The Key Questions
By George Hicks, CBI (About the Author)
 As an experienced South Bay business broker, my firm continually sees the common threads necessary to successfully buy or sell a business. At this time, I would like to address many of the questions that come up at our seminars on buying, selling and valuing a business.
It is a well-known fact that small businesses are a critical component of the South Bay economy. In fact, small business employment can lead an economic recovery when major employers are cutting back on staff. According to estimates, the Greater Los Angeles Metro area has over 500,000 privately held small businesses. Many of these successful businesses are right here in our own back yard.
Traditionally, small businesses transitioned by selecting an internal successor, often a family member that has been groomed to take the reins of the company. However, in recent decades the trend has been for business transitions to take place outside the family network. Increasingly, buyers and sellers may not have known each other prior to being introduced for the business’ transition and change of ownership.
A recent national study has indicated that over 50% of the work force in this country dream of owning their own business. Business buyers are most often middle-aged people dropping out of corporate America with some available cash or other workers from their industry. These individuals will have an entrepreneurial bent. Both types of buyers typically feel unfulfilled and want better control of their destinies for themselves and their families. We see strategic business purchases within a particular segment or what are called “roll ups”. But these are less frequent than most people realize. Not something a seller should count on.
What are buyers looking for in a business to purchase? They want something they can be passionate about, however, they are being pragmatic as well. On the pragmatic side, the deal has to make economic sense for both the buyer and seller. Ultimately, it is very rare for an all cash transaction to take place. Transactions typically require some financing either from a bank or from the seller in the form of a carry-back note. Sometimes it is a combination of the two. By far, the business transactions that get done have the following common theme. A buyer comes in with significant cash as a down payment. The business is making enough money to pay the new owner a salary and service the finance debt (with some margin for a rainy day). We call that a deal that “cash flows”. If it doesn’t cash flow, it is not a deal that will get completed.
What about confidentiality? Sellers normally do not want their employees or suppliers to know their business is for sale. That makes business brokerage a very confidential business. First, unlike general Real Estate, business brokers do not provide confidential information on a business until a detailed buyer confidentiality agreement is signed off. Most business brokers will also require a buyer profile. This way the broker and business seller can know a little bit about the buyer’s background and be comfortable with his ability to complete a transaction and run the company.
Sellers often ask what is a good time, or the right time to sell. This is really an individual decision for the seller. The best answer of course is to sell at the top when the business is good and making lots of money. But many business people cannot let go at that time. The most common reason we see for selling is retirement, but we also encounter people who may be bored and ready to move on after 20 years doing the same thing. There are also unfortunate situations with health that precipitate a sale. Whether it is the owner or immediate family circumstances.
How can a seller increase the value of their business in a sale? We could spend several hours on this but there are several basic things a seller can do. First, because business valuations and ultimately business transactions are most directly related to how much money the owner can make, the short answer is to make money. The revenues generated can include benefits and perks the owner may receive, but should be well documented.\
We call the money made in the business the “Owner’s Discretionary Earnings”. The definition of Owners Discretionary Earnings is “Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) plus the Owner’s Salary, Benefits and Perks”. Sellers however should not expect to include unreported cash receipts or general credit card expense accounts that lack backup as part of their discretionary earnings.
This all leads to the number one thing a seller can do --keep well-documented financials and strive for a clean balance sheet. Why? Because, after a buyer and seller sign off on the basic terms of a deal, every transaction enters what is called “due diligence.” As part of this due diligence process, the buyer does a form of an audit on the financials of the company. If the books are clean and support what has been represented, the deal stays on track and the seller has maximized his transaction value. If the books are sloppy and do not support what has been represented, the deal can get renegotiated to a lower price or it falls apart from the breakdown in trust that has occurred between the buyer and the seller in the due diligence process.
One significant way for a seller to increase his transaction value is to carry a secured note for the buyer. Businesses have assets that are comprised of “hard assets,” like equipment and “soft assets” called goodwill. Another way to put it is the difference between the liquidation value of the equipment and fixtures of the business and the transaction price, is the goodwill. Statistically, a great way to maximize goodwill value for a seller is to carry a secured note for the buyer.
Another often-overlooked way to maximize a seller’s transaction value is to have a facility that shows well. It is basic when you think about it but a business that “shows well, sells well.” Clean the place up before putting your business on the market. It will make a difference in maximizing the transaction value.
Finally, buyers and sellers often ask what they can do to help get a transaction completed. When we review the common threads for the hundreds of successful transactions we have done, we see that the buyer has picked a business he liked and found a seller he can trust. The seller has confidence the buyer can run his business and maintain the legacy he has built. We find that each side needs to cooperate fully in due diligence. Invariably something comes up that needs to be worked through. A seller and buyer that can work through the issues are the ones that complete a transaction. Also, the seller needs to stay committed to running the business until the close of escrow and then provide a several week transition/training period for the buyer as part of the transaction.
Oh…..I almost forgot. Select a good business broker. A relationship with a good broker will be invaluable to getting a deal done.
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