to find a fair price for your business. Good
companies are always valuable — even in hard times.

How to hold on to key employees

During a company merger, the devil is in the
details. Identifying key employees and
employment issues early on can facilitate a
smooth deal. And a communication plan can help
prevent, for example, top-producing salespeople
from defecting to competitors, decimating the
company’s customer base, and affecting its value.
It’s important to offer employees incentives to
stay, but you also need to anticipate potential legal
issues. Plan now to put in place protections to
prevent employees from disrupting your deal, both
before and after it closes.
Research to retain
As soon as you begin entertaining the idea of a
merger or acquisition, assess your current workforce.
Enlisting the help of your human resources
staff, interview managers and ask them to break
down employee responsibilities and identify the
top performers in each department. If units are to
remain productive after the company changes
hands, you must know which employees are
responsible for the most — or most important —
customer or client relationships. If your company’s
value relies heavily on research and development or
intellectual property, be sure you know who the key
brains are behind your brain trust. Without those
individuals, your business may have much less future
earnings potential and be a lot less attractive to a buyer.
And though the topic is broad and beyond this article’s scope, begin
reviewing patents and other intellectual property
to ensure you, not your employees, own them. The carrot and the stick
Once you or the buyer determines which
employees are essential, provide them with
incentives to stay put. Depending on the nature of
the business, the employee and the terms of the
deal, this could be anything from stock options in
the newly merged company to a guaranteed
executive position to extra vacation time.

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Scoring with Strategic Buyers - Take Advantage of a Resurging M&A Market

Following several years of stormy weather, the sun is
finally beginning to emerge, albeit slowly, on the M&A
market. Many observers expect strategic buyers to be
major players in this recovery. That’s good news for
most business sellers, because strategic buyers
typically pay more than financial buyers.
Finding and negotiating with strategic buyers isn’t
necessarily going to be easy, though. Intense
competition among businesses that have been
waiting for the M&A market to improve, and that are
now entering the market, means that sellers must be
prepared to make a compelling case.
The new dealmakers
Strategic buyers choose targets based on projected
synergies and other factors that they believe will
contribute to their company’s long-term growth. And
they aren’t only the dominant players right now —
they’re pretty much the only players.
A study conducted by the Association for
Corporate Growth and Thomson Reuters found that
through Nov. 30, 2009, strategic M&A activity totaled
$1.7 trillion. Although this number represents a 32%
decline from the comparable period in 2008, it
accounts for 94% of announced M&A deals last year
— the highest percentage of strategic deals since
2001. Private equity funds traditionally make up the
bulk of financial buyers, which choose their
acquisition targets based on economic value. But
scarce financing and poor investment returns have
kept most of these buyers out of the market in recent
years. Strategic buyers, on the other hand, tend to be
more financially stable and often have the capital
needed to make cash deals. They also don’t face the
same time pressures as financial buyers, who
typically look for temporarily undervalued targets that
can be bought relatively cheaply.

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Are You Ready for the Due Diligence Challenge?

Due diligence is a necessary stage in the M&A process, but most sellers would just as soon skip this stressful step if they could. Unfortunately, due diligence is only getting more onerous. In the wake of the recent economic downturn, business buyers are focused on risk like never before. And they’re using due diligence to head off negative surprises, such as excessive debt or pending litigation. Sellers in 2010, therefore, should be prepared to provide a serious prospective buyer with
everything from extensive financial records to long-term strategic plans to detailed lists of hard assets. You also should expect the due diligence period to last longer than it might have only a few years ago — potentially delaying the deal’s close.
Inevitable development Although the collapse of the financial markets in 2008 has fueled a more cautious attitude among buyers, ramped-up due diligence is a long time coming. Implementation of the Sarbanes-Oxley Act of 2002 (SOX) was a turning point, as SOX rules required public companies to assume greater responsibility for accurate financial reporting and fraud prevention — including those of the companies they acquired.

Click "HERE" for entire article.

The Confidentiality Myth

When it comes time to sell the company, a seller's prime concern is one of confidentiality. Owners are afraid that "if the word gets out" they will lose employees, customers and suppliers. Not to downplay confidentiality, but these incidents seldom happen if the process is properly managed. There is always the chance that a "leak" will occur, but when handled correctly, serious damage is unlikely. Nevertheless, a seller should still be very careful about maintaining confidentiality since avoiding problems is always better than dealing with them. Here are some suggestions:

Understand that there is a "Catch 22" involved. The seller wants the highest price and the best deal, and this usually means contacting numerous potential buyers. Obviously, the more prospective buyers that are contacted, the greater the opportunity for a breach of confidentiality to occur. Business intermediaries understand that buyers have to be contacted, but they also realize the importance of confidentiality and have the procedures in place to reduce the risk of a breach. Another alternative is to work with just a few buyers. This, however, does reduce the chances of obtaining the best price.
Another way to avoid this breach is to try to keep a short timetable between going to market and a closing. The shorter the timetable, the less the chance for the word to get out. One way to keep a short timetable is to gather all of the information necessary for the buyer's due diligence ahead of time. Create a place where all of this material can be consolidated. This can be as simple as a set of secured file drawers. Such documentation as: customer and vendor contracts, leases and real estate records, financial statements and supporting schedules (assets, receivables, payables), conditions of employment agreements, organization charts and pay schedules, summary of benefit programs, patents, etc. should be gathered. It is not unusual for due diligence examinations to look back 3 to 5 years, so there could be a lot of records.
The above means that the seller has to get organized. Selling one's business is fraught with paperwork. Set up some three-ring binders so all of the relevant paperwork and resulting documentation has a place. These binders should be kept in a secure location.
The seller's employees should be conditioned to having strange people (potential buyers) walk through the facility. One way to avoid suspicion is to arrange to have unrelated people, for example - customers, suppliers, advisors - tour the company facilities prior to placing the business on the market.
If sellers have not prepared their employees for strangers walking through the facilities as suggested above, awkward situations can develop. A valued employee may question why tours are being conducted. The seller is then placed in the position of explaining what is happening or covering the question with a "smokescreen." A seller could reply by saying that the strangers are possible investors in the company. If asked directly if the business is for sale, the seller could respond by saying that if General Electric wants to pay a bundle for it - anything is for sale. Once in the selling process, it is also important to minimize traffic by only allowing serious, qualified prospects to tour the operation.
Keep in mind that confidentiality leaks can emanate from many sources. For example, an errant email ends up on someone else's email. A fax gets sent to the wrong fax machine or UPS or FedEx deliveries go to the wrong people. Establish methods ahead of time on how to communicate with potential buyers or an intermediary.
The key to handling confidentiality may be for the seller to retain a third party intermediary. They will insist that all potential buyers sign a confidentiality agreement. They will also be able to advise the seller on how to handle the "company tours" and can insure that only qualified buyers are shown the facilities.
The "myth" is that confidentiality issues can make or break a deal, or cause serious damage to the seller's business. The reality is that breaches seldom occur when an intermediary is involved, and if they do occur and are handled properly, there is little damage to the business or a potential transaction.

10 Tips for a Successful Sale

1.Sellers should find out the loan value of the fixtures, equipment and machinery prior to a sale. Many buyers will count on using it for loan or collateral purposes. No one wants to find out at the last minute that the value of the machinery won't support the debt needed to put the deal together.

2.Sellers should resolve all litigation and environmental issues before putting the company on the market.

3.Sellers should be flexible about any real estate involved. Most buyers want to invest in the business, and real estate usually doesn't make money for an operating company.

4.Sellers should be prepared to accept lower valuation multiples for lack of management depth, regional versus national distribution, and a reliance on just a few large customers.

5.If a buyer indicates that he or she will be submitting a Letter of Intent, or even a Term Sheet, the seller should inform them up-front what is to be included:

price and terms
what assets and liabilities are to be assumed, if it is to be an asset purchase
lease or purchase of any real estate involved
what contracts and warranties are to be assumed
schedule for due diligence and closing
what employee contracts and/or severance agreements the buyer will be responsible for
6.Non-negotiable items should be pointed out early in the negotiations.

7.The sale of a company usually involves three inconsistent objectives: speed, confidentiality and value. Sellers should pick the two that are most important to them.

8.A PricewaterhouseCoopers survey of more than 300 privately held U.S. companies that were sold or transferred pointed out the most common things a company can do to improve the prospects of selling:

improve profitability by cutting costs
restructure debt
limit owner's compensation
fully fund company pension plan
seek the advice of a consultant
improve the management team
upgrade computer systems
9.Sellers should determine up-front who has the legal authority to sell the business. This decision may lie with the board of directors, a majority stockholder, and a bank with a lien on the business, etc.

10.Partner with professionals. A professional intermediary can be worth his or her weight in gold.

What is a Contingency?

A contingency in the sale of a business is a condition in the contract of sale or offer that must be resolved, satisfied or rectified by either a buyer or seller. If they are not satisfied then the sale will generally not go forward. Most offers on a business contain one or more contingencies. The sale may be subject to the buyer obtaining financing, or the seller repaving the parking lot. Experienced business brokers have seen just about every contingency there is. Most of these are placed in the offer by a buyer who has concerns about one or more issue and needs it or them to be satisfied before proceeding with or closing the sale.

It may be as simple as the sale is contingent upon the buyer receiving a five-year extension of the lease by [a certain date]. Or, the offer to purchase may state that the sale is conditional upon the buyer's approval of the seller's books and records.

The difference between the two examples is that in the first one, it is a specific event that must be satisfied, and a time limit is specified. The second example is open-ended, meaning that a buyer could opt out of the deal by disapproving the books and records essentially for any reason.

Here are some tips on contingencies:

There should be a time period in which the contingency must be satisfied. Without it the deal could go on almost forever.
It, or they, as the case may be, should be reasonable. There is no point in making the sale contingent on moving the building to the next state. As they say - "it ain't going to happen."
Contingencies should be limited to very important or critical issues - those that impact whether a buyer will actually purchase the business or not. Minor items should be resolved prior to an offer being written.
Confidentiality or proprietary issues may influence whether a buyer will buy the business, but the seller is not willing to proceed until an offer containing price and terms is agreed upon.
Contingencies come in all sizes and shapes. Very few offers don't contain at least one, and usually more than one. They are an inevitable part of selling - and buying a business. A business broker knows what is reasonable and what is not.

Secrets to Closing the Sale Successfully

There are several things to consider when buying or selling a business. The most important is to listen to the other side. There are always reasons why someone wants something - even if you don't agree at first. Find out where the other side is coming from, then make a decision on whether you can live with it or not.

Next, whether you are the buyer or the seller, you can not have everything your way. You can't win on every point or issue. Be prepared to give in on those areas that are not as important as those you feel most strongly about. If you are a seller, you may not be able to get a real high price and a real high down payment. You will have to decide which is more important. The same is true for the buyer. You can't have it both ways.

Always enter the purchase or sale of a business with a spirit of cooperation rather than one of confrontation. The buyer or the seller, as the case may be, is not the enemy. If the seller wasn't interested in selling, the business would not be for sale. If the buyer did not like the business there would be no negotiation or eventual sale.

The secret of a successful negotiation is laying out all the points on the table for discussion. It is key to understand where everyone is coming from and to understand what is and what is not important to each party. When there is a sense of cooperation among all of the players, a successful deal will usually result.

What Makes the Sale of a Business Fall Through?

There are myriad reasons why the sale of a business doesn't close successfully; these multiple causes can, however, be broken down into four categories: those caused by the seller, those caused by the buyer, those that just happen ("acts of fate"), and those caused by third parties. The following examines the part each of these components can play in contributing to the wrecked deal:

The Seller

1. In some instances, the seller doesn't have a valid reason for entering into the sale process. Without a strong reason for selling, he or she has neither the willingness to negotiate nor the flexibility to see the sale to a conclusion. Without such a commitment, the desire to sell is not powerful enough to overcome the many complexities necessary to finalize the sales process.

2. Some sellers are merely testing the waters. As detailed above, they are not at that "hungry" stage that provides the push toward a successful transaction. These sellers merely want to see if anyone wants to buy their business at the price they would like to receive.

3. Many sellers are unrealistic about the price they want for their business. They may be sincere about wanting to sell, but they are unable to be realistic about how the marketplace will value the business. The demand for their business may not be there.

4. Some sellers fail to be honest about their business or its situation. They may be hiding the fact that new competition is entering the market, that the business has serious problems or some other reason the business is not salable under existing circumstances. Even worse, some sellers do not disclose that there is more than one owner and that they are not all in agreement about selling the business.

5. A seller may decide to wait until a buyer is found and then check with their outside advisors about the tax and/or legal consequences. At this point, the terms of the deal have to be altered, and the buyer won't agree. Sellers should deal with these complications ahead of time. Nobody likes changes--especially buyers!

6. Sometimes sellers don't understand that almost all businesses are seller-financed. Buyers have to be able to make the payments while still making a living from the business. If the business cannot offer this necessity, no one will buy it.

The Buyer

1. The buyer may not have an urgent need or a strong desire to go into business. In many cases the buyer may begin with positive intentions, but then doesn't have the courage to make "the leap of faith" necessary to go through with the sale.

2 Some buyers, like sellers, have very unrealistic expectations regarding the price of businesses. They are also uneducated about the nature of small business in general.

3. Many buyers are not willing to put in the hours or do the type of work necessary to operate a business successfully.

4. Buyers can be influenced by others who are opposed to the purchase of a business. Many people don't or can't understand the need to be "your own boss."

Acts of Fate

These are the situations that "just happen," causing deals to fall through. Even considering the strong hand of fate, many of these situations could have been prevented.

1. A buyer's investigation reveals some unmentioned or unknown problem, such as an environmental situation. Or, perhaps there are financial deficiencies discovered by the buyer. Unfortunately, these should have been on the table from the beginning of the selling process.

2. The seller may not be able to substantiate, at least to the buyer's satisfaction, the earnings of the business.

3. Problems may arise, unknown to both the seller and the buyer, with federal, state, or local governmental agencies.

Third Parties

1. Landlords may become difficult about transferring the lease or granting a new one.

2. Buyers and/or sellers may receive overly-aggressive advice from outside advisors, usually attorneys. Attorneys, in their zeal to represent their clients, forget that the goal is to put the deal together. In some cases, they erect so many roadblocks that the deal can only fall apart.

Most of the problems outlined here could have been resolved before the selling process was too far advanced. There are also some problems that could not have been avoided--people do sometimes enter situations with the best of intentions only to find out that this is not the right answer for them after all. These are the exceptions, however. Most business sales can have happy endings if potential difficulties are handled at the appropriate time.

Business brokers are aware of the various ways a deal may fall through. They are experienced in resolving issues before the business goes onto the market or before a buyer is introduced to the business. To buy or sell a business successfully, sellers should resolve any potential deal-wreckers, following the advice of a professional business broker.

Although business brokers cannot provide legal advice, they are famililar with the intricacies of the business sale. They are also familiar with local attorneys who specialize in the details of these transactions. These attorneys will usually be more efficient, and therefore more cost-effective, than the attorney who handles a general practice.

Early Possession

There are times when the buyer and seller think it would be a great idea if the buyer began operation of the business prior to the closing of the sale. Why? Here are some typical reasons:

The buyer needs the income.
The seller has really "had it."
The time it takes to close a deal has been excessively long.
The seller is in poor health and can't operate the business (or something similar.)
The buyer feels the business is deteriorating and wants to get in before it all goes.
So, analyzing the reasons above for early possession, does the end justify the means? The answer is a resounding NO. Sellers (who often are as enthusiastic about early possession as the buyer) should remember that the sale hasn't closed yet and the buyer may still have second thoughts. Early possession can create a real obstacle to a closing, whether it's real estate, a business, or almost any other commodity. It makes good business sense to let the early possession "idea" remain just that: an idea and nothing more.

The Deal Is Almost Done -- Or Is It?

The Letter of Intent has been signed by both buyer and seller and everything seems to be moving along just fine. It would seem that the deal is almost done. However, the due diligence process must now be completed. Due diligence is the process in which the buyer really decides to go forward with the deal, or, depending on what is discovered, to renegotiate the price - or even to withdraw from the deal. So, the deal may seem to be almost done, but it really isn't - yet!

It is important that both sides to the transaction understand just what is going to take place in the due diligence process. The importance of the due diligence process cannot be underestimated. Stanley Foster Reed in his book, The Art of M&A, wrote, "The basic function of due diligence is to assess the benefits and liabilities of a proposed acquisition by inquiring into all relevant aspects of the past, present, and predictable future of the business to be purchased."

Prior to the due diligence process, buyers should assemble their experts to assist in this phase. These might include appraisers, accountants, lawyers, environmental experts, marketing personnel, etc. Many buyers fail to add an operational person familiar with the type of business under consideration. The legal and accounting side may be fine, but a good fix on the operations themselves is very important as a part of the due diligence process. After all, this is what the buyer is really buying.

Since the due diligence phase does involve both buyer and seller, here is a brief checklist of some of the main items for both parties to consider.

Industry Structure

Figure the percentage of sales by product line, review pricing policies, consider discount structure and product warranties; and if possible check against industry guidelines.

Human Resources

Review names, positions and responsibilities of the key management staff. Also, check the relationships, if appropriate, with labor, employee turnover, and incentive and bonus arrangements.

Marketing

Get a list of the major customers and arrive at a sales breakdown by region, and country, if exporting. Compare the company's market share to the competition, if possible.

Operations

Review the current financial statements and compare to the budget. Check the incoming sales, analyze the backlog and the prospects for future sales.

Balance Sheet

Accounts receivables should be checked for aging, who's paying and who isn't, bad debt and the reserves. Inventory should be checked for work-in-process, finished goods along with turnover, non-usable inventory and the policy for returns and/or write-offs.

Environmental Issues

This is a new but quite complicated process. Ground contamination, ground water, lead paint and asbestos issues are all reasons for deals not closing, or at best not closing in a timely manner.

Manufacturing

This is where an operational expert can be invaluable. Does the facility work efficiently? How old and serviceable is the machinery and equipment? Is the technology still current? What is it really worth? Other areas, such as the manufacturing time by product, outsourcing in place, key suppliers - all of these should be checked.

Trademarks, Patents & Copyrights

Are these intangible assets transferable, and whose name are they in. If they are in an individual name - can they be transferred to the buyer? In today's business world where intangible assets may be the backbone of the company, the deal is generally based on the satisfactory transfer of these assets.

Due diligence can determine whether the buyer goes through with the deal or begins a new round of negotiations. By completing the due diligence process, the buyer process insures, as far as possible, that the buyer is getting what he or she bargained for. The executed Letter of Intent is, in many ways, just the beginning.

Buying a Business - Some Key Consideration

What's for sale? What's not for sale? Is real estate included? Is some of the machinery and/or equipment leased?
Is there anything proprietary such as patents, copyrights or trademarks?
Are there any barriers of entry? Is it capital, labor, intellectual property, personal relationships, location - or what?
What is the company's competitive advantage - special niche, great marketing, state-of-the-art manufacturing capability, well-known brands, etc.?
Are there any assets not generating income and can they be sold?
Are agreements in place with key employees and if not - why not?
How can the business grow? Or, can it grow?

Is the business dependent on the owner? Is there any depth to the management team?
How is the financial reporting handled? Is it sufficient for the business? How does management utilize it?

The Term Sheet

Buyers, sellers, intermediaries and advisors often mention the use of a term sheet prior to the creation of an actual purchase and sale agreement. However, very rarely do you ever hear this document explained. It sounds good but what is it specifically?

Very few books about the M&A process even mention term sheet. Russ Robb's book Streetwise Selling Your Business defines term sheet as follows: "A term sheet merely states a price range with a basic structure of the deal and whether or not it includes the real estate." Attorney and author Jean Sifleet offers this explanation: "A one page 'term sheet' or simply answering the questions: Who? What? Where? and How Much? helps focus the negotiations on what's important to the parties. Lawyers, accountants and other advisors can then review the term sheet and discuss the issues." She cautions, "Be wary of professional advisors who use lots of boilerplate documents, take extreme positions or use tactics that are adversarial. Strive always to keep the negotiations 'win-win.'"

If the buyer and the seller have verbally agreed on the price and terms, then putting words on paper can be a good idea. This allows the parties to see what has been agreed on, at least verbally. This step can lead to the more formalized letter of intent based on the information contained in the term sheet. The term sheet allows the parties and their advisors to put something on paper that has been verbally discussed and tentatively agreed on prior to any documentation that requires signatures and legal review.

A term sheet is, in essence, a preliminary proposal containing the outline of the price, terms and any major considerations such as employment agreements, consulting agreements and covenants not to compete. It is a good first step to putting a deal together.

Buyer Introduction

Going into business for yourself is a big step, one that can be full of apprehension and even fear. Almost 90 percent of all those who purchase a small business have never owned a business. Most of them also bought a business that was different than what they had been looking for. These business buyers had the opportunity to explore the marketplace, and subsequently they found a business more to their liking. In most cases, the seller financed the sale of his or her business.

As you begin your search for a business, keep in mind that running your own business is more than a job; it is a lifestyle change. In most cases, it is a very big lifestyle change. Usually, you will be working longer hours, you will be making all of the decisions - and, as the expression says, "you will be the chief cook and bottle washer." In other words, you will be doing all of the work from running the business to, in may cases, sweeping the floor and changing the light bulbs. Most buyers are looking for many of the following in considering the purchase of a business:

Pride in the service or the product
Flexibility
Income
Control of your own destiny
Recognition
Security
Privacy
Status
Customer and employee contact
What To Look For

1. How long the business has been in business.

A business with a long track record means there are good reasons for that business to be operating. It will be well known in the area, and people will be used to patronizing the business or using its services. The longer it has been in operation, generally, the better the business.

2. How long the present owner has owned the business.

The longer the present owner has been in business, the more likely he or she has been successful. People don't stay in business if they are not making money.

3. Why the present owner is selling.

If the owner of a business has been in business for six months, is 37 years old and wants to retire, you should be suspicious. The more valid the reason for sale, the more realistic the seller will be in considering your offer. However, keep in mind that after five or six years or more, people do get restless or "burn-out" sets in, or people look for new challenges. Why the seller is selling is an important question - get the answer.

4. Why books and records are important.

The financial records of the business are a good indication of how well the business has been doing over the years. Keep in mind that tax records are not designed to show the business in the best light: no one likes to pay more taxes than they have to, and owners of businesses are no different. Generally, tax returns are a worst case scenario. You need to be able to look at the expenses and discover which ones are non-cash items, such as depreciation and business use of home and vehicles. How important was the business trip to Las Vegas? A professional business broker can point these items out to you. When in doubt, however, seek outside assistance.

Keep in mind that financial records are only history. There are no guarantees that they will or can be duplicated or repeated. All of your profits are future. In the final analysis, the financial records of the business are an indicator of what the business has done; what you do with its future is up to you.

5. How to determine if the seller is reporting all income.
The simple answer is - you cannot determine if the seller is reporting all income! Not reporting income is against the law. You should consider only the income that the seller can show you. We all know, of course, especially in cash type businesses, there is the possibility that the seller is not reporting all of his or her income for tax purposes. This "underground economy" has been well-documented and is in the billions of dollars. Many sellers will tell you about how much they are "skimming," but you should ignore their statements, since they have no way of proving these amounts. In determining whether a business is the right one for you, you should base the decision on the figures actually supplied to you by the seller.

The Bottom Line

Being in business for yourself can be a daunting prospect. There are no guarantees. At some point, after all of your investigation is completed, you will still have to make that "leap of faith" that is necessary to proceed with the purchase of the business. You will have to work hard, perhaps even "tighten your belt" a little and perform many different jobs to be successful in your own business. But, if running your own show, making your own decisions, not having to worry about job security (remember, no one can fire you from your own business), and just being on your own are important - then owning a business is for you. After taking this leap of faith, almost all business owners will tell you that they would never go back to being an employee.

How Big Are Most Businesses? Smaller Than You Think!

Are you intrigued by the subject of just how big most businesses are?

American Business Information, an infoUSA company, has a breakdown that is quite revealing. Following is a randomly selected list of different types of businesses and the percentage of the total number in the U.S. that have less than $500,000 in annual sales.

Type of business % of the total number with sales less than $500,000
Advertising Agencies 58%
Apparel & Garments (retail) 67%
Art Galleries 78%
Art Supplies 53%
Auto Lube 77%
Auto Exhaust System Repair 56%
Auto Parts & Supply 27%
Auto Body Repair 66%
Bagels 58%
Beauty Salons 96%
Bicycle Shops 54%
Book Dealers (stores) 48%
Check Cashing Agencies 58%
Coffee Shops 79%
Coin-Op Laundries 96%
Convenience Stores 19%
Delicatessens 77%
Doughnut Shops 69%
Florists 82%
Hotels & Motels 57%
Ice Cream Parlors 74%
Lawn & Grounds Maintenance 82%
Liquors –Retail 42%
Paint – Retail 16%
Pet Shops 58%
Restaurants 59%
Sporting Goods – Retail 46%
Tanning Salons 94%

Auto dealers, manufacturers and many other companies that would have certainly lowered the percentages are not included, but the above create a cross-section of main street type businesses. These businesses make up almost 90 percent of the total number of businesses in the U.S. Looking at the above selection and not counting the numbers of each, but just the percentages - over 60 percent, on average, have annual sales of less than $500,000. That's what small business is all about. Being your own boss, running your own show, making your own decisions, answering (most of the time) to no one, living your own life, and making a living - that's small business. It would appear from the data that small business is alive and well!

SOLD!

The Serious Buyer

A serious buyer should have the answers to the following questions:

Why are you considering the purchase of a business at this time?
What is your time-frame to find a suitable business?
Are you open-minded about different opportunities, or are you looking for a specific business?
Have you set aside an amount of capital that you are willing to invest?
Do you really want to be in business for yourself.
Are you currently employed or unemployed?
Are you the decision maker or are there others involved?
The real key to being a serious buyer, however, is whether you can make that "leap of faith" so necessary to the purchase of a business. No matter how much due diligence a buyer performs, no matter how many advisors there are to advise the buyer, at some point, the buyer has to make a leap of faith to purchase the business. There are no "sure things" and there are no guarantees - if a buyer is not comfortable being in business, he or she should not even contemplate buying a business.

An Update on Earnouts

New accounting rules may require that acquirers and acquiring companies report earnout agreements as liabilities.

Joel Johnson, president of Orchard Partners Inc., in his article, “Earnouts,” published by Valuation Strategies, states: "In a given year, 2% - 3% of announced mergers and acquisition agreements involve earnouts. These figures probably understate their prevalence. Earnouts tend to be a characteristic of smaller deals; and in many small deals, terms are not announced. Earnouts are rare when public companies are acquired and more common when ownership is concentrated among a few shareholders."

This would mean, if implemented, that earnout agreements must have a value placed on them for accounting purposes. As Joel Johnson points out, “The higher the earnout, the greater the liability.”

Why the Earnout?

Johnson further states that earnouts are used for various reasons:

1. to bridge the pricing gap between the seller who places a heavy emphasis on the company's projections, and the buyer who places most of the company's value on its present and past performance.
2. to tie the acquisition payout to future performance.
3. to create a form of seller financing in that some of the buyer's purchase price is delayed into the future. 4. to establish a form of escrow account in that the money is paid on condition of meeting certain thresholds.
5. to act as a type of employment agreement in that the CEO has to stick around in order to collect.

Remember: It Is Not Always the Price

The following are situations where the price was not the deciding issue in the successful sell of a business. The ultimate buyer may be the only one who really understands the situation. A business intermediary really understands the issues and can lead the buyer and seller to a successful resolution.

• One seller had 60 shareholders who needed to walk away from the deal. The losing buyer wanted all selling shareholders to be accountable for the "reps and warranties." The winning buyer waived the reps and warranties at closing.

• A seller's management team wanted some future upside in the deal. The losing buyer offered all cash and normal compensation. The winning buyer offered 80% cash, 20% stock plus 3-year earnout on revenues -- including acquisitions.

• Time was of the essence. The losing buyer needed 30 day due diligence and negotiations plus a 60-day window to close the deal. The winning buyer offered to close within 40 days of the Letter of Intent and agreed to have limited due diligence.

The Three Ways to Negotiate

Basically, there are three major negotiation methods.

1. Take it or leave it. A buyer makes an offer or a seller makes a counter-offer – both sides can let the “chips fall where they may.”

2. Split the difference. The buyer and seller, one or the other, or both, decide to split the difference between what the buyer is willing to offer and what the seller is willing to accept. A real oversimplification, but often used.

3. This for that. Both buyer and seller have to find out what is important to each. So many of these important areas are non-monetary and involve personal things such as allowing the owner’s son to continue employment with the firm. The buyer may want to move the business.

There is an old adage that advises, “Never negotiate your own deal!”

The first thing both sides have to decide on is who will represent them. Will they have their attorney, their intermediary or will they go it alone? Intermediaries are a good choice for a seller. They have done it before, are good advocates for their side and they understand the company and the seller.

How do the parties get together in a win-win negotiation? The first step is for both sides to work with their advisors to settle on the price and deal structure positions. Both sides should be able to present their side of these issues. Which is more important – price or terms, or non-monetary items?

Information is vital to a buyer. Buyers should keep in mind that the seller knows more about the business than he or she does. Both buyer and seller need to anticipate what is important to the other and keep that in mind when discussing the deal. Buyer and seller should do due diligence on each other. Both buyer and seller must be able to walk away from a deal that is just not going to work.

Bob Woolf, the famous sports agent said in his book, Friendly Persuasion: My Life as a Negotiator, “I never think of negotiating against anyone. I work with people to come to an agreement. Deals are put together.”

Considerations When Selling...Or Buying

Important questions to ask when looking at a business...or preparing to have your business looked at by prospective buyers.

• What’s for sale? What’s not for sale? Does it include real estate? Are some of the machines leased instead of owned?

• What assets are not earning money? Perhaps these assets should be sold off.

• What is proprietary? Formulations, patents, software, etc.?

• What is their competitive advantage? A certain niche, superior marketing or better manufacturing.

• What is the barrier of entry? Capital, low labor, tight relationships.

• What about employment agreements/non-competes? Has the seller failed to secure these agreements from key employees?

• How does one grow the business? Maybe it can’t be grown.

• How much working capital does one need to run the business?

• What is the depth of management and how dependent is the business on the owner/manager?

• How is the financial reporting undertaken and recorded and how does management adjust the business accordingly?

Reasons to Sell / Reasons to Acquire

A January 2004 survey conducted by the DAK Group/Rutgers found the following breakdown of why businesses are for sale:

Reasons To Sell

Risk reduction 44%
Competition or market changes 41%
External pressures 27%
Lifestyle factors (age, health, etc.) 14%
Lack of capital 9%
Ownership/management issues 07%
Note: Multiple responses allowed; Source: DAK Group/Rutgers

It is interesting to note that the top, by far, three reasons to sell are financial as is the fifth reason. The information furnished by much of the media suggests that the big reason to sell is generational – in other words, all of yesterday’s owners are now ready to retire. According to the survey above, that motivation (included in “Lifestyle factors”) represents only 14 percent, and it includes health and other personal issues. The last reason, at 7 percent, might also include retirement since ownership/management could be involved with retirement issues. Twenty-one percent of the respondents mentioned either lifestyle or ownership/management issues. Placing these reasons at the top of the list does not justify the hype of the “baby-boomers” retiring over the next few years.

Shown, below, the reasons for considering an acquisition seem to be more obvious. Although growth leads the list by a hefty margin, all of the other reasons could also be considered growth issues.

Reasons for Considering an Acquisition

Growth 72%
Acquire competitor 38%
Product diversification 37%
Geographic diversification 29%
Technology 09%
Note: Multiple responses allowed; Source: DAK Group/Rutger

Tips for Buyers

Don't be greedy.

Sellers deserve a fair price for the years they have spent developing their business. Be prepared to pay for the goodwill of the business.

Have a good reason to be buying.

Buying a business is hard work! It takes a commitment! Spend time deciding why you want the responsibility of owning a business.

Be prepared.

Be prepared with a resume and financial statement. Remember, the seller will most likely be your banker and will want to know that you can run the business successfully.

Keep an open mind.

There are no perfect businesses.

Don't forget the tax benefits.

Remember tax benefits are realized from intangible as well as tangible assets.

Offer a reasonable down payment.

A low down payment indicates a lack of commitment. When sellers question commitment, serious negotiations are in jeopardy.

Businesses are priced on cash flow.

A business making huge profits with few assets could save you money later in capital outlay for expansion.

Time is of the essence.

After all parties have agreed upon price and terms, it is important to quickly proceed toward closing.

Meet the landlord.

Landlords usually have little to gain by cooperation. Therefore, come to meetings armed with resume and financial statement.

Full disclosure.

Disclose pertinent information early and avoid surprises that might destroy your credibility.

Keys to a Successful Closing

The closing is the formal transfer of a business. It usually also represents the successful culmination of many months of hard work, extensive negotiations, lots of give and take, and ultimately a satisfactory meeting of the minds. The document governing the closing is the Purchase and Sale Agreement. It generally covers the following:

• A description of the transaction – Is it a stock or asset sale?

• Terms of the agreement – This covers the price and terms and how it is to be paid. It should also include the status of any management that will remain with the business.

• Representations and Warranties – These are usually negotiated after the Letter of Intent is agreed upon. Both buyer and seller want protection from any misrepresentations. The warranties provide assurances that everything is as represented.

• Conditions and Covenants – These include non-competes and agreements to do or not to do certain things.

There are four key steps that must be undertaken before the sale of a business can close:

1. The seller must show satisfactory evidence that he or she has the legal right to act on behalf of the selling company and the legal authority to sell the business.

2. The buyer’s representatives must have completed the due diligence process, and claims and representations made by the seller must have been substantiated.

3. The necessary financing must have been secured, and the proper paperwork and appropriate liens must be in place so funds can be released.

4. All representations and warranties must be in place, with remedies made available to the buyer in case of seller’s breech.

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What Should You Look For When Considering a Business to Purchase?

Unfortunately, too many prospective buyers want to know the asking price first, and then they ask how much money can they make. These are the wrong questions to ask initially. Buyers need to know how much cash the seller requires as a down payment. There is no point in looking at a business, no matter how good the numbers are, if the seller wants three times as much cash as you are willing to invest.

Remember, the actual amount of money a business earns is usually much more than just the bottom line. A smart approach is to get more information on the business, and even make a visit, before ruling it out or getting too involved in the numbers. It's all part of the learning process.

Financing the Business Purchase

Where can buyers turn for help with what is likely to be the largest single investment of their lives? For most small to mid-sized business acquisitions, here are the best ways to go:

Personal Equity

Typically, anywhere from 20 to 50 percent of cash needed to buy a business comes from the buyer and his or her family. Buyers who invest their own capital (usually an amount between $50,000 and $150,000) are positively influencing other investors or lenders to participate in financing.

Seller Financing

This is one of the simplest and best ways to finance the acquisition, with sellers financing 50 to 60 percent--or more--of the selling price, with an interest rate below current bank rates, and with a far longer amortization. Many sellers actively prefer to do the financing themselves, thereby increasing the chances for a successful sale and the best possible price.

Venture Capital

Venture capitalists are becoming increasingly interested in established, existing entities, although this type of financing is usually supplied only to larger businesses or startups with top management and a good upside potential. They will likely want majority control, will want to cash out in three to five years, and will expect to make at least 30 percent annual rate of return on their investment.

Small Business Administration

Similar to the terms of typical seller financing, SBA loans have long amortization periods. The buyer must provide strong proof of stability--and, if necessary, personal collateral, but SBA loans are becoming more popular and more "user friendly."

Lending Institutions

Those seeking bank loans will have more success if they have a large net worth, liquid assets, or a reliable source of income. Although the terms are often attractive, the rate of rejection by banks for business acquisition loans can go higher than 80 percent.

Source of Small Business Financing (figures are approximate)

Commercial bank loans 37%
Earnings of business 27%
Credit cards 25%
Private loans 21%
Vendor credit 15%
Personal bank loans 13%
Leasing 10%
SBA-guaranteed loans 3%
Private stock 0.5%
Other 5%

Friends and Family: A Financing Option

The first job facing many prospective business owners is rounding up the cash necessary to make the purchase. They may find that banks have made borrowing difficult (or all but impossible), and that even SBA loans have requirements too stringent to meet. One viable option is obtaining financing from the seller; another is to seek help from family and friends.

Borrowing money from family members and/or friends is one of the most frequently-used methods of small business financing. The pluses are obvious--there is trust, familiarity, and a general comfort level when dealing with those you know. The drawbacks are self-evident as well: "doing business" with family and friends comes with cautionary notes of legendary proportions. Everybody knows that family ventures can be complex and stressful, stirring up "bad blood" and lingering ill will. However, by taking the right preventive steps, buyers can take advantage of friendly financial help.

1. Set up an informal meeting to introduce your ideas.

This is the time to "feel out" friends and relatives casually, being sure they understand that this is strictly a fact-finding (and fact-presenting) meeting. Anyone who is not interested or cannot afford to be involved has plenty of opportunity to say so without feeling obligated--or emotionally "blackmailed."

2. Follow up with a professional business plan.

Those who have indicated interest should now be treated with utmost professionalism. A formal business plan, including detailed financials, and a carefully-drafted business contract should be presented at this subsequent gathering. Consult a business professional for help in establishing a schedule for repayment based on the appropriate interest rates. Nothing will inspire more confidence in lenders than the care taken with this vital paperwork.

3. Be clear about the structure of the business envisioned.

How much voice are investors to have in the business? This is a vital question. Be sure that all parties understand whether this is to be a simple investment or some sort of partnership, and put this agreement in writing.

4. Take care in identifying your borrowing "targets."

Sometimes willing and eager family members can't really afford to invest. If possible, try to spread the borrowing around so that no one person bears the crux of the loan. It may take more energy to get smaller amounts from a larger circle of people, but the safety factors for all concerned will more than compensate for the time spent.

5. Keep your investors involved.

Once the buyer becomes an owner and the new business is in operation, friends and family lenders are due more than their repayment. They will want to be informed and updated about the progress of the business. Keeping in touch is a cost-free way to return the vote of confidence your friendly investors have placed in you.

Seller Financing: Another Option for Commercial Real Estate

Credit markets are forecasted to continue to be tight through 2010. As a result, financing commercial and industrial real estate deals will be tough. We likely will not see what were considered to be conventional terms for real estate deals for some time, so why not consider seller financing if waiting out the market is not feasible?

Why do a Seller-financed deal?
Even credit-worthy buyers are unable to get financing in this market, so Seller financing makes sense if you have a Buyer that can give you satisfactory security and acceptable rate of return. Seller-financed deals are more flexible because you are not dealing with a financial institution's standards for interest rates, maturity dates, and so forth, although the deal will still have to comply with applicable laws regarding caps on interest rates, unconscionable provisions and so forth. In addition, because a lending institution is not involved, a Seller-financed deal may move more quickly.

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Small Business Loans on The Rise

The Indiana Statewide Certified Development Corp. (ISCDC) is reporting an increase in the amount of small business loans made during the first half of the 2010 fiscal year. Officials say they have approved more than $16 million for 22 projects, which is more than double the figures from the previous year.
In good news for the Indiana economy, the first half of fiscal 2010 saw a robust rebound in small business loans made by the Indiana Statewide Certified Development Corporation compared with the same period last year.

The Statewide CDC approved over $16 million in loans for 22 projects, more than double last year’s figures, and the third highest dollar amount in its 27-year history. The loans were made between September 1, 2009 and March 31, 2010.

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