Buying and Selling a Business. Garrett Sutton
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There is much less financial risk involved with buying an existing business than with starting one up. It is that initial period from startup to breaking even that is the most deadly for a business. An existing business must be doing something right to still be in existence. The rewards of ownership and independence are the same for a startup and for an existing business, but an existing business has a past to help guide the future. A path has been cleared for new owners to tread.
History is a valuable tool in any business. There is a level of expectation – a theoretical roadmap for the future. It is this aura of predictability that makes financing a purchase easier than financing a startup. The existing business has financial statements, assets, cash flow – in short, collateral that can be used for bank loans. And if the banks prove uninterested, many a motivated seller will help out with the financing, often with better terms than a commercial lender. An owner may even stick around after the sale to help with the often complicated, always delicate transition period.
We live in a time when small businesses are not only able to exist alongside big businesses; they are able to thrive. Technology has made access nearly seamless. Your business can reach customers on the other side of the world just as easily as the other side of the street. Fax, E-mail, Internet, video conferencing, printed material – all allow a local business to reach a global market while keeping overhead low and inventory small. These avenues may not have been explored by a company’s current owner and could be the difference between his or her getting by and your getting ahead.
Why Sell (vs. Hang On)
The best time to sell is when the economy and the industry are in good shape. While sellers have little or no control over these factors, they can keep their companies in prime selling condition in order to take advantage of unforeseen opportunities. A well-run business is a valuable commodity in any market. Knowing economic and industry norms and how the company stacks up against them will help a seller set the best price should he or she decide to sell.
Sometimes events completely out of a seller’s sphere of influence pop up and motivate a sale. Some of these include:
1. Change in the competition (such as when a large company decides to move into the arena and is looking for a company to buy)
2. Death of a partner or a majority shareholder (the owner may have to sell to pay off other partners or to divide up the deceased’s estate)
3. The owner’s own heirs don’t want the company (or are not competent to run it)
4. Unexpected changes in finances (such as from divorce or medical emergencies)
5. Changes in the rules (such as zoning changes or new laws)
Sometimes events completely within the seller’s sphere of influence are prompting the sale. Sellers must understand their motivations to avoid making a mistake.
Burnout is a common sale motivator. But burnout is seldom long-term; a sale is. Maybe the seller just needs a vacation or shorter hours. Maybe he or she needs to shake things up and bring the fun and adventure back into the business. If the owner decided to sell, that freedom (just as with short-timer’s syndrome in the workaday world) might prompt him or her to make changes. Sellers, why not make those changes now?
Timing
Timing is important whether buying or selling a business. The health of the overall economy, the state of the company’s specific industry, and the condition of the company all play into the decision-making process. The overall economy’s health may dictate the availability of loans while also coloring the perspective of potential buyers. Good economic times breed optimistic buyers. Optimistic buyers have rosier hopes for the future, and it is this future they are purchasing. The state of the target company’s industry and the health of the target business help define levels of perceived risk. Lower risk means higher prices, even if those risks are only in the eye of the beholder.
While buyers and sellers have no control over the health of the economy or even the state of the industry, assessing trends and perceptions will greatly influence their ability to be in the right place at the right time. The key ingredient to good luck is good planning.
Economic slumps may be good news for buyers. If buyers have the purchasing power (or better yet, the cash), there are usually bargains to be had during a recession. Of course, the risks are higher. After all, buyers are likely buying in the hopes of the economy turning around. Eventually it will, but weathering the storm can be an expensive proposition.
Economic booms may be good news for sellers. Optimism loosens purse strings. But higher purchase prices generally mean more debt for the buyer and if optimism turns out to be unfounded, carrying a company with significant debt and insufficient valuation may require a buyer to sell. A struggling company in a struggling economy is the worst of all situations for the seller.
Either way, in good economies or bad, buyers want to be sure they have enough money on hand to cover not only the purchase but also the initial slump that generally accompanies new ownership.
Risk of No Sale
Imagine putting a company up for sale and getting no offers. Or getting only low offers. What went wrong? Maybe the asking price was too high. This would be the time for the seller to go back to the value analysis and reconsider the assumptions used in projections of future sales. Were the assumptions realistic? If the owner still wants to sell, he or she will need to consider lowering the price or taking the company off the market. If the former, the seller may need an ego check first. If the latter, damage control is warranted.
A good way to understand some of the concepts we’re discussing is through the use of case studies. Our first one is instructive.
Case No. 1 – Walter, Peter and Anian
Walter owned a chain of three closet design and home organizing businesses in a large, populous state. Walter did a fair amount of advertising and so many people throughout the region knew of The Closet Admiral.
Walter had built the business up to the point where he could step away and do other things. He had brought in Peter to be the general manager of the three closet design businesses. Peter, being aggressive and confident in his abilities, insisted that he be able to acquire an ownership interest in the business over time. Walter agreed to this, but beyond an acceptance in principal, the negotiations had not yet begun and the terms for an acquisition of ownership had not even been discussed.
Shortly thereafter, Walter’s plans for the business changed. An opportunity to own an even more profitable business with a much greater upside potential had landed in Walter’s lap. To pull it off, he would have to sell The Closet Admiral in order to generate enough cash for the down payment he needed on the new business.
Walter decided to quietly solicit offers to purchase The Closet Admiral. He wanted to fly under the radar, so that no one would know of, or impede, his future plans. He didn’t tell Peter or his banker or any of his inside circle of advisors.
Anian owned a chain of five closet design locations in the southern part of the state. She was a hard-nosed businesswoman, always interested in a deal. When Walter approached her about a quiet sale she responded with interest. On a handshake, she agreed to keep the whole matter confidential. In reality, she just wanted to see Walter’s books. She wanted to know how he had been able to expand so quickly.
After reviewing the books, Anian placed two disastrous phone calls. First, she called Walter’s banker to demand why she couldn’t get the same favorable terms that Walter had received for equipment purchases. The banker was very angry that the confidential relationship between he and Walter had been compromised. Then, Anian called Peter to see if he would work for her. Peter learned for the first time that the business he thought he had an ownership interest in was for sale. He was furious at Walter for what he considered to be an offensive betrayal of trust.
Both Peter and the banker refused to do business with