Before you start wading through the buying process, it's imperative to learn about common pitfalls that often trip up unwary buyers and how to determine a fair value for a business that attracts your interest, even businesses that at first glance appear to have little or no reported earnings. Mr. Gibson, who has been helping buyers and sellers for more than thirty years, helps you do your due diligence. Make it a point to gain all the knowledge you can as you think about one of the most important financial decisions of your life. Learn what constitute the elements of value, why adjustments to financial statements are important and how to determine the accuracy of financial statements. Gibson also describes how to prepare a purchase contract that will protect your interests and ensure a smooth closing. You'll read case studies that help you discover if profits are overstated or, maybe, understated as in the case of "hidden" assets. And you'll read comments from experienced business owners who wish they had known more about how to avoid the common mistakes many buyers make. The book also contains a useful study and discussion guide.

HOW TO BUY A BUSINESS WITHOUT BEING HAD

Successfully negotiating the purchase of a small businessBy John V. M. Gibson

Trafford Publishing

Copyright © 2010 John V. M. Gibson
All right reserved.
ISBN: 978-1-4269-3618-0

Contents

Preface.....................................................................vAcknowledgements............................................................viiIntroduction................................................................xiiiCHAPTER 1 WHY BUY A BUSINESS?...............................................1CHAPTER 2 WHAT KIND OF BUSINESS TO BUY?.....................................13CHAPTER 3 BUSINESS VALUATIONS...............................................23CHAPTER 4 ADJUSTMENTS TO FINANCIAL STATEMENTS...............................55CHAPTER 5 EARNINGS CAPACITY AND OTHER VALUATION FACTORS.....................87CHAPTER 6 HOW TO STRUCTURE A PURCHASE AGREEMENT.............................99CHAPTER 7 THE CLOSING ON THE SALE...........................................137CHAPTER 8 CONCLUSION........................................................159Glossary of Terms...........................................................171Index.......................................................................177Bibliography and Suggested Reading..........................................183APPENDIX A..................................................................A-1

Chapter One

WHY BUY A BUSINESS?

There are several familiar choices available to help you reach the goal of self-employment and business ownership: (1) find a location and start a new business yourself; (2) go into business with your spouse, children or friends; (3) buy a franchise; or (4) buy an existing business. This book is about this last choice.

Going into business for oneself is becoming an increasingly popular goal for many people from all walks of life. In fact, more new jobs are created each year by the estimated 10 million small businesses in the U.S. than by all the large corporations in the Fortune 500 or by the 10,000 publicly traded companies in the U.S. Small businesses form a dynamic and growing sector of our economy and by some recent estimates provide as many as 70% of all new jobs created each year. Current data about small business and the important and expanding role it plays in the economy, even in times of economic uncertainty, can be found by visiting many web sites, among them: U.S. Bureau of Labor Statistics (bls.gov), CNN.com/small business, Smallbusinesstrends.com or Bricklin.com/smallbusiness.htm.

Finding a location and starting a new business from scratch often takes a long time and often turns out to be considerably more expensive than originally anticipated. Of course, people start new businesses all the time, but start-up businesses do not have a great record of success. Some sources suggest that 50% of all start-ups fail within the first year and 90% do not survive beyond the fifth year. Franchised businesses have lower failure rates than "stand alone" businesses but their income potential seems to be lower as well. CNN.com is also a good source of data to find failure rates for start-ups in various industries. Buying an existing business is less risky and has proven to have other advantages as well.

1. It automatically eliminates a future competitor.

2. It usually saves both time and money.

3. An existing business normally has cash coming in from the first day you take over ownership, so it can pay you a regular salary.

4. If you stay on good terms with the former owner, you may glean valuable tips and leads from him or her that will help you guide the business to its next level.

5. An established business has a credit history.

Many people who sell their businesses do so because they are looking forward to retirement, or simply to getting some time off, rather than because the business is failing or has serious problems. In every case the Seller has extensive knowledge of the industry of which the business is a part and should be happy to pass this knowledge along to you.

Former business owners often have well-formulated ideas about how their own businesses could expand and become more profitable. They know their employees, customers and suppliers' habits, quirks and preferences, and can guide you in how to deal with them effectively. And they can advise you about handling the bumps in the road that every business owner has experienced. Their experience is one of the most valuable assets that a business has.

If a business has a good credit history, suppliers will probably ship goods without requiring payment at time of shipment or requiring your personal guarantee. If the business has been established for several years and has a history of generally paying its suppliers on time (or early, to receive purchase discounts) the business will have a favorable credit history. Do not underestimate the value of this hidden asset.

On the other hand, while starting a new business, it may take a long time to find a suitable location and to develop the facilities and contracts needed to establish a profitable business and a positive cash flow. It may be difficult to find trained and reliable employees. With a "new" business, it may take months or even years before it grows to the point that it is breaking even and maybe even longer, before it can pay you a salary that matches the salary you earned in your last position. Generally, when buying an existing business, you will not lose salary during your "startup" period and you may avoid some of the typical startup costs associated with a new business. Buying one that has been around for a while provides you with a running start.

First Generation and Second Generation Business Owners. A business is often called a "first generation" business if it was founded by its present owner. The buyers of first generation businesses become second generation owners and the businesses then become second generation businesses. The differences between the two are instructive.

The first generation owner typically starts his business with little capital and with little formal business training. It is unusual to find a first generation owner who has previously worked in "corporate America." For these reasons the typical first generation owner has limited management skills and little formal knowledge of accounting or bookkeeping. He does not delegate much authority to employees. However, he usually has solid technical skills. As the business grows, this first generation owner goes through a steep learning curve, and over the years, through trial and error, he develops the policies, procedures, business forms, job descriptions and vital contacts that enable his business to survive, operate efficiently and to become (in most cases) profitable. All of these "assets" have value because they would cost money to develop, but their value would rarely appear on the Balance Sheet of the business.

Many times, also, the first generation owner mingles business accounts with his and his family's personal funds. To these owners there is no distinction between "personal" and "business." What the business earns is what they earn. Many first generation owners did not incorporate their businesses; they operate as sole proprietors and file their business tax returns on the Schedule "C" of their individual tax return.

The second generation owner, by contrast, often has less technical knowledge but extensive business training. He tends to keep "business" and...