Buying or Selling a Business in Orange County
Note, as stated in the terms of service, this publisher, writers, and posters do not necessarily have professional knowledge of business transactions. This publication should not be considered in any way complete or a substitute for professional advice.
We suggest that you do your research on this site, and use other resources such as books, and then contact a qualified business broker or business consultant. One place to find a consultant is Orange County SCORE http://www.score114.org/ which is made up of retired executives and sponsored by the Small Business Association. The advantage of working with a retired person is that there is no hidden agenda—they are not trying to sell you anything. The seminal problem in finding an expert you face is what is referred to as adverse selection. If the expert really knew how to operate the type of business you are interested in, why aren’t they making a lot of money operating that business? In some of the material we read, the mythical consultant was discussed like homeowners talk about the repair guy–if something breaks, a repair guy how specializes in fixing it must exist. But there is not natural or man made law which states he exists or you will be able to find him. It’s best to educate yourself rather than hoping to rely on a consultant.
Surf’s Up SCORE also offer low cost seminars at local libraries and colleges on a wide range of topics—everything from internet marketing to preparing a loan application.
Business Broker ?
From the buyer’s perspective, a business broker will generally be paid by the seller so you will not pay anything out of pocket for her services. And she may offer advice based on her experience, and she will have access to more opportunities than you could find yourself. But brokering a business deal is a lot of work, more so than selling a house, and she may not be too enthused about selling you a low cost business—because her commission will be low. Also be aware that she has an incentive to help you see things through rose colored glasses. Just like selling a house is not about selling the structure—it’s about selling a lifestyle; selling a business is not about selling a cash flow stream–it’s about selling a dream. It wouldn’t hurt ask them how they can help you.
From the seller’s perspective, paying for an agent’s expertise may be the best money you have ever spent. You might be an expert in your business, but the business of selling a business is a tough business. There are some things you have to keep in mind. If your business is low valued, she may not be too motivated to work hard. Ethically, she shouldn’t take your listing in that case, but she may look at it as a lottery ticket–if it’s a long shot to sell so just keep the listing and do the minimum amount of work possible. The second issue is that there will be a pay me clause in your listing agreement. Even if uncle Bob flies in the day after you sign your listing with suitcases of cash, she will want a commission.
How do you find a business broker? You don’t see a lot of advertising for their services. There are a couple of professional associations which list brokers
The California Association of Business Brokers http://www.cabb.org Each broker has a little bio about them on this site under contact information or a link to their website.
The International Association of Business Brokers http://www.ibba.org/
Surf’s Up Check out our sister site where you can post business for sale, put a post up if you are interested in buying a business or finding a business partner. www.OCBusinessForSale.com
[Also see our section on buying a franchise.]
That said, why not just call a broker and have her do all the work? Well if you think that way, maybe you are not a true business person at heart. There are a lot of things you can do to help get a good deal. But you have to start working before you contact a broker. And as with any employee, you don’t know if she is doing a good job unless you know what a good job consists of.
Surf’s Up A good place to start doing research on this topic is by reading a book from prolific business-legal writer Arnold S. Goldstein
The E-Z tile is a bit misleading in that it is a rather comprehensive book, with a lot of information applicable to medium and large businesses. All of these books seem to go over the same stuff, but this is one of the best written and complete books we came across.
Since Buying and Selling are two sides of the same coin, we have tried not to duplicate issues too much. But you should think about the process in terms of a game. The buyer should think about what a seller should do and why a seller is saying what she is saying. A seller should think about what the buyer wants to hear.
Selling your business
If you plan to profit, sell above the businesses asset value, in a few years, the time to start the sales process is now. You need have a good marketing plan for potential buyers, and the most salient fact to incorporate in that kit is: Buyers are looking for certainty.
This is a basic investment principle that is easy to explain by way of analogy. Consider Mrs. Saver. She cannot decide which is better: to put money into an insured CD at National Bank or to put her money into a bond from a Banana Republic. Assume these pay 2% and 20% respectively. Another way to look at these numbers is that she is paying $500 for each certain dollar of interest at the bank; and she is only paying $50 for each uncertain dollar of interest from the Republic of Banana. You want the income form your business to look more like the sure thing from National Bank. Then each dollar of projected profit is worth more in the eyes of a potential buyer.
Numbers and facts make us feel good when we are buying anything. Even if these facts are not specifically relevant to your business. Think about all those nice facts in a sports car brochure. They don’t really matter as we are heading down the 405 at 30mph. Truth-be-told we bought the car because it looks cool, but all those facts make us feel better about our purchase. Consider, in advertisements for national franchises you will see information such there are x thousand driveways North America so the snow clearance business can’t fail. Well all you really should care about is the number of people who call, but including facts like that in your information packet makes potential buyers feel good.
Start keeping good records. If you haven’t already done so, establish a business bank account so you can have a verifiable paper trail of deposits you made from your business. Another source of verifiable numbers buyers will be interested in is your federal tax form. Tax evasion will cost you. If you have been pocketing some cash or exaggerating expenses a bit, this will hurt your sales price when it comes to sell. Buyers will believe the numbers in the boxes of your Federal return. If you explain that your business actually made big bucks but you have been cheating Uncle Sam, projected profits will seem uncertain like the interest payments on Republic of Banana bonds. Hence you pay the price by lowering the sales price of your business. You may pay on other ways to Leona Helmsley spent time in the federal pen.
And you cannot fill out extra copies of your tax return with better numbers to show buyers. A savvy buyer or her agent will request copies of the form you actually filed with the IRS. This can be done via handy IRS Form 4056 (http://www.irs.gov/pub/irs-pdf/f4506.pdf) It costs about $60/tax year, but that’s an insignificant cost to a buyer who will pay thousands of dollars for your business.
- Demographic Information—Buyers love numbers. If you have a retail business, your buyer will want to see the demographics of the surrounding area. One easy way to get this in a nice report format is from loopnet.com. If you are working with a broker, she will probably have an account. [If you have decided to sell yourself, you may want to pay for an account. The deal with Loopnet is that the free account entitles you to advertise to only those who have paid to have an account—mostly agents and brokers. They may not be keen to present your businesses if they are not compensated. The paid listing is searchable by prospective buyers, and a lot of people just search with out an agent.] Event though it is known as a real estate site, a lot of businesses are listed on loopnet. Loopnet repackages US Census data to provide a nice looking report that list the number of people living in a radius of your location and their family income, ethnic make-up and educational level.
- Buyers will also want to see financials—income statements, balance sheets, and cash flow statements—prepared by a financial professional. They will be skeptical of something you did yourself, but especially after the Madoff scandal, the verifiable paper trail of bank records and actual tax forms will carry more weight. Unlike Madoff’s statements yours will not even be audited.
- Include a list of business assets and their approximate replacement cost if they needed to be re-purchased. If equipment had to be custom fabricated/installed in your facility, include these costs.
Assuming these look good, the next question in the buyer’s mind is: Why are you selling such a great business? Have an answer for the buyer. The next step is to overcome the possible negative factors a potential buyer will come up with:
- You have a bad lease. It is about to expire or is the low-rent period is over and your business will not be so profitable when the rent goes up. Well, to get past this hurdle, negotiate. Demonstrate to a potential buyer that they have time on the lease. Currently, you see those space available signs all over town. It might be a good time to negotiate a longer term lease, or better yet a lease with a lot of options to renew.
- Insurance. Show that your business has consistently been insured. This takes the buyer’s mind off the possibility that there is a latent claim she will have to deal with.
- Debts. List all the credit arrangements you have with suppliers or any other debts that go along with the business. Savvy buyers will inquire as to which debts are backed by your personal guarantee. For instance, a supplier may have agreed to supply your inventory based on your personal credit/guarantee. Your buyer will have to re-establish this relationship with these creditors, and you will want to contact these creditors after your business sells so you are not libel for future credit taken out in the business’s name.
- Assure the buyer you will not compete with her. Tell her that you will sign a non-complete clause in the purchase agreement which forbids you from opening a similar business in the geographical area and/or for a period of time.
- Agree to help the buyer out after the sale. Also if you have key employees it would be a good idea to have them agree to stay on for a period after the sale. You cannot bind them contractually to work at a business—as we no longer have endentured servitude —but a letter from them stating that they intend to stay will reassure buyers.
The next question a buyer will have is: Why should I pay a premium for this business when I could just start my own down the street? You will have to show the buyer what makes your business special. Your handout and website should have information about the historical background of the company and what makes your business special.
- If your business was started by your grandparents and you use a family recipe, let potential buyers know this. Highlight customer loyalty. If you have been seeing the same customer for a long time get a quote from him. Something like, “John Smith, a ten year customer says he likes the widget factory because they get the job done on time.” Emphasize the uniqueness of the product. Talk about how your business is well known in the community. “We have been doing business for x years in the same location, and belong to several community organizations…” This type of value is known by accountants as “good will.” This cannot just be bought off the shelf for a new business.
- If you are willing to participate in financing the business, you increase the number of potential buyers and hence the price you could receive. Some argue that buyers look at out of pocket costs rather than the total price of the business. The down payment is like an auto dealer’s drive-off cost. Owner financing sends a message that you believe in your business’s prospects. Why else would you be willing to help finance?
Protect Yourself You have the right to qualify the buyer before you start answering all her questions. If they have no prospect of getting funding, you don’t need to waste your time dealing with them. Also make sure they sign a confidentiality agreement. This should prevent them from telling your competitors all about your business. It will also prevent the buyer from starting up a bidding war between you and another business for sale. With out such an agreement, for instance, the buyer could go to the other business and tell them they should lower their price because your cash flow to price ratio is higher. Then the buyer could come to you and say that the other business has more customers and is selling at the same price so you should lower your price… A confidentiality agreement has the practical benefit of preventing a buyer from playing lets make a deal.
Surf’s Up You most obvious prospect list is the other people in your profession. See if you can get a membership list from any professional associations you belong to. If you are working with a broker, this will help her out a lot. Send out a flyer to let them know they have a great opportunity to expand by buying your business. Some associations hold on to their lists, but they will mail advertisements to them for a fee.
Buying a Business
First and foremost don’t be taken in by get-rich-quick talk. Why is she selling if the seller could really make these great sums of money? Couldn’t she just hire employees to run the business? In some cases it is illegal for someone selling a business, particularly a franchisor, to make explicit earning claims. They have to back them up with facts and state things in a manor such as “the average business in our experience makes X dollars per month in sales.”
As a buyer, you can look at purchasing a business as purchasing customer relationships and the ability to monitorize those relationships. So a good place to start analyzing a business is from the customer’s point of view. If there is no rational reason for customers to appreciate the business’s service/product the financial statements, trade marks, leaseholds are meaningless. One recent example illustrates this point. With video on demand coming to every TV set via your cable company or internet connection, what is the value of DVD rental business? Why would people rent when in the near future they can just push a button on their remote? The numbers on their financial statements are meaningless.
Do a customer based evaluation by asking yourself why are the customers frequenting this business? Possible answers include location, superior service, long term relationships, it’s product is different than the competitors, this is the only place arround that provides the service or advertising is really effective. Now ask your self if any of these is based solely on the current ownership. For instance, do they come into the bar because the owner seems to be everyone’s best friend?
Next, ask customers why they frequent the business. If it’s a retail business, go there and hang-out. If they want your money, the owner should not complain. If she does, that’s a red flag. Talk to the customers.
Surf’s Up Be sure to give them a chance to open up by asking open ended questions. i.e. Do you like coming here? Is not as good as Why do you like coming here? Simply because they will respond to the first question with “yep” and a weird look. The second question allows them to give you more information. For instance they might explain that this place is cool, but there is another one opening up next month that will be ultra cool. Also talk to the employees working behind the counter. You never know what they will say.
For a non –retail type business look for risk factors. Does the business have one or two dominant customers? What is the basis for customer loyalty? Are they there just because it’s the cheapest?
If you are paying for the business, you have the right to ask. If there are key employees, ask if they will stay with the business? Ask the owner what is not included in the sale. You may assume that everything in the facility is included, but the owner may want to take “personal property” with her. And in a small business, the line between personal and business property gets blurry. A savvy buyer will have a repair person do an inspection. Ask her if the equipment will need extensive repair pretty soon or if it is obsolete. She may say something like, “those were great machines, but after the manufacturer went under you cannot get parts.” If that’s the case, you can deduct the partial cost of the machine from the sales price.
Surf’s Up Don’t forget about the building. Even if it’s a leased facility, most commercial leases make the tenant is responsible for repairing the building. The extent of that responsibility is spelled out in the lease. Bring in a building inspector to see if there are any problems. Remember that the laws that govern your apartment’s rental agreement only apply to residential property.
To further understand the operations, see if you can work within the business before you buy it. This may be easy in a franchise situation. For instance ask another franchisee if you can work in business for free. The real thing you may learn is that you hate this business—better to discover this before you buy.
The first and foremost financial issue is does the seller have the right to sell. Are all the partners on board? Is there an ex-spouse who is claiming 50% interest in the business?
Next consider the lease. The landlord has the right to reject a transfer to a non-qualified tenant. But who decides what is qualified? The landlord or her manager will ask you to fill out a rental application and run your credit. If they reject you—perhaps because of bad credit or not enough assets to your name—that’s a problem. The only solution is to get a co-signer or guarantor. The seller might be willing to co-sign—after all she has an incentive to have the deal go through. You might also want to talk to the insurance agent. In some cases, you might have to pay more for insurance because of your lack of experience in this business, your claims history, or your credit rating. Some of the consumer protection laws that allow you to be insured do not apply to commercial policies. There is no assigned-risk program or renewal guarantees for businesses.
Another thing you have to be concerned about as a buyer are non-disclosed liabilities these can range from a former contractor who was not paid, a pending lawsuit, money owed to a taxing authority such as the EDD, or unpaid invoices to an supplier. As the new business owner you will have to deal with these. If you are working with an attorney/broker she will be able to check the county courts to see if there are any pending lawsuits. If you are taking the DIY rout, you may want to search the Superior Courts case index http://www.occourts.org/online-services/, for filed cases, but that might not tell you what you want to know. There may be cases that haven’t been filed yet, and there might be cases that have been filed in a different court. [We are not offering legal advice other than you may want to contact an attorney for this service.]
One way to get around this problem is to have an attorney prepare a purchase agreement. She will prepare it in such a way as to state that you are not purchasing the business per se but you are purchasing all the assets of that business and the right to do business in the business name. In the contract, the attorney will also have a statement where by the seller personally “warrants” various facts that she has provided to you are true—including the numbers on their financial statements. The implication is that you can request compensation in the future if you can show these facts were not true. It forces the seller to think twice about what they are telling you. Your attorney will also request a list of all liabilities that are “off-balance sheet.”
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