The federal government, via Small Business Administration loan guarantees, makes it easier for bankers to say yes. Interest rates are very low, which lowers the cost of debt financing and raises the purchase price that can be amortized. Banks just need sensible deals, just as they always have. A sensible deal is one that cash flows with a reasonable cushion (the exact amount hinging on risk factors such as volatility of earnings) and also has a meaningful secondary source of repayment, i.e., collateral or a good personal guarantee.

Equity contributed by the buyer will reduce the amount that must be borrowed and thereby improve the cash flow, i.e., “bankability” of the deal. And when the sum of the equity contributed and debt that can be borrowed falls short of the purchase price, the only way to make it up is seller financing. Most deals include some seller financing. That’s just the way it is. Yes, and the bank will want the seller note and payments subordinated to the bank.

“Banks get a lot of flak as being unfriendly to business, unjustifiably in many cases, in my view,” says Brit Callahan, a private business owner. True, banks are not set up to take much risk. They earn a slim profit on each loan, and one bad loan can wipe out profit earned on hundreds. “Many people get confused between equity investors and commercial lending institutions,” Britt adds. “Equity investors are ‘partners’ of the owner as they are in the same position, as holders of equity. It’s referred to as risk capital because they take larger degrees of risk. They only get what’s left over after the liabilities and cost of the same have been paid. As compensation for their more risky position, they have the chance to earn returns far in excess of their lenders.”

Cash Flow Is King

“It’s extremely difficult to sell a business that is not making a profit,” says Blayne Frieden, dealmaker with Acquisition Advisors. “Buyers just aren’t very imaginative. They assume what the business is doing now (and in the recent past) is what the business will do in the future. So if your business is performing well, this works in your favor. Storm clouds may even be on the horizon, but you will likely be able to get a deal done based on current (recent) cash flow. But if your business is not profitable, it’s almost impossible to sell the potential,” Frieden continues. “Try and you’ll almost certainly waste time and energy, unless you’re willing to give it away.”

And so the rich get richer. Those with profitable companies today can sell for a bit of a premium. This is because buyers of all types — individual, industry and private equity — are “out there” in great quantity; they just want profitable firms. Those earning profits today have the opportunity to sell for nice valuations as a multiple of cash flow. Owners of unprofitable businesses are stuck until they succeed in establishing a track record of profit.

Buyer Types and Selling Prices

“Much is written about business purchase prices and multiples,” says David L. Perkins, Jr., also of Acquisition Advisors, “but it’s not that darn complex and it doesn’t fluctuate all too much over time.“ Businesses with less than $500,000 in annual earnings almost exclusively sell to individual buyers at multiples of EBITDA in the 2.5 to 4.5 range, depending on risk factors and rate of growth. Private-equity groups and corporate buyers (primarily peers and competitors) will begin to enter the picture as possible buyers as annual EBITDA exceeds $500,000 but don’t become real players until annual profits exceed $1,000,000. Purchase prices (for all the non-cash assets and the assumption of working liabilities of a business) are in the 4x to 5x range. Higher growth rates can command higher multiples, as can synergies with the buyer. When annual EBITDA exceeds $3 million, the industry, i.e., corporate and private-equity buyers, come out in full force. These are the deals that have been bid up of late because of the supply-demand imbalance. Multiples of 6x are now pretty common, and growth and synergies can raise prices further. Look at it this way: It’s a reward for being able to operate profitably during a very weak economy.

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It’s a fine time to sell a business. Nothing is holding you back except, well, the performance of your business. Many businesses, of course, are struggling because of the moribund economy. Unfortunately, business salability and sale price are a function of current and near-term profit performance. There’s just no getting around it. If your business is performing well and you really want to do something different, it’s a fine time to exit. And you can expect to be rewarded for your business operating profitably during these difficult economic times.

What are these bugaboos that can rise out of nowhere to snatch defeat from the jaws of victory? Here are the most common:

Real Estate. In three classic situations, real estate can bite you. First, location is critical, but you can’t convey this to the buyer at a price certain for a sufficiently long time into the future. The second, you are obligated to a long-term lease, but the buyer wants to relocate the business. Third, you own the facility occupied by the business, the buyer wishes to relocate it, and you’re not confident you could find another buyer or tenant.

Unresolved Litigation. Business buyers avoid acquisitions that include assumption of unquantifiable liabilities. Unresolved disputes, litigation and threatened litigation are unquantifiable liabilities. That is, they carry a cost—in both time and money—that’s difficult or impossible to estimate.

Environmental Liability. Business buyers test the ground and groundwater beneath any business they consider purchasing. If contamination is found, the deal is as dead as the tree your letter of intent is made from. If there’s any chance you could have an issue here, talk to your lawyer about it—before you move to sell—going ahead and investigating the facts and remediating any problems.

Assignment of Contract. Any time a landlord, lessor, franchisor, distributor or licensor must approve a sale or transfer of control, the deal is not entirely in the hands of the buyer and seller. The time to avoid or minimize the clauses is when the agreements that contain them are established, or at the very least, well in advance of an attempted business sale.

Title Issues. Whenever rights to an asset are critical to the ongoing revenue stream or profitability of a business, buyers want total assurance that after their contemplated purchase they will have use of the asset. In some cases, assurance of exclusive usage is required. To the extent that buyers can secure use of the important asset but at an inflated price, the business purchase price goes down commensurately.

Unlicensed Use of Copyrighted Works. If you’re using a software program or other intellectual property on an unauthorized basis, your buyer may not be willing to “risk it” as you have been doing. Most buyers—during the pre-purchase audit—identify all intellectual property used by the company and then investigate whether the company’s use is authorized. If unauthorized use is identified, most buyers want to figure out the total cost of “going legit.” Such may include penalties plus ongoing costs. If the expense can be pinned down pre-closing, the purchase price can be reduced dollar for dollar. If it cannot, you may have a problem.

Debt Prepayment Penalties and Re-Price Triggers. Typically, interest-bearing debt of the seller is paid off in full at closing (by the seller, using monies paid by the buyer). If said debt has a prepay penalty, it could put a dent in the seller’s sale economics. Conversely, if the seller enjoys debt financing that’s attractive to the buyer, so-called change-of-control covenants could spoil the party.

Double Taxation. Uncle Sam takes a healthy cut whenever a gain is realized, but few sellers pull back from the closing table because of the taxes, that is, except when the selling entity is a C-corporation. C-corporation sellers face double taxation when the buyer buys assets. Yes, the seller could require the buyer to purchase the stock instead, but it’s not that easy. Buyers pay less when they are forced to acquire C-corporation stock. There are a few strategies for reducing taxes in a C-corporation asset sales (click here to read A Means For Reducing C-Corp Sale Taxes), but it’s an uphill battle. The best strategy is to convert to S-corporation status well in advance (eight or more years) of the anticipated sale date.

Minority Shareholders. If you don’t own 100% of your company, your deal could get held up. First, if the parties choose to effect the sale by purchase of stock, any minority shareholder could hold up the deal if you don’t have agreements in place that force them to accept terms agreed to by the controlling shareholders. This is because buyers almost always want to buy 100% of the outstanding stock. Second, minority owners can hold up asset sale transactions if a so-called super-majority provision exists in your governing documents.

When it comes to selling a business for maximum value, timing is everything. Start the process when the business’ performance is trending up, the economy is strong and buyers are aggressive. Get multiple buyers working and you’ve got it made—so long as you’ve cleared away the deal killers in advance.

Concentration risk is lack of diversification in revenue or profit sources.

———

Kenneth F. Albright, a tax lawyer and transaction lawyer partner at the firm of Albright, Rusher and Hardcastle, contributed expertise to this article.

• The cash to which the buyer is referring is cash generated from operations, as opposed to cash generated from any changes in assets or liabilities; and
• The business was valued based on an estimate of the cash the business will generate from operations on an annual basis; and
• To justify the price, the business should generate 1/365th of such on the first day of ownership; 30/365th during the first 30 days of ownership; 90/365th in the first 90 days; etc.

The only way for the above to actually hold true in an acquisition is if the buyer pays his price in cash and, in exchange, receives the entire business including:

• All assets necessary to operate the business – cash, accounts receivable, inventory, accruals, furniture, fixtures, equipment, etc. (at “normal” levels with no deficiencies); and
• All “normal” non-interest bearing liabilities of the business – typically accounts payable and accruals – are assumed by the buyer.

Only via this “deal structure” will cash flow be “normal” and in line with the purchase price. For example, every business needs some cash to operate. If XYZ business requires $5,000 in cash but such was not “left in the business” by the seller, the buyer will have to contribute the $5K on his first day of ownership. Now if the buyer paid full price for the business, he has now paid full price plus $5K. He’s over paid.

For another example, let’s say the working assets of XYZ average $500,000 and the working liabilities average $350,000. XYZ, thereby, needs $150,000 in working capital. Buyer “B” has valued XYZ … based on its annual “profit” (i.e., cash flow) … at $1 million. The seller, however, wants to keep for himself all working assets and pay off all working liabilities. As such, the buyer will inherit a business that, on the first day of operation, has no current assets and no current liabilities. The impact of this deal structure will be that the operating cash of XYZ will be hindered, over the first month or two, for a negative $150K. In other words, the buyer will have to contribute $150K into the business for working capital. The buyer, in effect, paid his target price of $1 million plus $150K to cover the impact of the deal structure. And deal structure strikes again.

Businesses should be valued on the operating cash flow they will generate. If the deal structure impacts the cash flow, such as delays when the operating cash will begin to flow, then the purchase price should be modified accordingly.

Answer: Let’s tackle the easier question first – regarding compensation. Owners should completely separate compensation for labor from return to owners (equity holders). Fair compensation should be paid to persons who render service to the company. A good indication of “fair” is that which the person could obtain from another source for rendering similar services on an arms-length basis. If your partner does not work, how could any compensation be merited?

How can you agree on price? You’re in a tough spot. One method is a “take or pay” deal. You flip a coin to decide who gets to name the price. Then, once a price is named, the other gets to decide whether he wants to sell his ownership at that price or buy out his partner at that price. Another is to hire an independent appraiser to represent both of you. He could help you both understand his opinion of “fair value” and then attempt to mediate the determination of a price. Good luck. I’m sure I don’t need to tell you that these tough issues should have been tackled years ago and a buy-sell agreement put in place.

In addition, due diligence costs time and money and you’ve spent enough time and money on this project already. You’ve negotiated a great price, so let’s just get the deal done and get going.

So, what’s the problem?

Typically due diligence is left to the very end of the process, by which time the momentum of the deal and willingness of parties to complete the deal results in blind faith that it will be a successful acquisition. It is easy to ignore problems and is impossible to be impartial if you want the deal to go ahead. Due diligence needs to be taken seriously and conducted without bias.

Why is it so important?

In short, many acquisitions and mergers go sour even in the very best of circumstances. Significant attention and research needs to be done to predict, expose and prevent problems before they occur, and in many cases to walk away from a deal if it doesn’t make sense. Losing thousands now is better than losing millions later.

The financial viability of the acquisition needs to include a bottom-up analysis of all the potential costs of the acquisition and integration of the target company. These “unexpected” costs can often be predicted in advance if you take the time to thoroughly investigate the target company. So the next thing to do after deciding to acquire this company is to look for every reason not to go ahead. Below, we list some of the important business issues to examine.

Essential Elements of Due Diligence

Financials:

management accounts, capital expenditures, ratios, debt capacity, verification of reported financials, inventory value, accounts receivable risk, identification of adverse trends.

Industry:

growth rate, growth patterns, micro and macroeconomic trends and cyclicality, risk of product obsolescence, market share, performance of business relative to competition.

Customers:

customer base, customer satisfaction, customer retention and loyalty, risk of customer loss after acquisition, order volume changes, new demands on quality or product design.

Competition:

strengths and weaknesses of key competitors, changes in competitive strategy, barriers to entry, proprietary capabilities, potential or emerging competitors, supplier base, market share, pricing strategies, product and service development.

Suppliers:

continuing availability of materials, trends in supplier base, changes in supplier leverage, changes in material cost.

People:

employee tenure and turnover, compensation and demographics, employment contracts, remuneration and benefits, training and skills gaps, retention and reliance on key employees, availability of capable management, unionization, management structure, management philosophy and style, formal and informal employee networks.

Liabilities:

taxes, pending litigation, environmental factors, employees, violations, liens.

Reputation:

customer satisfaction and service history, history of regulatory violations, Better Business Bureau records, late shipment and poor quality history, customer attitudes, credit history: with banks and suppliers, media exposure.

Operations:

loss of proprietary capabilities, patent expiration, required capital expenditures, insurance cost changes, purchasing procedures, inventory management, production technology, resource requirements, IT systems and expenditure.

Legal:

statutory records, tax filings, property titles, contracts, corporate registers, good standing in desired operating regions.

Property, Plant & Equipment (PP&E):

condition of property, availability of equipment and facilities post-acquisition, lease expiration, lease terms, zoning, room for expansion.

Other Risks:

integration risks of merging multiple businesses, environmental issues, health and safety issues, insurance policies, internal controls.

Opportunities to Investigate in Due Diligence

Saless:

customer base expansion, increase volume to existing customers, new product extensions, marketing efforts, inside and outside sales efforts, sales strategy.

Price per unit growth:

product improvements and services that add value, customer segmentation and targeted pricing.

Modeling:

cash flow and debt service modeling with various scenarios.

Cost reduction:

productivity enhancement, implementation of IT systems, plant layout and workflow redesign, supplier cost reduction, asset utilization improvements.

Roll-up:

potential scale efficiencies, availability of add-on acquisitions, vertical integration opportunities.

Exit:

exit strategy should be developed and written with options based upon events, appeal to strategic or financial buyers, potential for IPO or private resale, timeline and transition plan.

Conclusions

Create a report of the risks and rewards with their value weighted by probability. Added value is to identify the areas to address in a written integration plan and forecast the cost of integration and/or additional post closing investment needed.

Data needs to be obtained through various sources including plant and equipment inspections, financial statement reviews, government records, industry research, interviews with customers, suppliers, employees and management, consultations with outside experts and other sources.

Don’t make the mistake that so many smart business owners have made before you. If everything goes well, you’ll get through this with information that supports and justifies your desire to go ahead in the first place.

Not only does seller financing help minimize the equity required, it provides ready and meaningful recourse in the event the seller breaches duties, obligation, representations or warranties. Try to get “right of offset.”

Assets, not stock

Buying stock is risky. A foolproof method for reducing risk is to buy only assets. Asset purchases also reduce taxes.

Real and physical possession of important assets at closing

Regardless of how well you know and trust the seller, resist all temptation to allow trust to override prudence. Money and fear can make people do incredible things.

Fair compensation

If the business can’t safely pay, beginning on day one, a fair compensation for you and a comfortable repayment/return to debt and equity, you’re paying too much.

Each promise in writing

Don’t accept the ol’ “I’ll agree to such and such, but I don’t want to put it in the agreement.” Insist that it be written into the purchase/sale agreement.

A clear, actionable penalty for every seller promise

Seller promises are weak and often meaningless if your agreement doesn’t have specific, clear, actionable and valuable recourse outlined for each.

UCC/lien search and releases

Search filings for secured creditors a month before the purchase and the day of purchase. You must ensure that all secured creditors are notified of the pending purchase, provide current payoff terms in writing and agree to release and remove the lien upon full payoff at closing.

Payoff of unsecured creditors

Unless you’re purchasing assets out of bankruptcy, you want to be sure all unsecured creditors are paid in full, or agree to settlement terms before or at closing. Sure, you may not have a legal obligation, but if some get stiffed, they can blame you and cause all kinds of problems.

Verify seller’s ownership and rights to sell

Don’t trust that the owner legally owns anything, especially intellectual rights like trademarks, trade names, web domains, websites, formulas, patents, copyrights, etc. Similarly, have him prove that he has the right to authorize a sale.

Ensure that the non-compete is enforceable

I can assure you, no matter how sick or old or ill or tired or incompetent the seller says he is, nor how far away he says he’s moving, get a non-compete that your competent lawyer says is enforceable and has “teeth.”

Run both a background check and credit check on the seller

Charlatans usually leave a trail, and greed can make a guy an incredible salesperson. No matter how well you think you know him …

Pay no more than can be comfortably serviced by proven, historical cash flow

Feel free to analyze and estimate all the synergies and cost reductions you’ll gain after the purchase, but pay only for the profits that are historically stable and proven.

Get personal recourse for seller breaches

For each and every promise, get the seller to agree to be held personally liable for any breach.

Title search on any real property

Of course. And your mortgage lender will require it.

Environmental audit on any real property being purchased or leased

Just ask any attorney.

New, valid, long-term lease on important real estate or assets

Never assume that a landlord will renew a lease or keep the same terms. Get it in writing, firm, unequivocal, irrevocable, unchangeable, etc.

List the three things that could put you out of business the fastest

Then, for each one, answer: “When x occurs, how will I survive?” Don’t accept, “Oh, it won’t happen,” as an answer. If it “could,” you better plan for it.

Assure that all these are covered, and I can almost guarantee you’ll be spared any of the following fates:

a. personal financial demise

b. a nomination for “dumbest person in the solar system award” (or worse, win the darn thing!)

c. your friends avoid you because they’re so tired of hearing you say, “I just, never in a million years, thought …”

Note

If you buy a company, no matter how large or small, we urge you to exercise extreme caution before you waive a single one of these items. In buying a business for our own account, we have failed to heed our own advice and in each instance, to our peril. We suffered the fate of “b” and “c” above, and narrowly avoided “a.” In consulting others in the purchase and sale of companies, we’ve also seen these items save and sink.

Test #1: Is the business able to pay fair compensation for the talent and labor contributed by each owner?

Test #2: Can all post-purchase debt be comfortably serviced via normal “commercial” terms?

Test #3: Will the equity holders receive a fair return on investment?

So XYZ Company is worth $12,000,000?  OK, let’s see if it passes the three tests of reasonableness. To do this, you’ll need.

1. Beginning Balance Sheet: Should be a “best guess” of what it will look like on the first day after the hypothetical purchase/sale before any purchase-related debt or equity.
2. Ten-Year Projections: These must include annual income statements, balance sheets and statements of cash flows.
3. Debt Service Requirements: Projected until all purchase-related debt is repaid.

Below is the summary balance sheet and income statement for XYZ Company.

At the top of the table is the proforma beginning balance sheet (day 1 of new ownership). Below it is a proforma income statement and estimate of cash flow for the first year of ownership before any interest or principal payments on debt (purchase-related or otherwise). For simplicity, we will assume each year will perform as year one (i.e. flat income and cash flow in each year post-purchase).

Test #1: Fair Compensation for the Talent and Labor of Each Owner-Employee?

Business owners are notorious for sacrificing pay. However, why buy a business that cannot pay fair compensation to the owners for their talent, time and effort?  What is “fair?”  It’s the compensation that could and would be obtained “on the open market.” If you could get a job for $50,000 per year working full time, the business should be able to pay you this “fair market rate.”

So the first test is, “Can the business afford to pay the working owners a fair price for their labor?” This test is met when, in your projections, you burden the business with fair compensation for all the owner-employees and the business will still make a profit and have positive cash flow from operations.

Test #2: Will Projected Cash Flow Cover the Debt Service?

Businesses are purchased with debt and equity. The senior obligation is to debt. The second test of reasonableness is whether the business will generate enough cash to comfortably make all of its debt payment obligations … both interest and principal.

To estimate this, you need more than the price of the business. You need to know how the purchase price will be paid – the “deal structure.”  Because investors typically want to borrow as much as they are able (equity is scarce and more costly than debt), it makes sense to first estimate the amount of bank debt that could be borrowed against the assets of the business. To do this, take the proforma balance sheet to your banker. Below we have applied common loan-to-value rules of thumb to XYZ’s assets.

As calculated, $6,500,000 can be borrowed against the assets of the business. Loan terms on business purchase transactions, non-real estate, are typically five to seven years. We’ll use seven for our example and assume that the bank wants all of the debt repaid over the seven years (as opposed to leaving the A/R and inventory portion on a revolving line of credit) at a 7 percent rate.

The remainder ($5,500,000) of the total price must come from equity, seller financing, or a blend of the two. Now every seller will say, “I won’t seller finance”, but the numbers hardly ever work when there is no seller financing. And, studies show that 80 percent of private businesses that sell do so with seller financing. (By the way, of the company’s sales that do include seller financing, the most typical percent of the price is 50%). For this example, let’s assume that the buyer and seller agree to split the balance of the purchase price that cannot be borrowed from a traditional lender. That places $2,750,000 in seller financing and $2,750,000 in cash contributed by the buyer (i.e. equity). So, the equity piece comes to 23% of the total purchase price. This is in the range of what we actually see in the real world (most deals have 20% to 30%).

Because the seller debt will be subordinate to the bank financing, it is more risky and merits a higher rate of interest than the senior debt. Let’s say three points over prime or 9 percent.

Now, add to your projections the debt service obligations for both bank and seller financing, as in the accompanying table. For explanations of the other calculations in the table, study the notes.

¹ Projected cash flow is derived via projections. Cash flow here is after tax and all expenses except purchase related debt.

² To keep our analysis on an after-tax cash basis, we adjust the interest expense to after-tax. Doing so calls for a reduction of interest expense because interest is tax deductible, so the real cash cost of the interest is 60 percent of the gross or pre-tax cost (calculated by using a 40 percent blended federal and state tax rate).  For example, bank loan interest expense in year one is $420,000, times 60 percent (calculated as one minus the tax rate of .40) is 25 percent.

³ Annual bank loan principal is simply the borrowed amount ($6,500,000) divided by the loan term (seven years).  No tax adjustment is needed as principal borrowing and repayment does not impact taxes.

⁴ Seller loan interest is derived by using common terms for seller financing – seven year note at prime plus 3 percentage points (we used 9 percent). See note 2 above for the rationale for adjusting to after-tax.

⁵ Seller loan principal is the annual amount of principal that must be paid on the seller note ($2,750,000 divided by 7).

⁶ “Free cash flow” is the excess cash generated each year after all obligations are met (compensation, taxes, interest and principal). This is the number that contributes to the investors (buyer) return on investment (calculated in this case via the IRR method).

⁷ Interest coverage ratio is an important indicator of the ease to which cash flow is able to pay interest burden. Banks, in the worst case, want to be sure interest can be paid. The coverage here is healthy.

⁸ Debt service coverage ratio shows the ease to which the business is able to meet its total principal and interest obligations. A ratio of 1.0 would indicate there is just enough cash to meet the P&I burden. Lenders and investors want a cushion for safety, of course, and 1.5 is a common threshold of safety.  Anything above 1.5 is even healthier. As we can see, debt service coverage begins at a healthy 1.5 and then slowly improves in the later years.

*  Beginning in year eight, free cash flow is $2,500,000, as all debt service will be paid by end of year seven. This is also after fair compensation to the owners.

Test #3: Will the equity holders receive a fair return on investment?

Well, what is a “fair return” for an equity investment in a private company?  We know that over the past 80 years in the United States, holders of equity in publicly traded companies have earned per year, on average, 11 percent and 18 percent for large cap and micro cap stocks, respectively. Given that equity stakes in private companies tend to be much more risky, slower growth, volatile and illiquid, return on investment should be higher. Generally, private equity stakes should yield at least 25 percent, if not higher.

So, what do we estimate the return to equity would be on XYZ Company at the $12,000,000 valuation and using the deal structure example above?  Using your financial calculator or Excel, you can take the projected annual free cash flow from the table above, apply it to the initial cash invested ($2,750,000) and you will get a 38 percent after-tax internal rate of return. This substantially exceeds our minimum threshold of 25 percent, so the estimated value of XYZ of $12,000,000 meets the third test.

This article is adapted from an article titled “The Justification of Purchase Test” by Rand M. Curtiss, which appeared in the fall 1999 issue of Business Appraisal Practice. Note: In an attempt to keep this example simple, some liberties have been taken. Before you make investment decisions, consult an expert.

Why might a person want to own a business? Buy a business? Certainly, the reasons are unique to each person. Motives range from the material (i.e., money, possessions) to the spiritual; may originate from within (i.e., reside within oneself) or outside us (i.e., be socially or relationship-motivated); may be substantially selfish (i.e., greed, power) or altruistic; may be healthy and rational (i.e., strategic or self-actualizing*) or unhealthy and irrational (i.e., an inappropriate and unwise response to pressure, fear or deficiency).

Buying a business is a big decision. It’s not for the timid, tired or tethered. Before you buy, ask yourself a few questions.

Question 1: Is this right for me?

From a personal standpoint, this is a tough one. This is the stuff of philosophers, psychologists, spiritual advisors, career counselors and maybe mothers. This subject goes well beyond the scope of this publication, but I do believe that to find happiness and fulfillment every person must spend time getting to know who you are: what are your talents, abilities, strengths and weaknesses; at what are you most well suited; and what endeavors give you the most satisfaction.

At times, I’ve found the work of Abraham Maslow helpful. The 20th Century psychologist spent his life studying and writing on such issues. For a brief introduction, read the article herein titled “Maslow’s Hierarchy.”

It also might be helpful to consider that successful business owners tend to be:

• Energetic and motivated
• Comfortable being in charge
• Confident
• Decisive
• Calm under pressure
• Competitive
• People-friendly

Question 2: Is this business a good fit for me? Is it a natural addition to my existing business?

This question deals more with strategy. Is the business a good fit for you as an individual? How well does it fit with your skills, abilities, experiences, contacts and financial resources? Are you fully prepared for the challenge? If you were accused of being “out of your league,” would a jury convict?

If it’ll be an add-on to your existing business, is it a good fit? Do others readily see the fit? Is the fit real and practical and in the here and now or is it more intellectual or emotional?

Will you enjoy real and immediate synergies? If the purchase goes bad, can you survive? Could it sink your whole ship and, if so, are you really sure you want to risk that?

Question 3: Will the right people be on board and committed?

Ownership: Are they committed and clearly in control?

Leadership: Are they passionate and clear about the new vision?

Management? Are they proven leaders who will be committed and have they bought in to the purchase? Employees: Are they experienced, committed and dependable?

Question 4: Am I gambling or investing?

The most successful business buyer of the past 100 years is Warren Buffett. He explains, “Investing is not gambling. Know the difference.” Said another way, when you buy a business, risk return ON investment, if you wish (i.e., rate of return), but don’t risk return OF investment (i.e., whether or not you eventually get back what you invested). Gambling is for entertainment. Investing is for making money. Before you agree to a purchase, make sure it’s a winner.

Question 5: Will I earn a fair rate of return?

You must not buy until you have a good handle on what will be your minimum after-tax, cash-on-cash, rate of return. That’s after (i.e., over and above) fair compensation for the time and talent of all laborers – both owner and non-owner. That includes you.

More particularly, you should require a return on equity that fully compensates you for the burdens and risks inherent in a private-company investment. Private companies are incredibly illiquid, undiversified, and require a tremendous amount of management/oversight time. Compare this to investment alternatives such as high quality, publicly traded stocks and bonds. They consistently provide annual rates of return of 6 – 18 percent and they’re liquid, require almost none of your time, are easily diversified, and there’s almost no chance you’ll lose your equity (as long as you diversify).

So what should your equity return be on investment in a private company?  Well, 25 percent per year or more.

To conclude, buying a business is a serious matter. It requires substantial financial outlay and obligation, plus considerable time, energy and responsibility. Fail, and although you no longer risk being stoned to death, you could lose all your material possessions and more. It’s not for the uncommitted, unprepared or undercapitalized.

*  Self-Actualization is a term primarily associated with the work of famed psychologist Abraham Maslow. He defines it as the drive every person has to fully use and exploit his unique talents, abilities, capacities, potentialities, etc. See the accompanying article titled, “Maslow’s Hierarchy: A Framework for Understanding Ourselves?”

Business Brokers:

Business brokers typically represent owners of businesses valued well under $2 million that serve a local clientele. Their clients are often referred to as “main street” businesses. Examples of “main street” businesses are dry cleaner, gas station, convenience store, restaurant, laundry, lawn care, landscaping, nursery, repair shop, beauty shop, individual franchise, and many other business-to-consumer operations with a single location.

Business brokers typically represent businesses that are run by the owner him or herself and no middle management.

Business brokers mainly represent businesses that have little expansion potential.

Business brokers usually work with businesses that resell products made by another (not their own, proprietary products) or are a franchisee or licensee.

Businesses offered by business brokers rarely sell for more than four times proven annual cash flow.

The most likely buyers for main street businesses are individuals that live near the business, and the buyer will typically work in the business after they have purchased it.

Buyers of main street businesses often have never owned a business before or been involved in the purchase or sale of a business before, and tend to have little or no knowledge of business transactions, financing, etc.

Merger & Acquisition (M&A) Advisors:

M&A Advisors typically represent owners of businesses valued in excess of $2 million. These businesses may be multi-unit retail establishments, dealers and franchisors, but are more often manufacturers, distributors or service businesses with regional, national or international clientele.

Businesses represented by M&A advisors may have a separation of ownership and management, and will almost always have some middle management personnel.

Businesses represented by M&A advisors will typically have much greater expansion potential than smaller businesses typically represented by business brokers.

Businesses represented by M&A advisors will have a much higher incidence of having their own proprietary brand, branded products and innovations.

Businesses offered by M&A advisors have a greater potential for garnering higher sale prices and earnings multiples, sometimes considerably higher.

Buyers of businesses represented by M&A advisors may be individuals (at least on the lower size deals), but are more often other companies and/or private equity groups.

Buyers of M&A advisor-represented businesses have typically owned and/or purchased and sold companies before. They also tend to be well-educated, well-connected and fairly experienced in business matters. As such, these buyers can be more of a “competitive threat” in that they can and may attempt to use their knowledge to their advantage (and your detriment). To that end, business sellers of mid-size companies should engage representation that has the education, experience and skill to match these shrewd buyers.

Services Provided

Business Brokers:

Business brokers typically act more like a real estate broker, listing many businesses and advertising them locally and on a website.

Business brokers will typically do little buyer search, outside of web postings and newspaper advertisements, and almost no direct prospecting to select buyer candidates.

Business brokers typically spend far less time per deal than M&A professional, primarily because they cannot afford to, given the smaller size (and fees) of each deal.

Business brokers themselves will typically have a background in real estate or general business, and may or may not have a college education, and have limited knowledge of the finance, accounting, tax and legal issues that impact a transaction.

Merger & Acquisition Advisors:

M&A firms operate less like a real estate brokerage firm and more like a consulting firm.

M&A firms will rarely advertise their “opportunities” within their local market, and will do little or no mass marketing. Instead, M&A firms will tend to conduct targeted buyer searches to buyers who have demonstrated interest in opportunities of the type being represented.

M&A firms typically have far fewer engagements than the business broker, and spend considerable amounts of time on each deal.

M&A advisors have a high level undergraduate degree in business, finance or law, and often an MBA or law degree. Prior industry experience is in finance, banking, or private equity before becoming an M&A advisor.

Fee Structure

Business Brokers:

Business Brokers will charge a commission of up to 15 percent of the transaction value and little or nothing up-front.

Merger & Acquisition Advisors:

M&A firms will require sizeable monthly retainer payments to offset the risk associated with the substantial amount of work that they will do up-front in researching the industry, packaging the business and preparing it for sale, proactively contacting and working with buyers, and managing the deal through to closing. Retainer fees can be a lump sum up front (which we highly discourage) ranging from $10,000 to $75,000 or a commensurate monthly amount (preferable), ranging from $5,000 to $10,000. This up-front fee should be discounted from the back-end fee if the sale is successful.

Back-end “success” fees for M&A deals vary widely depending on the size and complexity of the transaction but tend to be a lower percentage of the transaction value, ranging from 3 percent for deals above $75 million to 7 percent for deals under $10 million.

Who to Hire

The “who to hire” decision is largely determined by the type of business that you own. If you are selling a company that has less than $500,000 in annual earnings, you’ll want to hire a business broker. There will be little or no up-front cost and their listing service should adequately serve your needs. A true M&A firm would not be as skilled at representing you, given that they rarely work with buyers that target businesses valued under $2 million.

Consider the cost benefit. An M&A Firm will charge significant fees for representing your business. The good news is the better M&A firms will increase the value of your business sale by many multiples of its fee.

If your business is valued north of $2,000,000, you want a firm that focuses exclusively on larger deals. Such firms will be much more likely to have the education, experience and network that matches your opportunity. And, a good M&A firm will be capable of adding considerable value to your deal.

Answer:

Actually, the executor of your estate will be responsible for filing an estate tax return soon after your death. IRS rules stipulate that your assets must be valued at “fair market value” as of the date of death, which is defined as “the price the property would bring when offered for sale by a willing seller to a willing buyer, neither being compelled or obligated in any way to buy or sell.” Some assets, such as publicly traded stocks or bonds, have a readily determinable value – the price at which it is traded on the open market. Other assets that are unique or not actively traded, such as a piece of real estate or your business, will need to be appraised by a qualified appraiser. Estate taxes will be due and payable nine months from the date of death.