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There is the old saying that the time to develop an exit strategy is the day you open for business. Sounds good, but it’s not very realistic. Further, it also isn’t very optimistic. On the day you open for business, thoughts about how you get out of it aren’t pleasant, or helpful, thoughts. However, as you get the business to a place where you have a bit of extra time to plan, you will find that the things you need to do to improve your business are some of the very things you will need to work on to plan an exit strategy.

You can’t predict misfortune, but you can plan for it. One never knows when an accident or illness will force one to sell. When the drive to your business becomes filled with dread, maybe it’s time to consider selling. The following ideas will improve your business, even if you’re not currently considering selling. Dealing with these areas will also supply the information a buyer will most likely be looking at when the time does come to sell.

Buyers want cash flow.

This, at least on the surface, is the thing a potential buyer will want to look at.

Appearances are important.

You may think everything about the business looks fine, but the two letters on the neon sign that don’t work indicate to a possible buyer that the seller may have lost interest in the business, causing them to also wonder what else doesn’t work or has been neglected.

There is probably more value than you think.

Business owners often don’t look at things that do create real value such as: customer lists, secret recipes, specialized computer systems, programs, customer loyalty programs, etc.

Eliminate the surprises.

Make sure the lease is transferable and that your landlord is willing to cooperate.  Resolve that issue with town hall.  Resolve the problem with that angry customer. Minor problems and issues will often raise their ugly heads during sensitive times, spooking a possible buyer. So, the time to resolve them is before going to market.

1. Established.

An existing business is a known entity. It has an established and historical track record. It has a customer or client base, established vendors, and suppliers. It has a physical location and has furniture, fixtures, and equipment all in place.  The term “turnkey operation” is overused, but an existing business is just that with ALL these items in place and ready to go. For start-ups, you are starting from scratch and you need to ramp up and therefore the risk is higher.

2. Business Relationships. 

In addition to the existing relationships with customers or clients, vendors, and suppliers, most businesses also have experienced employees in place who are a valuable asset. Buyers may already have established relationships with banks, insurance companies, printers, advertisers, professional advisors, etc., but if not, the existing owner does have these relationships, and they can readily be transferred.

3. Not “A Pig in a Poke”. 

Starting a new business is just that: “a pig in a poke.” No matter how much research, time, and money are invested, there is still a big risk in starting a business from scratch.  The existing business has a financial track record and established policies and procedures. A prospective buyer can see the financial history of the business — when sales are the highest and lowest, what the real expenses of the business are, how much money an owner can make, etc. Also, in almost all cases, a seller is more than willing to stay on to teach and work with the new owner — sometimes free of charge.

4. Price and Terms.  

The seller has everything in place. The business is in operation and a price is established. Opening a new business from scratch can be the proverbial “money pit.”  When purchasing an established business, the buyer knows exactly what he or she is getting for his money. In most cases, the seller is also willing to take a reasonable down payment and then finance the balance of the purchase price.

5. The “Unwritten” Guarantee.

By financing the purchase price, the seller is saying that he or she is confident that the business will be able to pay its bills, support the new owner, plus make any required payments to the seller.

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Buyers are generally categorized as belonging to one of the following groups although, in reality, most buyers fit into more than one.

The Individual Buyer

This is typically an individual with substantial financial resources, and with the type of background or experience necessary for leading a particular operation.

The individual buyer usually seeks a business that is financially healthy, indicating a sound return on the investment of both money and time.

The Strategic Buyer

This buyer is almost always a company with a specific goal in mind — entry into new markets, increasing market share, gaining new technology, or eliminating some element of competition.

The Synergistic Buyer

The synergistic category of buyer, like the strategic type, is usually a company. Synergy means that the joining of the two companies will produce more, or be worth more, than just the sum of their parts.

The Industry Buyer

Sometimes known as “the buyer of last resort,” this type is often a competitor or a highly similar operation. This buyer already knows the industry well, and therefore does not want to pay for the expertise and knowledge of the seller.

The Financial Buyer

Most in evidence of all the buyer types, financial buyers are influenced by a demonstrated return on investment, coupled with their ability to get financing on as large a portion of the purchase price as possible.

Almost all the purchasers of the smaller businesses fall into the individual buyer category. But most buyers, as mentioned above actually fit into more than just one category.

© Copyright 2013 Business Brokerage Press, Inc.

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Sellers

· Sellers don’t have a specific reason for selling.

· Sellers are testing the waters to check the marketplace and the price. (They are similar to the buyer who is “just shopping.”)

· Sellers are completely unrealistic about the price and don’t understand the marketplace for their business.

· Sellers are not honest about their business or their situation. The reason they want to sell is that the business is not viable, revenues are declining, possible environmental problems, new competition is entering the marketplace or some other serious issues that the seller has not revealed.

· Sellers don’t disclose that there are more than one owner and they are not all in agreement.

· Sellers have not checked with their outside advisors about possible financial, tax or legal implications of selling their business until an offer is presented.

· Sellers are unprepared or misinformed about providing seller financing to complete a transaction. This is key since according to a recent WSJ survey, up to 90% of closed transaction involved some form of seller finance.

Buyers

· Buyers don’t have a valid reason to buy a business, or the reason is not strong enough to overcome the fear of purchasing a business.

· Buyers have unrealistic expectations regarding the value/price, appropriate terms, the buying process, and how family-owned businesses operate.

· Buyers aren’t willing (some of them) to do the work necessary to own and operate their own business.

· Buyers are influenced by a spouse (or someone else) who is opposed to the purchase of a business when that person is not informed on what is being purchased.

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Seller financing has always been a mainstay of Business Brokerage.  Buyers typically don’t have the capital necessary to pay cash, are unable to borrow the money, or are reluctant to use all of their capital.  Buyers also feel that a business should pay for itself and are wary of a seller who wants all cash or who wants the carry-back note secured by additional collateral. What sellers seem to be saying, at least as perceived by the buyer, is that they don’t have a lot of confidence in the business or in the buyer or perhaps both.  However, if you look at statistics, it’s apparent that sellers usually receive a much higher purchase price if they accept terms.

Studies reveal that, on average, a seller who sells for all cash receives only about 80 percent of the asking price.  Sellers who are willing to accept terms receive, on average, 86 percent of the asking price. The seller who asks for all cash receives, on average, a purchase price of 36 percent of annual sales while the seller who will accept terms receives, on average, 42 percent of annual sales.  These are compelling reasons for a seller to accept terms.  Business brokers have long been aware that reasonable terms are necessary if sellers are serious about selling their businesses.

The primary reason sellers are reluctant to offer terms is their fear that the buyer will be unsuccessful.  If he or she should stop making payments, the seller will be forced to take back the business, hope that the buyer can resell the business, or forfeit the balance of the note.  Another reason is that sellers feel that they can do more with cash than with the receipt of monthly payments. How often do sellers say that they need cash so they can buy another business?  That is probably not the real reason, but selling their business may be the only time that they can get a “chunk of cash.”  A Certified Business Broker can help alleviate these fears by pointing out some of the ways sellers can protect their investment and by explaining some of the advantages of carrying the balance of the purchase price.  Equally important is how the deal itself is structured. In other words, the key is knowing how to properly structure the seller carry back note to reduce the probability of default.

Let’s first take a look at the advantages to the seller of financing the sale:

• The chances of the business actually selling are much greater with seller financing.
• The seller will achieve a much higher price for the business with seller financing.
• Most sellers are unaware of how much the interest can increase their actual selling price. For example, a seller carry-back note at 8 percent carried over nine years will actually double the amount carried.  $100,000 at 8 percent over a nine year period results in the seller receiving $200,000.
• With interest rates currently low [at this writing], sellers can get a much higher rate from a buyer than they can get from any financial institution.
• Sellers may also discover that, in many cases, the tax consequences of accepting terms are a lot more advantageous than those on an all-cash sale.
• Financing the sale tells the buyer that the seller has enough confidence that the business will, or can, pay for itself.
• The seller may be able to borrow some cash using the note and security agreement as collateral.  It may not be as easy as borrowing against real estate notes, but it’s still better than nothing.

Bottom line, in today’s environment seller finance is essential in selling a business.

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There is the old anecdote about the immigrant who opened his own business in the United States. Like many small business owners, he had his own bookkeeping system. He kept his accounts payable in a cigar box on the left side of his cash register, his daily receipts – cash and credit card receipts – in the cash register, and his invoices and paid bills in a cigar box on the right side of his cash register.

When his youngest son graduated as a CPA, he was appalled by his father’s primitive bookkeeping system. “I don’t know how you can run a business that way,” his son said. “How do you know what your profits are?”

“Well, son,” the father replied, “when I came to this country, I had nothing but the clothes I was wearing. Today, your brother is a doctor, your sister is a lawyer, and you are an accountant. Your mother and I have a nice car, a city house and a place at the beach. We have a good business and everything is paid for. Add that all together, subtract the clothes, and there’s your profit.”

A commonly accepted method to price a small business is to use Seller’s Discretionary Earnings (SDE). The International Business Brokers Association (IBBA) defines SDE as follows:

Discretionary Earnings – The earnings of a business enterprise prior to the following items:

• income taxes
• nonrecurring income and expenses
• non-operating income and expenses
• depreciation and amortization
• interest expense or income
• owner’s total compensation for one owner/operator, after adjusting the total compensation of all other owners to market value

Here are some terms as defined by the IBBA:

• Owner’s salary – The salary or wages paid to the owner, including related payroll tax burden.
• Owner’s total compensation – Total of owner’s salary and perquisites.
• Perquisites – Expenses incurred at the discretion of the owner which are unnecessary to the continued operation of the business.

Developing a Multiplier

Once the SDE has been calculated, a multiplier has to be developed. The following (just as a guideline) should be rated from 0 to 5 with 5 being the highest. For example, if the business is a highly desirable business in the current market, “desirability” would be rated a 4 or 5. If the business is in an industry that is quickly declining or nearly obsolete, “industry” would be given a 0 or 1 rating.

• Age: Number of years the seller has owned and operated the business.
• Terms: Is the seller willing to offer terms?  For example, will the seller accept 40 percent as a down payment with the seller carrying back 60 percent at terms the business can afford while still providing a living for the buyer?
• Competition: Consider the local market.
• Risk: Is the business itself risky?
• Growth trend of the business: Is it up or down?
• Location/Facilities
• Desirability: How popular is the business in the current market?
• Industry: Is the industry itself declining or growing?
• Type of business: Is the business type easily duplicated?

The average business sells for about 1.8 to 2.5. Obviously, if the SDE is solid and the multiple is above average, the price will be higher. Keep in mind that the price outlined includes all of the assets including fixtures and equipment, goodwill, etc. It does not include real estate or saleable inventory. The price determined above assumes that the business will be delivered to the buyer free and clear of any debt.

Veteran Wisdom

When all else fails, the words of a veteran business broker will work.

Asking Price is what the seller wants.

Selling Price is what the seller gets.

Fair Market Value is the highest price the buyer is willing to pay and the lowest price the seller is willing to accept.

Sellers should keep in mind that the actual price of a small business is about 80 percent of the seller’s asking price.

How much is your time worth?

Business owners have a business to run, and they are generally the mainstay of the operation. If they are too busy trying to meet with prospective buyers, answering their questions and getting necessary data to them, the business may play second fiddle. Buyers can be very demanding and ignoring them may not only kill a possible sale, but will also reduce the purchase price. Using the services of a business broker is a great time saver. In addition to all of the other duties they will handle, they will make sure that the owners meet only with qualified prospects and at a time convenient for the owner.

How involved do you need to be?

Some business owners feel that they need to know every detail of a buyer’s visit to the business. They want to be involved in this, and in every other detail of the process. This takes away from running the business. Owners must realize that prospective buyers assume that the business will continue to run successfully during the sales process and through the closing. Micromanaging the sales process takes time from the business. This is another reason to use the services of a business broker. They can handle the details of the selling process, and they will keep sellers informed every step of the way – leaving the owner with the time necessary to run the business. However, they are well aware that it is the seller’s business and that the seller makes the decisions.

Are there any other decision makers?

Sellers sometimes forget that they have a silent partner, or that they put their spouse’s name on the liquor license, or that they sold some stock to their brother-in-law in exchange for some operating capital. These part-owners might very well come out of the woodwork and create issues that can thwart a sale. A silent partner ceases to be silent and expects a much bigger slice of the pie than the seller is willing to give. The answer is for the seller to gather approvals of all the parties in writing prior to going to market.

How important is confidentiality?

This is always an important issue. Leaks can occur. The more active the selling process (which benefits the seller and greatly increases the chance of a higher price), the more likely the word will get out. Sellers should have a back-up plan in case confidentiality is breached. Business brokers are experienced in maintaining confidentiality and can be a big help in this area.

Groupings of Family Members

People within a business owner’s own family often opt to buy the family business. In fact, this stands as one of the more common types of small business buyers.  One reason is that business owners are more comfortable with a relative taking over the prized business, as they often built it up from nothing.  Quite often the family member looking to take over the family business has been carefully groomed and tested over the years to ensure that he or she is ready to be the true “heir apparent.”  In this kind of situation, the family member truly is the best person to buy the business.

However, there is a downside.  Family dynamics can be quite complex, and a variety of conflicts may develop.  Issues may quickly arise ranging from whether or not the departing business founder and family member can really leave the business to whether or not the new buyer actually has the funds to make the purchase.  These, and similar issues, can cause significant disruption in the transaction of the sale.  In short, families come with histories and their own, and often complex, internal issues and discord can arise.  This means that an outside buyer is often the best possible option.

When it comes to determining whether or not a family member is the right buyer for a given business, it is necessary to look at three vital issues: the ability of the family member, the financial standing of the family member and the agreement amongst the family.

Selling a Business to a Business Competitor

Business competitors are frequently overlooked when it comes time to sell a business.  Why?  Usually there is a concern that a competitor will take advantage of the knowledge that a business is up for sale and may try to attract existing customers or clients away from the selling business.  Yet, if the business meets the needs of a competing company, they may be willing to strike a very good deal in order to acquire the business and expand.

When it comes to selling a business to a competitor, a business brokerage professional can prove to be quite useful.  One reason for this is that they can use confidentiality agreements so that the name of the business being sold is only revealed after contacting the seller and further qualifying the competitor in question.

Selling to a Foreign Buyer

Foreigners love the idea of buying a business in the United States.  There are many reasons why they find this notion to be attractive.  For example, by opting for an existing business many foreigner business owners are able to bypass difficulties such as licensing, finding a job in their own profession and issues with a language barrier.  Many of these types of concerns can by circumvented, to an extent, by opting for an established entity.

Commonly this kind of buyer is accustomed to working very long hours and is already a successful business owner in his or her own right.  Yet, this does not mean that their business acumen will coincide with that of the seller.  Once more, this is where the expertise of a company can come into play.

There is one additional note to consider when selling to a foreign buyer.  Small business owners often believe that foreign companies and independent buyers will “pay big” for their business.  However, the fact is that foreign companies are usually only interested in acquiring businesses or companies that already have sales in the millions.

Dealing with Synergistic Buyers

A synergistic buyer is one that believes that a given business would stand as a perfect fit for his or her own existing business.  Part of the thinking is that by acquiring the new business, this buyer will be able to lower costs, gain new customers and incur other important benefits and advantages.  It is interesting to note that synergistic buyers often will pay more than other buyers due to the fact that they see tangible, and perhaps even immediate, benefits for making the purchase.  Similar to working with a foreign buyer, synergistic buyers rarely look at small businesses, but instead seek out mid-sized companies that meet their overall criteria.

Financial Buyers

In short, financial buyers can be quite demanding as they potentially have a long list of demands.  The bottom line for these buyers is that they want maximum leverage.  Yet, they also fall into the right category for a seller who wants to continue to manage his or her company after it has been sold.  Financial buyers frequently play “hardball” and will make an offer that is lower than other types of offers.  However, they often make non-financial provisions that could be important to the seller, such as the location of the business, the retention of key employees and a myriad of other factors.

Financial buyers are only interested in a business that is able to yield enough profits to support both the existing management and provide a return on the investment to the owner.

The Individual Buyer

The majority of sellers of small to mid-sized businesses want to deal with the individual buyer if possible.  Quite frequently these buyers are mature, ranging in age between 40 and 60, and are experienced veterans of the corporate world.  For these buyers, owning a business not only is a dream, but also it is something that they now can afford.  Understanding what this kind of buyer wants is a key component in making the deal happen.

In general, any buyer that is looking to replace an existing job is a very good prospect.  Owning a business is clearly much more involved than being someone else’s employee, and these new responsibilities and potential risks can frighten many prospects away.  Yet, this category of buyer has a deep internal need or “drive,” which may help make the deal happen.  Further, the individual buyer may approach the deal with fewer strings and other assorted complications than many other types of potential buyers.

One Final Thought

Sifting through the various potential buyers to find the right one can be complicated.  As a result, it is best to leave this process in the hands of professionals  who have the experience and know how necessary to decide on the best possible prospects.

Here are five key factors to look for in a business.

Factor One-The Assets

Having an intangible asset, such as the perfect location with a locked in long-term lease (which would, of course, transfer to a new owner) is of vital importance.  However, this is not the only example of critical intangible assets.  Other examples would include a robust mailing list of past and current clients that was built up over a series of years, a popular franchise relationship, trademarks and copyrights or a respected and known product line.

Factor Two-Is the Business Easily Replicated?

If a business is easily replicated, then it can fall prey to knockoff artists.  One example would be the fact that franchises often, but not always, limit the number of franchises in a given geographical area.  Another example would be whether or not a business has a liquor license, since most jurisdictions have limiting factors on the number of liquor licenses available.

Factor Three-What is Proprietary?

Proprietary technology, services or products are, simply stated, always a good thing to see when you are considering a business and evaluating how unique and valuable it may be.  Attractive factors would include buying a business that has developed unique technology, such as software, or a process that is patented or extremely difficult to reproduce.

Factor Four-Reputation

Is reputation everything?  In business the answer is, “yes!”  Reputation matters a great deal, and having a business that possesses a great reputation in a given community can mean money in the bank.  A good example would be a pharmacy that is well known for its ability to deliver prescriptions in a timely fashion, or perhaps it is the local hardware store that always has “everything you need” in stock and ready to go.  Just remember it will be up to you as the new owner to keep up a good reputation as you progress into the future.

When you are considering a business to buy, it is necessary to go beyond the simple numbers and dive deeper.  This means accessing a business to determine what makes it unique, how robust it is likely to be to challengers and what characteristics it has that could help ensure its long-term survival.

Family Members

Members of the seller’s own family form a traditional category of business buyer – a category of buyers that is “tried” but not always “true.” There is something appealing about a family member taking over the business. There is a sense of keeping the business in the family and an assumption that such an arrangement will translate into the prime advantage of continuity. Continuity may in fact be the result as long as the family member buying the business treats the role as something akin to a hierarchical responsibility. This can mean years of planning and diligent preparation, involving all or many members of the family in deciding who will be the “heir to the throne.” If this has been done, the family member may be the best type of buyer.

Too often, however, the difficulty with the family member as buyer lies in the conflicts that may develop. For example, does the family member have sufficient cash to purchase the business? Can the selling family member really leave the business? In too many cases, these and other conflicts result in serious disruption to the business itself and/or to the sales transaction, not to mention the impact on family relationships. An outside buyer eliminates these often insoluble problems.

When considering a family member as a buyer, a business owner should carefully evaluate three factors: ability, family agreement, and financial worthiness.

Business Competitors

This is a category often overlooked as a source of prospective purchasers. The obvious concern is that competitors will take advantage of the knowledge that the business is for sale by attempting to lure away customers or clients. However, if the business is compatible, a competitor may be willing to “pay the price” to acquire a ready-made means to expand. A business brokerage professional can be of tremendous assistance in dealing with the competitor. They will use confidentiality agreements and will reveal the name of the business only after contacting the seller and qualifying the competitor.

The Foreign Buyer

Many foreigners arrive in the United States with ample funds and a great desire to share in the American Dream. Many also have difficulty obtaining jobs in their previous professions, because of language barriers, licensing, and specific experience. As owners of their own businesses, at least some of these problems can be short-circuited.

These buyers work hard and long and usually are very successful small business owners. However, their business acumen does not necessarily coincide with that of the seller (as would be the case with any inexperienced owner). Again, a business broker professional knows best how to approach these potential problems.

Synergistic Buyers

These are buyers who feel that a particular business would compliment their business and that combining the two would result in lower costs, new customers, and other advantages. Synergistic buyers are more likely to pay more than other types of buyers, because they can see the results of the purchase. Synergistic buyers seldom look at the small business, but they may find many mid-sized companies that meet their requirements.

Financial Buyers

This category of buyer comes with perhaps the longest list of criteria and demands. These buyers want maximum leverage, but they also are the right category for the seller who wants to continue to manage his company after it is sold. Most financial buyers offer a lower purchase price than other types, but they do often make provision for what may be important to the seller other than the money—such as selection of key employees, location, and other issues.

For a business to be of interest to a financial buyer, the profits must be sufficient not only to support existing management, but also to provide a return to the owner.

Individual Buyer

When it comes time to sell, most owners of the small to mid-sized business gravitate toward this category of buyer. Many of these buyers are mature (aged 40 to 60) and have been well-seasoned in the corporate marketplace. Owning a business is a dream of theirs, and one many of them can well afford. The key to approaching this kind of buyer is to find out what it is they are really looking for.

The buyer who needs to replace a job can be an excellent prospect. Although owning a business is more than just a job, and the risks involved can frighten this kind of buyer, the buyer without a current job will have the “hunger” necessary to take the leap. A further advantage is that this category of buyer comes with fewer complications than many of the other types.

A Final Note

A business intermediary has the experience needed to sort out the “right” type of buyer.