Understanding Owner’s Discretionary Cash Flow – Part I
Let the numbers do the talking
We cannot stress enough the importance of hones and verifiable cash flow on the sale price of a small business. Many buyers and business brokers go as far as stating that cash flow is everything. Over 70% of small business buyers are first time buyers coming out of corporate America. These people have one primary goal – to replace the income stream they lost coming out of their former jobs. For these buyers, the owner’s discretionary cash flow secured through a small business acquisition is their salvation and their main decision point on company value.
BUYER PROFILES – Part II
In buyer classifications, there also exists a somewhat rare species known as the turnaround specialist. This buyer is usually an experienced consultant looking for a bargain or diamond in the rough that he can transform from an under performing business to a profitable status. This type of buyer usually concentrates in the larger or mid market arenas where deals have the resources to justify his time. Smaller business offerings generally are not of interest to these buyers because of limited operational scope and lack of customer base. For similar reasons, most intermediaries will not work with companies that are in trouble in the small arena.
At first glance, it can be a bit overwhelming for buyers to acknowledge the many types of buyer groups that are active in the marketplace. In reality, the different classes of buyers will be concentrated on distinct types of acquisition strategies at any one time. It is our contention that an analysis of the types of buyers and their buying parameters can aid the acquirer to focus on deals that are most suited to their needs and buying capabilities. By being more focused, buyers will not jump from deal to deal as frequently and can concentrate on offerings that they are better positioned to acquire.
Gathering Pertinent Documents – Part II
Asset and Liabilities
There are assets and liabilities on a balance sheet that can be transferred with the sale or kept by a seller. A buyer needs to know exactly what assets and liabilities are to be transferred with the sale so that he can make an educated offer. Samples of these items include: accounts receivable, accounts payable, pre-paid deposits, cash, debt on assets, leases, etc. By identifying what is included from the start, misunderstandings can be eliminated. It is prudent for a seller to identify which leases and notes can be transferred to the buyer before the negotiating process begins. Discovering a liability that cannot be assumed until late in the process, after the deal has been structured, is inconvenient and could cause a deal to collapse.
A prospective buyer wants to know everything about the facility that will house his new business. A few questions to ask are: Where is it located? Is there a long-term lease? Is real estate included in the deal? What is the square footage? If you are renting, it is imperative to perform preliminary due diligence to determine if the lease can be assumed, how much time is left on the lease, and other factors that would be covered respective to the business transfer. Leases are not easy legal instruments to negotiate. The lease can be a deal stopper if attention is not paid to this area in the beginning. Most owners do not want to involve their landlords in the sale process until they know that the deal is going to go through. If the landlord is going to be difficult or change the lease term or rate to the buyer, it is a good idea to know what the new parameters will be before starting the process. If a landlord desires a longer lease than a buyer wants, a lease option to extend after the base period rather than a fixed long-term commitment may be used.
If you own the real estate and will be leasing to the buyer, it is important to determine the trend of building taxes and insurance and be prepared to put these trends in the lease. If is also important to determine the rent you would charge a new owner since it will have an impact on his cash flow. If you own the real estate and plan to increase the lease amount, be aware that this added amount would be subtracted from the cash flow resulting in a lower business sale price. Often the lease amount can be structured to remain constant for the first two or three years and then increase it. This delayed increase may not lower a sale price, as an immediate increase will. Again, awareness of these factors before the process begins gives you a stronger negotiating position.
The most valuable asset in addition to FF& E (Furniture, Fixtures and Equipment) is the employee base. At a minimum, the following questions at should be answered in the information prepared in a marketing package: How many employees are there? What is the tenure of each employee? What is the pay structure? Is there a stable workforce? Do the employees know the business is for sale? Is the owner willing to stay on as an employee? Whatever employee information is provided can be displayed without use of specific names by replacing the names with titles.
An excellent graphic tool to summarize the employee situation is an organizational chart. The chart should include the following variables: employee hierarchy, tenure, pay, responsibilities, and titles. Because the value placed on employees is a part of goodwill, it is more difficult to validate. The more information provided about employees, the more salable a business will be.
A chronological summary of a business will provide a prospective buyer a road map to a company’s history. A prospective buyer will be able to look at historic financial statements together with the company’s business history to perform an overall analysis. A sampling of questions to consider is as follows: Has a new line been recently added? Has the business been moved? When was this business formed? Is the business run by the original owner? What has been the marketing program since the company’s beginning?
Vantarakis, Alexander and Whitehurst, William. EXIT.
Gathering Pertinent Documents- Part I
When studying for a big final exam, attending study groups, preparing classroom notes, and going to the library were keys to success. The same is true for one of life’s biggest exams – selling a business. Having all the pertinent documents ready for the sale will shorten the amount of time it takes to garner the greatest amount of qualified buyers and to attain the highest justifiable price. Without all the pertinent documents, a buyer cannot make an informed purchase decision. The following items are a list of the minimum documents and information needed to prepare a business for sale.
Interim profit and loss statement and balance sheet
The interim financials will bring a buyer up-to-date on the financial strength of a company since the last completed corporate year and resulting tax return. A buyer cannot rely on dated information since sales trends can change monthly. The interim financial information is also necessary for lending institutions, and it is a safe bet that financials dated within 60 days of closing will be needed from buyer as well.
Three years of tax returns and income statements
Three years of data will paint a picture on the financial stability of a company. A prospective buyer needs to analyze sales and earnings trends to determine the direction the business is heading and also to be prepared for any cyclical trends. In addition, buyers need to track and analyze trends in expenses and margins. Even though sales are increasing, it does not mean a business is heading in the right direction. Any fluctuations, good or bad, will ultimately be determined with financial data from the past three years.
Current asset list
It is easier to justify a business sale price if assets comprise a significant part of the sale price. Anything above asset value is goodwill and is more difficult to justify. Comprising an asset list with a total value of the asset at fair market price will create a floor to the value of a business. It is important not to place individual values on assets, but rather to place a total value. By itemizing asset values, a buyer will spend more time questioning the value of individual assets rather than focusing on the collection of assets and the overall business. One exception to not listing out individual asset values exists when outside financing is used for a business transfer. A lender will normally require a fair market value to be placed on all assets over $500 including serial numbers.
Vantarakis, Alexander and Whitehurst, William. EXIT.