In today’s post on mastering the business acquisition, I’ll write about some basic issues a business buyer may see when buying a business. The main one is valuation: what is the buyer paying for the business?.
BUSINESS ACQUISITION BASICS: WHAT ARE YOU PAYING FOR?
First on the list for business acquisition basics is what is the buyer paying for? Much like buying a house or a car, the buyer is buying a bundle of “things” that constitute the house, the car, the business. Similar to how you can buy car parts instead of the whole car, a business can be bought piecemeal. That’s why the most important factor in buying a business, above price, is determining what the seller is actually selling. Thus, before a buyer offers to buy a house, they want to know how many bedrooms, how many bathrooms, what’s the acreage.
Similarly, a business purchaser needs to know is it getting the whole of the business, or is the seller just spinning off an operating division of a larger business. Example: I have a client business that operates landscaping, festival crowd control (fencing, toilets), charter busing, roll-off dumpsters, and construction barricades as its business. He found a purchaser for just the transportation “division” of his business and sold it off.
In that instance, the business acquisition was only for a part of the business – the charter busing.
Yet another example: I recently heard of a well-known sandwich shop in town that the owner is selling. But he isn’t selling the branding – the name, advertising, logo. He’s selling a bundle of parts that is smaller than the whole. A buyer who can’t rely on the goodwill of the business to retain customers might not pay as much for the business.
WHAT STUFF ARE YOU GETTING?
That’s big picture. The nitty-gritty is literally a list of all the stuff the seller is selling, and the buyer is buying. Example: for a construction business, how many dump trucks (model, age, mileage etc.); how many ready-mix trucks; spare parts on hand; miscellaneous tools (yes, count all the shovels); computer systems including software; land (purchase, or take over the lease); the name of the business including marketing cladding.
SETTING THE VALUATION OF A BUSINESS ACQUISITION
I don’t value businesses for my clients who are buying or selling a business. There’s third-party companies that do that. Just like selling a house or car, we look to comparable sales. What has a similar company sold for in the past? Next, factor in inflation since the comparable sale. Factor in economic conditions. Look at past sales and profitability. Factor in customer orders in the pipeline. Take account of the reputation of the company in the community and its past history.
That said, the three main business valuation methods are: book value; liquidation value; and either of revenue or earnings multiplier. Each is a valid method, if used in the right context.
Book value is a simple function of assets minus liabilities.
Liquidation value sets the sale price as the value of the assets if sold off (like in a bankruptcy).
Revenue / earnings multiplier: Just what it sounds like. When you buy an existing business you’re buying a cash flow. What’s the value of that cash flow, projected out 3, 4, 5 years?
GOODWILL AND THE BUSINESS VALUE
“Goodwill” is generally considered in either of a book value or multiplier business acquisition. It’s a term that’s been loosely defined as that intangible value of a business that a buyer is willing to pay a premium for. It’s derived from the reputation of the business, longevity, brand name, long-term customer relationships, order pipeline. Yes, it’s a made-up number. But it’s real, and it sets the value of a business (and the profit to the seller, often).
CONCLUSION ON BUSINESS ACQUISITION ISSUES
If you are selling or buying a business, contact me early in the process so we can work on this and other business acquisition issues. Get your business ready for sale before you put it up for sale. It shows the buyer that you are a serious, organized, and well-run business.
Call me for all business buy/sell projects in the Western North Carolina area including Asheville, Hendersonville, Waynesville, Marion, (312 671-6453; or email at palermo@palermolaw.com.
Listen to my podcast on this and other business law topics at the link above or here on Spotify: Palermolaw Business Law Podcast
Other related blog posts are here:
The Corporate Conglomerate
Seller financing the sale of a small business
