How to Buy, Sell or List a Small Business
Pat Sims
Smashwords Edition
Copyright 2011 Pat Sims
From A Distance Publishing, 2011
All rights reserved. No part of this publication may be reproduced either by hard copy or electronic methods in any form without the prior written permission of the author and publisher.
Table of Contents
Things you need to know; Small business definition; Business categories; Forms of Ownership; Confidentiality; Agency.
Chapter Two - Preparing the Sale
Why is the owner selling? Reasons they don’t want to talk about; Qualifying the buyers; Commissions; Assets or Shares? Taxes; Unreported Cash Sales.
Chapter Three - The Sales Brochure
The Shopping List; Compiling the Brochure; Contents.
Chapter Four - Financial Statements
Types of statements; Business ratios; Reconstructing statements.
Chapter Five - How Small Businesses are valued
Return on Investment method; Typical R.O.I.s; Other appraisal methods.
The three sources; Sellers holding paper; Investors; Friends and Family; Banks; Government.
Chapter Seven - The Final Chapter of a sale
Letter of Intent; The Offer; The Deposit Due Diligence; Steps to a successful Negotiation and Sale; Conclusion.
Forms
A number of forms are freely available to you by downloading them from our web site. They include a ‘Confidentiality Agreement’; ‘Letter of Intent’; ‘Entrepreneur’s Questionnaire’; ‘Confidential Buyer’s Financing Questionnaire’.
Chapter One
~ Introduction ~
I am going to make an assumption - that all you really want to know is how to value a business because you already know everything else there is to know about buying, selling and listing a small business. I say this after doing hundreds of seminars on this topic and receiving feedback from my students which can be summarized as, “Just give me the formula”. I want to encourage you to read this entire eBook as it will give you much more than an explanation of values because it deals with the entire marketing process. Values shouldn’t be ‘plucked from the sky’ in ignorance of the factors that have developed them. Time spent here is very worthwhile.
There is a strong need for everyone to be ethical in trading high-priced items and all parties to a contract should be aware that we live in an age of litigation and, in the event a person feels aggrieved, court action may become a real possibility. The seller can be considered a fraud if he/she lies about the business income or withholds some hidden defect. The agent can also be considered a fraud for making false statements and failing to protect the interest of his/her client. That same agent is also legally obliged to act honestly and fairly with everyone else in a transaction. The buyer is unlikely to be sued for being a smart negotiator but he/she is the most likely person to commence legal action if the financial statements turn out to be incomplete or inaccurate and the business just isn’t what he/she was promised or expected.
The old saying is that, ‘a little knowledge is a dangerous thing’ and another is, ‘I know enough to be dangerous.’ This eBook cannot make you an overnight expert but it can help to introduce you to the world of business which I believe is the most exciting, frustrating, devastating, and satisfying of them all.
Agents are most commonly realtors, business brokers and accountants who should be aware of their ethical and legal obligations but for those who are not, here are just a few which everyone could use in a business transaction.
A REALTOR shall protect and promote the interest of his/her client…..
A Member shall discover and verify the pertinent facts relating to a property …. that a reasonably prudent Member would discover.
Do not rely solely on information provided by the seller if it can be independently verified.
All financial information must be disclosed to the buyer.
Do not provide an opinion of value unless you have the knowledge, skill and training and have completed the necessary research.
If you can’t provide competent service either alone or with another qualified person, decline to act.
Note to reader;
No one should enter or be counselled to enter a contract for the sale of a business or real estate without seeking competent legal and financial advice.
Things you should know before you begin
In the course of listing, negotiation, and sale you will be faced with an array of business jargon which can be confusing unless you have some prior knowledge. It is not in your best interest to learn them from the opposing party to a contract and you may miss important points unless you are ‘up to speed’.
Defining a ‘Small Business’
There is no generally accepted standard description for small, medium, or large businesses. All levels of government use different criteria and so do banks, accountants, and taxation departments. Some use the number of employees as a benchmark while others use gross sales volume, and still others say that it is defined by its management structure.
A single management structure is where one person is in direct charge of the business and its employees. This is a typical situation for a small business. Larger companies have a president and a secondary tier of management called vice-presidents who are in direct charge of their own departments within the same company.
For the purpose of this eBook, I will assume a small business to be an enterprise that is intended to be profitable (some enterprises are ‘non-profit’) and where the owner is also the manager. I will also assume the business has fewer than twenty employees and has less than $10 million in gross annual sales. Even if the business you are interested in does not fit these criteria, the principles of marketing are still much the same.
Business Categories
It is useful to know these categories as buyers have their own preferences and it helps to focus the search. Federal governments and other institutions recognise the Standard Industrial Classification code (S.I.C.) or the newer system called the North American Standard Industry Classification System (NAICS) which classifies all business entities but an abbreviated form from Wikepedia shows the following:
Agriculture and mining businesses are concerned with the production of raw material, such as plants or minerals.
Financial businesses include banks and other companies that generate profit through investment and management of capital.
Hospitality Industry includes lodging, restaurants and fast food outlets.
Information businesses generate profits primarily from the resale of intellectual property and include movie studios, publishers, and packaged software companies.
Manufacturers produce products from raw materials or component parts, which they then sell to other businesses or to the public. Typical examples are furniture, toys, cars, and fabrics.
Real estate businesses generate profit from the selling, renting, and development of residential, industrial, and commercial land and buildings.
Retailers and Distributors act as middle-men in getting goods produced by manufacturers to the intended consumer which generates a profit as a result of providing sales or distribution services. Most consumer-oriented stores and catalog companies are distributors or retailers.
Service businesses offer intangible services rather than a product to other businesses, government, and consumers. Typically they may be accountants, lawyers, consultants and agents.
Transportation businesses pick up and deliver goods and people from location to location. Typically they could be taxi and bus companies, courier service, and trucking companies.
Utilities produce public services such as electricity or clean water, often under a government charter.
Forms of business ownership
Every business enterprise has a legal status.
Sole proprietorship
This is a common form of business enterprise where there is one owner and he/she is entirely responsible for its debts and liabilities. The proprietor may work alone or have employees. Its advantage is that it simple to set up and may not need the services of a lawyer or an accountant. An entrepreneur may decide to start a business today and actually start trading or offering services right away.
The disadvantages of sole proprietorship include the lack of business partners for expertise and support; the unlimited liability for the owner in the event insolvency; lenders consider them to be less stable; and the company is likely to cease operations on the death or illness of the owner.
Some of the disadvantages can be covered by insurance or by employing key management and staff. Typically, sole proprietorships are very small or ‘start-up’ companies where the owner is looking to keep costs to a minimum.
Partnership
When two or more people carry on business together for a common purpose and profit they are called a partnership. The partners do not always share the profits equally particularly if new partners are added later. In that case, there may be senior and junior partners.
Liabilities, however, may be shared equally unless specifically agreed otherwise. In the event one partner cannot pay a business debt, the other partners must pay his/her share (called "joint and several" responsibilities).
The benefits of partnership include the company's variety of expertise, support, and its increased ability to borrow money. The death or departure of one partner is not so likely to end the business operation.
Most partnerships are formed by using a partnership agreement that sets out all the conditions and financial aspects of the business arrangement. This would include the eventuality of death or break-up. A lawyer generally draws up the agreement.
Commonly, the partners are insured so that there is money to pay out the dead partner's interest to the heirs.
Incorporation
The process to become incorporated is usually handled by a lawyer and involves government registration of the name; production of a ‘Certificate of Incorporation’ or ‘Articles of Incorporation’ that describes the purpose of the enterprise, it names the officers, the shareholders and their number of shares, and provides the registered address. This becomes public information by registration at government offices.
One of the main purposes of incorporation is that it limits the financial exposure of the officers (president, vice president, secretary and treasurer) and the shareholders to the value of the company's assets. In the event the company cannot pay its debts, the creditors may sue the company but the shareholders' personal assets (home, car, savings etc.) are safe from their action. Many times, lenders will want to make the company's officers or shareholders personally responsible for the debt in order to overcome this limitation and this is called a "recourse loan".
In some cases, suppliers and service providers may require a personal guarantee of payment
Incorporated companies show either "Ltd" or "Limited" or “Inc” or "Incorporated" after their name to tell their creditors and the public that their liability is limited.
LLC
A limited liability company (BBBBLLCBBBB) is a flexible form of enterprise that blends elements of partnership and corporate structures in most of the United States. It is a legal form of company that provides limited liability to its owners and does not need to be organized for profit. It is a hybrid business entity having certain characteristics of both a corporation and a partnership or sole proprietorship (depending on how many owners there are). An LLC, although a business entity, is a type of unincorporated association and is not a corporation.
Co-operative
A limited liability enterprise intended to transact business on a non-profit basis. The decision-making is shared by its members rather than shareholders.
Limited Liability Partnerships
This is a company that has a general partner and limited liability partners. It has often been used to raise money for a new development such as condominiums and is an alternative to traditional financing by banks. In the event of insolvency, the creditors’ debt collection is limited to the amount of a partner’s investment in the project. Conditions vary between jurisdictions.
Registration of Names
The purpose of registering a name is to prevent someone else from using it without authority and to the detriment of an existing registered user. So, if a new company was set up that sold coffee and donuts and called itself “Dunkin Donuts” without permission then it would be stealing the reputation already built by the registered owner of the name. Their loss of business and overall value is an obvious concern. By registering the name the company can enforce its rights by legal process.