Thinking about buying a business? More and more investors are considering the acquisition of an existing business as the best way to control their own destiny and accumulate wealth. It is estimated that over 80 percent of the millionaires in the United States own their own business. Below are some questions frequently asked by entrepreneurs considering the acquisition of a business.
HOW ARE BUSINESSES VALUED?
There is no simple method, and there are numerous formulas for valuing a business. Our experience has shown that there are three key components that are used in computing valuation models: 1) earning power; 2) specific assets being sold; and 3) marketplace demand. Earning power is a function of annual earnings. For larger businesses, particularly those with audited financial statements, an EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) calculation is used. For smaller businesses, the calculation is adjusted by adding back the expenses attributable to private ownership. An appropriate capitalization rate is then applied to calculate value. Most investors place extensive weight on the company’s ability to generate earnings, since the cash flow allows them to 1) pay themselves a suitable salary, 2) pay off the debt generally required to buy the business, and 3) receive a return on investment. The appraised or fair market value of the assets being transferred is also considered. These factors are overlaid on industry and market conditions to come up with a range of value for the business.
SHOULD IT BE A STOCK OR ASSET SALE?
Although each transaction must be reviewed on a case by case basis by experienced accountants and attorneys, most buyers acquire the assets of an existing company rather than the stock of the corporation being sold, both for tax purposes and to avoid assuming unknown liabilities of the selling corporation.
SHOULD YOU CONSULT AN ATTORNEY AND/OR ACCOUNTANT WHEN BUYING A BUSINESS?
Yes, buying a business can be a complex transaction. We advise all buyers and sellers to avail themselves of professional help when involved with a business transfer. Usually, professional advisors do not get called in until the buyer selects a business and is reasonably certain that the seller will sell on terms acceptable to the buyer. Attorneys are used to review contracts and prepare closing documents with appropriate protection for the parties involved. Accountants are consulted for tax advice and verification of existing financial data. In selecting an attorney and accountant, try to retain an advisor with prior experience in business transfers.
IS IT BETTER TO BUY AN EXISTING BUSINESS OR TO START A BUSINESS?
There are many advantages to investing in an existing business, but the reduced risk of failure is usually the most compelling. An existing business will have an established track record and customer base already in place. This existing customer base provides immediate cash flow and improves the probability of obtaining acquisition financing.
WHY SHOULD YOU CONSULT A BUSINESS BROKER?
Unlike selling a house, when a seller elects to sell a business, the seller, in order to maintain confidentiality, will not typically place a sign on the property or list the business in a multiple listing directory. Consequently, buyers may have difficulty locating businesses that are for sale. At The FBB Group, Ltd., we represent numerous businesses in a variety of different types and sizes. This selection, along with appropriate financial and operational data in our files, plus our considerable experience in negotiating transactions, can save buyers substantial time and effort in locating a suitable business. Additionally, as a result of the volume of transactions that we complete, we have financing contacts in place to provide the buyer with options for obtaining the most competitive financing package.