Two businesses could report the same numeric value for earnings but that doesn’t always tell the whole story. As it turns out, there is far more to earnings than may initially meet the eye. While two businesses might have a similar sale price, that certainly doesn’t mean that they are of equal value.
In order to truly understand the value of a business, we must dig deeper and look at the three key factors of earnings. In this article, we’ll explore each of these three key earning factors and explore quality of earnings, sustainability of earnings after acquisition and what is involved in the verification of information.
Key Factor # 1 – Quality of Earnings
Determining the quality of earnings is essential. In determining the quality of earnings, you’ll want to figure out if earnings are, in fact, padded. Padded earnings come in the form of a large amount of “add backs” and one-time events. These factors can greatly change earnings. For example, a one-time event, such as a real estate sale, can completely alter figures, producing earnings that are simply not accurate and fail to represent the actual earning potential of the company.
Another important factor to consider is that it is not unusual for all kinds of companies to have some level of non-recurring expenses on an annual basis. These expenses can range from the expenditure for a new roof to the write-down of inventory to a lawsuit. It is your job to stay on guard against a business appraiser that restructures earnings without any allowances for extraordinary items.
Key Factor # 2 – Sustainability of Earnings After the Acquisition
Buyers are rightfully concerned about whether or not the business they are considering is at the apex of its business cycle or if the company will continue to grow at the previous rate. Just as professional sports teams must carefully weigh the signing of expensive free-agents, attempting to determine if an athlete is past his or her prime, the same holds true for those looking to buy a new business.
Key Factor # 3 – Verification of Information
Buyers can carefully weigh quality and earnings and the sustainability of earnings after acquisition and still run into serious problems. A failure to verify information can spell disaster. In short, buyers must verify that all information is accurate, timely and as unbiased as is reasonably possible. There are many questions that must be asked and answered in this regard, such as has the company allowed for possible product returns or noncollectable receivables and has the seller been honest. The last thing any buyer wants is to discover skeletons hiding in the closet only when it is too late.
By addressing these three key factors buyers can dramatically reduce their chances of being unpleasantly surprised. On paper, two businesses with very similar values may look essentially the same. However, by digging deeper and exercising caution, it is possible to reach very different conclusions as to the value of the businesses in question.Read More
When it comes to your deal being completed, having a signed Letter of Intent is great. While everything may seem as though it is moving along just fine, it is vital to remember that the deal isn’t done until many boxes have been checked.
The due diligence process should never be overlooked. It is during due diligence that a buyer truly decides whether or not to move forward with a given deal. Depending on what is discovered, a buyer may want to renegotiate the price or even withdraw from the deal altogether.
In short, it is key that both sides in the transaction understand the importance of the due diligence process. 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.”
Before the due diligence process begins, there are several steps buyers must take. First of all, buyers need to assemble experts to help them. These experts include everyone from the more obvious experts such as appraisers, accountants and lawyers to often less obvious picks including environmental experts, marketing personnel and more. All too often, buyers fail to add an operational person, one familiar with the type of business they are considering buying.
Due diligence involves both the buyer and the seller. Listed below is an easy to use checklist of some of the main items that both buyers and sellers should consider during the due diligence process.
Understanding industry structure is vital to the success of a deal. Take the time to determine the percentage of sales by product lines. Review pricing policies and consider discount structure and product warranties. Additionally, when possible, it is prudent to check against industry guidelines.
Accountants’ receivables should be checked closely. In particular, you’ll want to look for issues such as bad debt. Discover who’s paying and who isn’t. Also be sure to analyze inventory.
There is no replacement for knowing your key customers, so you’ll want to get a list as soon as possible.
Just as there is no replacement for knowing who a business’s key customers are, the same can be stated for understanding the current financial situation of a business. You’ll want to review the current financial statements and compare it to the budget. Checking incoming sales and evaluating the prospects for future sales is a must.
The human resources aspect of due diligence should never be overlooked. You’ll want to review key management staff and their responsibilities.
Other issues that should be taken into consideration range from environmental and manufacturing issues (such as determining how old machinery and equipment are) to issues relating to trademarks, patents and copyrights. For example, are these tangible assets transferable?
Ultimately, buying a business involves a range of key considerations including the following:
- What is for sale
- Barriers to entry
- Your company’s competitive advantage
- Assets that can be sold
- Potential growth for the business
- Whether or not a business is owner dependent
Proper due diligence takes effort and time, but in the end it is time and effort well-spent.Read More
Partnership agreements are essential business documents, the importance of which is difficult to overstate. No matter whether your business partner is essentially a stranger or a lifelong friend, it is prudent to have a written partnership agreement.
A good partnership agreement clearly outlines all rights and responsibilities and serves as an essential tool for dealing with fights, disagreements and unforeseen problems. With the right documentation, you can identify and eliminate a wide range of potential headaches and problems before your business even starts.
Determining the Share of Profits, Regular Draw, Contributing Cash and More
Partnership agreements will also outline the share of profits that each partner takes. Other important issues that a partnership agreement should address is determining whether or not each partner gets a regular draw. Invest considerable time to the part of the partnership agreement that outlines how money is to be distributed, as this is an area where a lot of conflict occurs.
The issue of who is contributing cash and services in order to get the business operational should also be addressed in the partnership agreement. Likewise, the percentage that each partner receives should be clearly indicated.
Partnership Agreements Outline and Prevent Potential Problem Areas
Another area of frequent problems is in the realm of who makes business decisions. Here are just a few of the types of questions that must be answered:
- Are business decisions made by a unanimous vote or a majority vote?
- What must take place in order to consider new partners?
- Who will be handling managerial work?
- How will the business continue and what changes will occur in the event of a death?
- At what stage would you have to go to court if a conflict cannot be resolved within the framework of your partnership agreement?
You might just want to get your business running as soon as possible, but not addressing these issues in the beginning could spell disaster down the road.
The Uniform Partnership Act
One option to consider, which is offered in all states except Louisiana, is the Uniform Partnership Act or UPA. The UPA covers all the legal regulations that specifically apply to partnerships.
Reduce Conflict Via a Partnership Agreement
Forming a partnership can be great way to launch a new business, but it is also important to keep in mind that no matter how exciting the process may be it is still a business. New businesses face an array of challenges, and the last thing any new business needs is internal disruption. Mapping out via a partnership agreement the duties and expectations of all partners is an easy and logical way to reduce internal conflict within the business so that you can stay focused on building the business and making money!Read More
At first glance the idea of buying a business with no collateral may seem impossible, but in reality it can be done. Let’s examine your options. When it comes to achieving this goal, your greatest assets are an open mind and a commitment to hanging in there despite the odds.
The Small Business Association’s 7 (a) Program is Your Friend
One possible avenue for buying a business with zero collateral is to opt for the SBA’s 7 (a) program, which works to incentivize the bank to make a loan to a prospective buyer. Under this program, the SBA guarantees 75%. The buyer still has to put in 25%; however, this money doesn’t necessarily have to be his or her money. This is where things really get interesting. The cash that the buyer uses can come from investors or even be a gift from parents in the case of young buyers. These possibilities all fall within the SBA’s guidelines.
Look into Seller Financing, You Might Be Surprised
There is a second way to buy a business with no collateral, and that comes in the form of finding a seller who is willing to finance. Again, this might seem counter intuitive at first glance. But the facts are that a large percentage of sellers do agree to offer some level of financing. So in other words, seller financing is not unheard of and stands as a viable way for a prospective buyer to buy without collateral.
Combining Seller Financing and the SBA’s 7 (a) Program
Combining the SBA’s 7 (a) program with seller financing can prove to be a powerful combination. It is important to note, however, that if you do use the SBA’s 7 (a) program the seller cannot receive his or her repayment for two years.
Ultimately, you will likely need to be rather persistent when trying to find a bank. Rejection is likely. But if you are persistent, it is possible to make the SBA’s 7 (a) program work for you.
One key way to keep yourself motivated is to constantly remember that jumping through some hurdles is all part of the process since you’re trying to circumvent the traditional route of using collateral. But working relentlessly may be worth it because if you are successful, you have acquired a tangible asset without any collateral of your own. That is no small accomplishment.
Don’t be afraid to ask for advice from S.C.O.R.E., the Small Business Administration (SBA), or an experienced business broker. While it might sound very unlikely that you’ll be able to buy a business without collateral, plenty of people have successfully done so.Read More
While being a business owner may in the end not be for everyone, there is no denying the great rewards that come to business owners. So should you buy a business of your own? Let’s take a moment and outline the diverse benefits of owning a business and help you decide whether or not this path is right for you.
Do You Want More Control?
A key reason that so many business savvy people opt for owning a business is that it offers a high level of control. In particular, business owners are in control of their own destiny. If you have ever wished that you had more control over your life and decisions, then owning a business or franchise may be for you.
Owning a business allows you to chart your own course. You can hire employees to reduce your workload once the business is successful and, in the process, free up time to spend doing whatever you like. This is something that you can never hope to achieve working for someone else; after all, you can’t outsource a job.
Keep in mind that when you own a business or franchise, you never have to worry about being downsized or having your job outsourced. You also don’t have to worry about asking for a raise. No doubt business owners do have to contend with market forces and unexpected turns. But even considering those factors, business owners clearly enjoy a greater level of control over their destiny.
Are You Willing to Forgo Benefits?
As an employee, you’ll usually be able to count on a regular income and even allowances for sick days and vacation days. However, business owners lose money if they are sick or take a vacation. Plus, they won’t necessary have the steady salary that employees receive as they could see their income vary from one month to the next.
Do You Want to Grow Your Income?
Business owners have the potential to grow their income and take a range of proactive steps that lead to income growth. As an employee, your fate is far different. Employees usually exercise either minimal or no control over the course of a business and have no say in key decisions that impact its growth and stability. Being a business owner by contrast allows you to seize that control.
The amount of income made by business owners varies widely depending on everything from the industry to the region. But statistics show that the longer you own your business the more you’ll make. In fact, those who have owned their businesses for greater than 10 years tend to earn upwards of 6 figures per year.
One of the best ways to determine whether or not being a business owner is right for you is to work with a business broker. A broker understands everything that goes into owning a business and can help you determine whether or not you have the mindset to set out on the path towards business ownership.Read More
Before you jump in and buy any business, you’ll want to do your due diligence. Buying a business is no time to make assumptions or simply wing it. The only prudent course is to carefully investigate any business before buying, as the consequences of not doing so can in fact be rather dire. Let’s take a quick look at the three top overlooked areas to investigate before signing on the dotted line and buying a business.
1. Retirement Plans
Many buyers forget all about retirement plans when investigating a business prior to purchase. However, a failure to examine what regulations have been put into place could spell out disaster. For this reason, you’ll want to make certain that the business’s qualified and non-qualified retirement plans are up to date with the Department of Labor. There can be many surprises when you buy a business, but this is one you want to avoid.
2. 1099’s and W-2’s
Just as many prospective buyers fail to investigate the retirement plan of a business, the same is often true concerning 1099’s and W-2’s. In short, you’ll want to be sure that if 1099’s have been given out instead of W-2’s that it has been always done within existing IRS parameters. There is no reason to buy a business only to discover a headache with the IRS.
And speaking of employees, does the business you are interested in buying have employee handbooks? If so, you’ll want to make sure you review it carefully.
3. All Legal Documents
The simple fact is that you never want the business you are interested in buying to have its corporate veil pierced once you take over. You should carefully review all trademarks, copyrights and other areas of intellectual property to be sure that everything is completely in order. You’ll want to obtain copies of all consulting agreements, documents involving inventions as well as intellectual property assignments.
Everything should be protected and on legally sound footing. If you see any problems in this category you should run for the hills and find another business to buy.
Protect Yourself from a Potential Lifetime of Regret
Evaluating overlooked areas is essential in protecting your investment. For most people, the purchase of a business is the largest of his or her lifetime. It leaves little room for error.
Not only is it vital to investigate the major areas, but it is also essential to explore the smaller details. However, the truth of the matter is that when you’re buying a business there are no “small details.” No one realizes this fact more so than business brokers. Business brokers are experts in what it takes to buy and sell businesses. Working with a business broker is a significant move in the right direction. The time you invest in properly exploring and evaluating a business is time well spent and may literally save you from a lifetime of regret.Read More