October 2010 Archives

October 25, 2010

Purchasing Existing Businesses In San Diego, Part Two

Continued from Considerations When Purchasing a San Diego Business, Part One.

The Valuation: Add your own critical assessment to the appraiser's valuation by personally reviewing the company's records. For small businesses, the valuation can be done without the assistance of an appraiser if necessary. The process of conducting a thorough valuation will be discussed in a follow up article. Either way, think about the intangibles. Will there be a future market for the goods or services provided? Will the company maintain the same goodwill with existing customers that the current ownership enjoys? Is there a likelihood that competitors will open up in the same geographic area? Is there a potential for a shock to costs such as a shortage of a key ingredient or an anticipated new law that will increase licensing fees and/or taxes? The fact that a business enjoys a positive revenue stream today doesn't guarantee a future revenue stream.

183701_next_store.jpgCompare Other Options: It is common for prospective purchasers to fall in love with a particular business (much like first time home buyers). Recognize that the temptation is there, and look for other options, or if you are working with a broker ask that they provide several options. You may ultimately decide to go with the first business, but at least you have done so after comparing its value with other companies. Where possible, try and perform your own valuation before paying a professional appraiser. Narrow the field first, and then pay a professional to be sure you have chosen wisely. In addition, there's no reason not to consider starting a brand new business if you have the expertise in a particular area. Put a lot of time and thought into your initial decision before committing your time and resources to a new venture.

Know the business: It's a good idea to know something about the business you are investing in. If you have been in the restaurant business for twenty years, buying a manufacturing business may not be the best choice. Consider you personal expertise.

Escrow: Purchasers are often tempted to bypass escrow believing it an unnecessary complication. This is not a good idea. Escrow protects both the seller and the buyer. Sellers are reassured that deposits and purchase funds have cleared before closing. Buyers retain the ability to take deposits back upon discovering deficiencies in the seller's representations during the due diligence period. Escrow also performs a UCC search to ensure that the seller doesn't have other liens or encumbrances against the assets of the business, and that a "Notice to Creditors of Bulk Sale" is published putting other creditors on notice of the transaction so that they can file claims they may have against the business prior to closing.

Deal Killers: While it may seem counterproductive for this attorney to call lawyers potential "deal killers", it is in fact a common occurrence. However, lawyers are a necessary part of the contract negotiation. Sellers will almost always have a good business lawyer on their side negotiating the best possible deal. Buyers should do the same. To avoid problems, prospective purchasers should work closely with an attorney they feel comfortable with, and clearly define their objectives. Clearly defined objectives let the attorney know where the client wants the line drawn, and facilitates the decision making process when the attorney has concern about a particular contract clause. Your attorney should understand the art of the deal and relative bargaining power. If the seller has all the bargaining power, it's a deal killer to insist on every conceivable contract advantage. A reasoned and tempered approach works best.

October 19, 2010

Considerations When Purchasing a San Diego Business, Part One

As with any new venture, the purchase of an existing business is fraught with risk. Is the business viable? Does it have growth potential? What are its hidden weaknesses? Is the purchaser experienced enough in the company's business? Is current goodwill and reputation dependent on existing ownership? Is the revenue stream consistent? The list of questions is endless. Ultimately, the decision rests on the purchaser's due diligent efforts at valuing the business. This article briefly addresses some important considerations:

1302622_hh3_kitchen.jpgThe Seller is the Seller: Whatever the business and whoever you deal with, whether directly with the seller or a broker, the seller is determined to get the most value for their business. Aside from their financial investment, most sellers have poured their hearts and souls into the business. Either way, you can be sure that the product is going to be pitched in the light most favorable to the seller. Avoid being lured in by "pie in the sky" stories of marketing genius, unlimited revenue and unreported incomes. Take everything at face value and let the professionals (an appraiser and/or a CPA) give you a frank assessment of the stream of earnings you will be purchasing. Even then, it's wise to assume there are skeletons in the closet. Look for clues. If you have uncovered a minor misrepresentation, it might be a clue that they are hiding bigger secrets. Rely on your common sense and gut feeling about the seller and his or her representatives.

Funding: Marshaling the resources needed to purchase a business is not as prohibitive as many imagine. In fact, it is possible for some, especially those with good credit, to purchase an existing business entirely through seller financing. While the chances of obtaining 100% seller financing might be slim, seller financing of a portion of the sales price is common. Sources of funding include personal savings, asset backed loans, business loans and seller financing. Prospective buyers can expect to pay a 20% to 30% down payment on a business loan and sometimes a higher percentage for seller financing. However, a large cash layout isn't always necessary. The Small Business Administration (SBA) can assist with loans of all sizes with as little as 10% down, and sellers are often more flexible than expected. Diligently investigate options and shop around for the right deal for you. You might be surprised at how low the sales price is for many businesses. The key is to think creatively about funding the purchase. Explore all options and combine the most attractive and practical sources.

Entity v. Asset Purchase: There are two ways to structure the purchase of an existing business: an entity purchase (purchasing the Corporation, LLC or other formal business entity) or an asset purchase. Purchasing an entity involves taking on the company "as is" and absorbing all of its financial, contractual and legal obligations. Asset purchases are typically the better option for the buyer. With an asset purchase, you buy all of the company's assets, tangible and intangible including inventory, real estate, equipment, copyrights, patents, trademarks and trade secrets without absorbing any of the company's liabilities. In some cases, sellers may insist that the buyer in an asset purchase agree to take on some liability such as accounts payable, but this is all part of the negotiation. Prospective buyers should also talk with their CPA or tax attorney regarding the tax consequences of either approach.

Line up Professionals: Prospective purchasers of an existing business benefit from experienced advisors. In addition to diligently investigating the business, buyers should consult with experienced professionals: an appraiser to ensure the business is adequately valued; an accountant to ensure continued economic viability; a broker to expand your options; and a business attorney to protect your interests. Don't rely on your broker to value the business. His interest is in making the deal.

Continued in Purchasing Existing Businesses In San Diego, Part Two.

October 11, 2010

Purchasing an Existing Business Offers Benefits Often Overlooked

San Diego has seen a steady stream of young entrepreneurs starting up their own businesses over the last few years.  This is in large part attributed to the collapse of the financial markets and the ensuing recession.  Professionals in transition and the recently unemployed see starting their own business as an alternative to the continued disappointment they face in a tight job market.  An often overlooked alternative is to purchase an already proven business.  The idea perhaps gets little consideration.  In reality, purchasing an existing business is not that far out of the reach.  The option should at least be on the table for anyone thinking about starting a new business.  With numerous financing options available, many businesses can be purchased with the same up front capital typically necessary to start a new one.

566067_workers_01.jpgIn general, purchasing an existing business is less risky.  It doesn't matter whether one is purchasing a contracting business or a law firm.  An existing business has a proven track record.  It has developed a strong customer base and good will in the community; has invaluable systems in place for operations, accounting and employee management; and has reliable and trusted vendors, suppliers and professional advisors.  The purchaser takes over an operation that is already generating profits.  Of course, the quality of the existing business can vary widely.  Ensuring that the business is viable requires an in depth analysis of the company's history and finances, or what attorneys call "due diligence".  The importance of a "due diligent" examination of a prospective business cannot be overstated, and will be discussed in more detail in a follow up article.  

The point of this article is to highlight the benefits of purchasing an existing business and to inform prospective entrepreneurs that the alternative is feasible.  It seems that the biggest barrier to entry is an erroneous belief that purchasing a business is too costly.  People tend to see the buying and selling of businesses as a game played by large investors.  It is not.  Individuals motivated to go into business for themselves can and do buy existing companies.  They do so by marshalling personal resources, securing investment, securing seller financing, taking out business loans, and/or resorting to other creative financing.  In some cases, the purchase of an existing business is entirely financed by the seller.   

Purchasing an existing business may not be right for everyone, but it is a viable option for most people who have already chosen to go into business for themselves.  Barriers include lack of resources, bad credit ratings and inexperience in the particular business being considered.  However, these are the same barriers to starting a new business.  Where the motivation exists, entrepreneurs choose to make it happen.  If they have limited resources, they turn to specialized lenders like the Small Business Administration.  They solve credit problems by seeking investment partners and/or seller financing.  They substitute hard work and commitment for lack of experience.  If opting to purchase an existing business, be sure to consult with trusted advisers such as your accountant or business attorney before making the leap.  In addition, consider working with a broker but be careful about relying on his or her opinion about the valuation of the proposed purchase.  In the end, there is no substitute for due diligence.  See Considerations When Purchasing a San Diego Business, Part One and Part Two for further information.