Many buyers find themselves focused on the add backs and owner benefits when it comes to due diligence. This concern often overshadows the fundamental objectives of thier due diligence investigation. During due diligence the buyer’s main goal should be verifying the business’ earnings, and discovering whether or not the business will fulfill the buyer’s objectives. I recommend the buyer focus on these three simple ideas:
1. The business’ revenue
2. The cost of goods sold
3. Your future expenses
1. The business’ revenue is the first and most important number to verify. The most common verification method used is tax returns. Banks almost always rely solely on tax returns to verify revenues when approving a loan for a business acquisition. There are alternative ways to verify revenue such as bank statements, register receipts, sales logs, credit card processing, etc; however, none of these methods can give you the level of surety that tax returns provide. Though expenses will vary from owner to owner, you want the seller to prove to you the revenue for ths business.
2. The business’ cost of goods sold, which is the seller’s cost of the inventory sold, is the next item to verify. Many buyers will completely skip this step by relying on the numbers provided in the tax returns. This could be a costly mistake because many sellers adjust this number based on their individual tax situation. The number on the tax return may not be the actual cost of the inventory sold. Once you have verified the total annual revenue and the cost of goods sold you are left with the real “gross profit” of the business.
3. The thing to focus on now is future expenses. It doesn’t matter whether the seller paid their personal cell phone bill, vacations, or health insurance through the company. Understand the business owners are in business for themselves, not to pay as much in taxes to the government as possible. As such, expect to find personal expenses that are run through the business to lower their tax burden. Also, note the non-cash expenses, such as amortization and depreciation. These two line items reduce the tax burden, though don't reduce the true benefit to the seller of owning the business. Focus on what your expenses are going to be. For instance, find out what the current lease terms are and whether you should expect any significant increase in your rent expense. If the business has used a certain supplier, verify whether that supplier will still give you the same rate as the previous owner. It is also wise to review the seller’s payroll expense. In many cases, small business owners employ family members without paying them; in other cases, business owners may pay some of their employees in cash. Review the seller’s payroll expense to see if you will need to allot more money for your payroll expense. Review any contracts the seller has with equipment companies, suppliers, or vendors to find out how the current expenses might change after you have taken possession of the business.
There are surely other items to investigate and verify. Putting your initial focus on these 3 items will get your started on the right path to determine if this is the right business for you, and, what the business is worth to you.
Wednesday, November 18, 2009
Tuesday, October 6, 2009
CALIFORNIA TAX COLLECTORS EYE NON-RESIDENT FRANCHISORS
This is an article re-printed with permission from Barry Kurtz. Barry is an attorney that specializes in franchise law.
Franchisors beware. Ditto franchisees. Like New York, California wants to tax out-of-state franchisors with franchisees operating in the Golden State, with the result that their franchisees may have to act as the state's tax collectors.
With almost no fanfare, the California Franchise Tax Board has begun arguing that state income tax laws apply to non-resident franchisors who receive royalty, rent, or lease income from California sources, and if the FTB gets its way, non-resident franchisors will face an ugly choice. If they don't register with the California Secretary of State and pay taxes on California-source income at corporate rates, the FTB will require that their franchisees withhold 7 percent of all payments made to their franchisors on royalties, rents, or leases.
Now, make no mistake. Seven percent is a huge number, and the FTB surely wants to help solve California's extraordinary revenue problems. But the object of the game in floating that 7 percent number is to scare non-resident franchisors into making no fuss about paying taxes at corporate rates.
The Franchise Tax Board's argument may well stand up to legal challenge, and it one-ups a similar effort by New York's tax collectors. As I noted in my August newsletter, the Empire State's tax collectors succeeded in getting that state's legislature to pass a bill requiring that out-of-state franchisors report sales and royalty data on their New York operations - clearly, a prelude to taxing non-resident franchisors operating in that state.
The threat to non-resident California franchisors is more imminent. The Franchise Tax Board argues that state tax law already applies to royalty, rent or lease income paid to non-resident franchisors who have a "business situs" in the state - a complex legal notion centering on how franchisors make use of intangible property such as trademarks, trade names, and franchises.
Worse, the Franchise Tax Board wants franchisees to start making quarterly withholding payments this year and, adding to their bookkeeping burdens, to start sending annual statements to their franchisors detailing the income subject to withholding, plus the taxes actually withheld, by Jan. 31.
It is not a given that all non-resident franchisors with operations in California have a business situs in the state, however. But given the apparent strength of the Franchise Tax Board's argument, franchisors ought to waste no time finding out where they stand, not to mention what they can do about it.
Franchisors beware. Ditto franchisees. Like New York, California wants to tax out-of-state franchisors with franchisees operating in the Golden State, with the result that their franchisees may have to act as the state's tax collectors.
With almost no fanfare, the California Franchise Tax Board has begun arguing that state income tax laws apply to non-resident franchisors who receive royalty, rent, or lease income from California sources, and if the FTB gets its way, non-resident franchisors will face an ugly choice. If they don't register with the California Secretary of State and pay taxes on California-source income at corporate rates, the FTB will require that their franchisees withhold 7 percent of all payments made to their franchisors on royalties, rents, or leases.
Now, make no mistake. Seven percent is a huge number, and the FTB surely wants to help solve California's extraordinary revenue problems. But the object of the game in floating that 7 percent number is to scare non-resident franchisors into making no fuss about paying taxes at corporate rates.
The Franchise Tax Board's argument may well stand up to legal challenge, and it one-ups a similar effort by New York's tax collectors. As I noted in my August newsletter, the Empire State's tax collectors succeeded in getting that state's legislature to pass a bill requiring that out-of-state franchisors report sales and royalty data on their New York operations - clearly, a prelude to taxing non-resident franchisors operating in that state.
The threat to non-resident California franchisors is more imminent. The Franchise Tax Board argues that state tax law already applies to royalty, rent or lease income paid to non-resident franchisors who have a "business situs" in the state - a complex legal notion centering on how franchisors make use of intangible property such as trademarks, trade names, and franchises.
Worse, the Franchise Tax Board wants franchisees to start making quarterly withholding payments this year and, adding to their bookkeeping burdens, to start sending annual statements to their franchisors detailing the income subject to withholding, plus the taxes actually withheld, by Jan. 31.
It is not a given that all non-resident franchisors with operations in California have a business situs in the state, however. But given the apparent strength of the Franchise Tax Board's argument, franchisors ought to waste no time finding out where they stand, not to mention what they can do about it.
Monday, September 14, 2009
Sellers, does your broker cooperate with buyer's brokers?
Hmmmmm, what does that mean, "does a broker cooperate?" No, it doesn't refer to your broker being snooty or hard to work with. You'd be surprised how many business brokers, who are supposed to be looking out for their client's best interests, do not allow other brokers to get information about businesses they are supposedly trying to help sell. Why would that be? Well, you'll have to ask the brokers that don't cooperate.
In the real estate world, they've addressed this issue through the agreements governing the multiple listing service (MLS). For realtors, there is one main site where brokers go to input their listings. As business brokers, we don't have that luxury. One of the terms realtors agree to by using their MLS service is that they share their commission with an agent who brings the buyer that are members of their MLS.
Business sales are greatly de-centralized in this respect. There are 3 main websites that buyers and sellers go to in order to post and search for businesses for sale, and a myriad of others. (I market my client's businesses on over 50 websites.) Therefore, business brokers are not forced to sign an agreement where they will share their commission with a broker bringing a buyer.
This boggles my mind. I can't believe that the Department of Real Estate, who oversees business broker licensing in our state, does not feel this is against the seller's best interest. Is there another reason, other than greediness, that would preclude a broker from sharing a commission with the buyer's agent? Isn't it in the seller's best interest to have their business as exposed as possible, to ALL possible buyers? If so, why don't all business brokers "cooperate" with other brokers, who might just have a qualified and motivated buyer for their client's business?
In the movie "Wall Street", the character Gordon Gekko is famously quoted as saying "Greed is Good." Well, it seems that some business brokers are living that motto. And, their client's don't know about it...
In the real estate world, they've addressed this issue through the agreements governing the multiple listing service (MLS). For realtors, there is one main site where brokers go to input their listings. As business brokers, we don't have that luxury. One of the terms realtors agree to by using their MLS service is that they share their commission with an agent who brings the buyer that are members of their MLS.
Business sales are greatly de-centralized in this respect. There are 3 main websites that buyers and sellers go to in order to post and search for businesses for sale, and a myriad of others. (I market my client's businesses on over 50 websites.) Therefore, business brokers are not forced to sign an agreement where they will share their commission with a broker bringing a buyer.
This boggles my mind. I can't believe that the Department of Real Estate, who oversees business broker licensing in our state, does not feel this is against the seller's best interest. Is there another reason, other than greediness, that would preclude a broker from sharing a commission with the buyer's agent? Isn't it in the seller's best interest to have their business as exposed as possible, to ALL possible buyers? If so, why don't all business brokers "cooperate" with other brokers, who might just have a qualified and motivated buyer for their client's business?
In the movie "Wall Street", the character Gordon Gekko is famously quoted as saying "Greed is Good." Well, it seems that some business brokers are living that motto. And, their client's don't know about it...
Wednesday, August 12, 2009
Due Diligence and the timing of inspections
It is natural for a buyer to assume they have to ask all their questions and be 100% confident they want to buy the business, before they write their offer. They may also feel they have to do all of their due diligence inspections before writing the offer. I educate buyers to rely on the seller's representations during their initial investigation, and that if they are interested in writing an offer, once their offer is accepted, they will have a due diligence period to conduct as thorough review of the business as they want.
I feel it’s important for both buyer and seller not to conduct a full due diligence inspection before an offer is written. Typically a buyer is going to rely on a multiple gross sales, gross profit, net income, assets, or inventory to determine the value of the business to them. Therefore, it’s best for a buyer to present their offer before time is invested doing a full investigation. If the details aren’t proved during their inspection, they can always make adjustments to the purchase agreement, or cancel the purchase. This is especially important with business sales since there are so many terms involved with an offer. It is not only about purchase price. How much money is someone putting down, do they need seller financing, what is the time frame proposed for due diligence inspection, how much inventory is the buyer expecting to be passed along with the purchase, does the buyer agree to the lease terms and will they receive landlord approval, when do they propose to close the purchase, how much training do they want. So, it’s much more than just purchase price.
It's also important for a buyer to know, the way we handle the process, we will hold their deposit check uncashed during the due diligence inspection. If they don't like their findings, they let me know and I return their check. If they do approve of the inspection, we then open escrow, and the deposit check is sent to the escrow company for them to deposit.
This process is similar to when someone purchases a house. They don’t do their investigations first. They stop by the house a few times, asks the sellers some questions, then write their offer. Once the offer is accepted, they do their inspection. Do they need to do further inspection of the soil, air conditioning system, pool, roof, etc? They conduct these inspections after the offer is accepted.
It is ultimately up to the buyer and seller how much time they want to invest before agreeing to purchase terms. I always recommend to my clients that it’s best to see if there is a meeting of the minds on terms before they invest more time, effort, and perhaps money to do all of their investigations, and ultimately find out they can’t agree on terms. Also, can the seller afford to invest this amount of time and effort with all prospects (20, 30, 50 prospects?) while still trying to run their successful business?
Sellers can and should invest all the time they need with that one buyer who has shown their interest and intent by presenting a written offer. And that seller will save time by not doing all this work with all buyer inquiries, once they’ve accepted an offer.
I feel it’s important for both buyer and seller not to conduct a full due diligence inspection before an offer is written. Typically a buyer is going to rely on a multiple gross sales, gross profit, net income, assets, or inventory to determine the value of the business to them. Therefore, it’s best for a buyer to present their offer before time is invested doing a full investigation. If the details aren’t proved during their inspection, they can always make adjustments to the purchase agreement, or cancel the purchase. This is especially important with business sales since there are so many terms involved with an offer. It is not only about purchase price. How much money is someone putting down, do they need seller financing, what is the time frame proposed for due diligence inspection, how much inventory is the buyer expecting to be passed along with the purchase, does the buyer agree to the lease terms and will they receive landlord approval, when do they propose to close the purchase, how much training do they want. So, it’s much more than just purchase price.
It's also important for a buyer to know, the way we handle the process, we will hold their deposit check uncashed during the due diligence inspection. If they don't like their findings, they let me know and I return their check. If they do approve of the inspection, we then open escrow, and the deposit check is sent to the escrow company for them to deposit.
This process is similar to when someone purchases a house. They don’t do their investigations first. They stop by the house a few times, asks the sellers some questions, then write their offer. Once the offer is accepted, they do their inspection. Do they need to do further inspection of the soil, air conditioning system, pool, roof, etc? They conduct these inspections after the offer is accepted.
It is ultimately up to the buyer and seller how much time they want to invest before agreeing to purchase terms. I always recommend to my clients that it’s best to see if there is a meeting of the minds on terms before they invest more time, effort, and perhaps money to do all of their investigations, and ultimately find out they can’t agree on terms. Also, can the seller afford to invest this amount of time and effort with all prospects (20, 30, 50 prospects?) while still trying to run their successful business?
Sellers can and should invest all the time they need with that one buyer who has shown their interest and intent by presenting a written offer. And that seller will save time by not doing all this work with all buyer inquiries, once they’ve accepted an offer.
When does due diligence start??
It is natural for a buyer to assume they have to ask all their questions and be 100% confident they want to buy the business, before they write their offer. They may also feel they have to do all of their due diligence inspections before writing the offer. I educate buyers to rely on the seller's representations during their initial investigation, and that if they are interested in writing an offer, once their offer is accepted, they will have a due diligence period to conduct as thorough review of the business as they desire.
I feel it’s important for both buyer and seller not to conduct a full due diligence inspection before an offer is written. Typically a buyer is going to rely on a multiple gross sales, gross profit, net income, assets, or inventory to determine the value of the business to them. Therefore, it’s best for a buyer to present their offer before time is invested doing a full investigation. If the details aren’t proved during their inspection, they can always make adjustments to the purchase agreement, or cancel the purchase. This is especially important with business sales since there are so many terms involved with an offer. It is not only about purchase price. How much money is someone putting down, do they need seller financing, what is the timeframe proposed for due diligence inspection, how much inventory is the buyer expecting to be passed along with the purchase, does the buyer agree to the lease terms and will they receive landlord approval, when do they propose to close the purchase, how much training do they want. It’s much more than just purchase price.
It's also important to know the way we handle the process. We will hold their deposit check uncashed during the due diligence inspection. If the Buyer does not like their findings, they let me know and I return their check. If they do approve of the inspection, we then open escrow, and the deposit check is sent to the escrow company for them to deposit. This is similar to when someone purchases a house. They don’t do their investigations first. They stop by the house a few times, ask the sellers some questions, then write their offer. Once the offer is accepted, they do their inspection. Do they need to do further inspection of the soil, air conditioning system, pool, roof, etc? They conduct these inspections after the offer is accepted.
It is ultimately up to the buyer and seller how much time they want to invest before agreeing to purchase terms. I always recommend to my clients that it’s best to see if there is a meeting of the minds on terms before they invest more time, effort, and perhaps money to do all of their investigations, and ultimately find out they can’t agree on terms. Also, can the seller afford to invest this amount of time and effort with all prospects (20, 30, 50 prospects?) while still trying to run their successful business? Sellers can and should invest all the time they need with that one buyer who has shown their interest and intent by presenting a written offer. And that seller will save time by not doing all this work with all buyer inquiries, once they’ve accepted an offer.
I feel it’s important for both buyer and seller not to conduct a full due diligence inspection before an offer is written. Typically a buyer is going to rely on a multiple gross sales, gross profit, net income, assets, or inventory to determine the value of the business to them. Therefore, it’s best for a buyer to present their offer before time is invested doing a full investigation. If the details aren’t proved during their inspection, they can always make adjustments to the purchase agreement, or cancel the purchase. This is especially important with business sales since there are so many terms involved with an offer. It is not only about purchase price. How much money is someone putting down, do they need seller financing, what is the timeframe proposed for due diligence inspection, how much inventory is the buyer expecting to be passed along with the purchase, does the buyer agree to the lease terms and will they receive landlord approval, when do they propose to close the purchase, how much training do they want. It’s much more than just purchase price.
It's also important to know the way we handle the process. We will hold their deposit check uncashed during the due diligence inspection. If the Buyer does not like their findings, they let me know and I return their check. If they do approve of the inspection, we then open escrow, and the deposit check is sent to the escrow company for them to deposit. This is similar to when someone purchases a house. They don’t do their investigations first. They stop by the house a few times, ask the sellers some questions, then write their offer. Once the offer is accepted, they do their inspection. Do they need to do further inspection of the soil, air conditioning system, pool, roof, etc? They conduct these inspections after the offer is accepted.
It is ultimately up to the buyer and seller how much time they want to invest before agreeing to purchase terms. I always recommend to my clients that it’s best to see if there is a meeting of the minds on terms before they invest more time, effort, and perhaps money to do all of their investigations, and ultimately find out they can’t agree on terms. Also, can the seller afford to invest this amount of time and effort with all prospects (20, 30, 50 prospects?) while still trying to run their successful business? Sellers can and should invest all the time they need with that one buyer who has shown their interest and intent by presenting a written offer. And that seller will save time by not doing all this work with all buyer inquiries, once they’ve accepted an offer.
Thursday, July 30, 2009
Do you have a buyer for my business?
When I speak with sellers, sometimes their first question for me is, "Do you have a buyer for my business?" As common as that question is, I am still surprised when I hear it asked. If I know nothing at all about your business, or, if I've seen your website, how is it possible to have someone looking for exactly what you are offering, without knowing the following?
- What were your gross sales the last 3 years?
- What are your gross sales year-to-date?
- What was your net income the last 3 years?
- What is your net income year-to-date?
- What are factors affecting your gross and net income and what are those trends?
- Do you have any clients that represent more than 10% of your gross sales?
- How does your asking price compare to your gross and net income, and industry norms?
- How much inventory is included?
- Is that value at your cost or the retail value?
- How much of that inventory is salable?
- What are your lease terms?
- How does that compare to your gross sales, and current market lease terms?
- Do you have any debt on the business that I'd have to assume for this purchase price?
- Are you offering seller financing for part of the purchase price?
- What is the minimum down payment a buyer needs?
- How many hours a week are you working in your business?
- How much vacation time do you take?
- Are there any key employees, and what is the likelihood they remain with the business after the sale?
- What are your functions on a daily basis?
- Is your business cyclical?
- What are the minimum cash flow needs?
- What special skills does the buyer need to possess to be successful?
- What kind of non-compete clause are you offering?
- What kind and amount of training are offering during the transition period?
- What is the likelihood that business will be lost because of a change in ownership?
- Will I get paid my normal fee for bringing a buyer to you that purchases your business?
Thursday, July 16, 2009
When is the right time to sell my business??
2009 isn't shaping up to be a stellar year for many businesses. What are you to do if you have an interest in selling your company right now? For those of you tempted to hold on to your business until conditions improve, I'll share some timing information for you to consider.
As always, the sale of anything is a factor of your motivation. If you aren't really motivated, you'll place an unusually high price on your item, and if someone makes you a full-price offer, they can have it!
What if the motivation is there, though business conditions aren't ideal to get the highest price possible (like if you sold last year when business was better). I haven't figured out a way to sell your business last year if you still are operating it. Here is some insight into how buyers will likely value your business.
They'll typically want to see the last 3 years of operating results, and, the year-to-date results. If your YTD results haven't been good, waiting until 2010 doesn't do much to help with the market value of your company. In 2010, you'll have a full year of 2009 to show your buyers. If 2009 was not as good as 2008, assuming business picks up in 2010 (dust off your crystal balls, right?), you'll need to have the full year of 2010 completed to get credit for it. Though, buyers want to see a pattern, and one year does not make a pattern. It might help explain away 2009's results, though, 2009 did happen, and that will get averaged in someway with 2008 and 2010. So, now you are 2 years out (the rest of 2009, and all of 2010, and part of 2011), without knowing if 2010 will be better or the same as 2009.
Reality is. You need to get in touch with your motivation. If you still see yourself running your business in 2 years, and if you are ok with the value of your business being the same or even lower than it is today, then holding on and running it might be your best strategy. Though, if you are motivated to sell, and don't want to be running your business in 2 years, now is likely just as good a time to sell as it will be over the next few years.
As always, the sale of anything is a factor of your motivation. If you aren't really motivated, you'll place an unusually high price on your item, and if someone makes you a full-price offer, they can have it!
What if the motivation is there, though business conditions aren't ideal to get the highest price possible (like if you sold last year when business was better). I haven't figured out a way to sell your business last year if you still are operating it. Here is some insight into how buyers will likely value your business.
They'll typically want to see the last 3 years of operating results, and, the year-to-date results. If your YTD results haven't been good, waiting until 2010 doesn't do much to help with the market value of your company. In 2010, you'll have a full year of 2009 to show your buyers. If 2009 was not as good as 2008, assuming business picks up in 2010 (dust off your crystal balls, right?), you'll need to have the full year of 2010 completed to get credit for it. Though, buyers want to see a pattern, and one year does not make a pattern. It might help explain away 2009's results, though, 2009 did happen, and that will get averaged in someway with 2008 and 2010. So, now you are 2 years out (the rest of 2009, and all of 2010, and part of 2011), without knowing if 2010 will be better or the same as 2009.
Reality is. You need to get in touch with your motivation. If you still see yourself running your business in 2 years, and if you are ok with the value of your business being the same or even lower than it is today, then holding on and running it might be your best strategy. Though, if you are motivated to sell, and don't want to be running your business in 2 years, now is likely just as good a time to sell as it will be over the next few years.
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