Developing a new business has a higher risk and reward
profile. When developing a new business, one has to first develop a product or
service. The product or service will then have an adoption curve wherein the
target audience may or may not accept the offering. Marketing can eliminate
some of the questions upfront, but for the most part, the success of the
product is ascertained when the product or service hits the market.
An existing business has sufficient history to base decisions on. Even if an existing business has not been doing too well, usually there is sufficient data to ascertain what the problems are and turn it around
Some advantages of buying an existing business are:
- Existing client base to build on. However, you have to pay a premium (business goodwill) for the customers you acquire in the business.
- Greater probability of success than starting from scratch. This includes a product that has been launched and is profitable or potentially profitable
to value using tried and tested marketing formulas.
- Several risks can be eliminated through a detailed due-diligence process which includes evaluating the financials and marketing attributes of the business.
- Key relationships with suppliers, distributors, and personal are in place saving you time and money.
- Support and knowledge transfer from the previous owner.
- Existing cash flow and proven track record make it simpler to raise money for growth strategies or working capital.
- Existing business records can be reviewed to forecast
near-term and long-term profits.
Starting a business from scratch is simpler from a tax point of view. When buying an existing business, the tax consequences of the business must be considered very carefully during the due – diligence process. normally, no tax requires to be paid when you buy the business but the continuing tax consequences must be considered carefully:
- The business may have continuous tax liabilities which must be considered in
- The business may be audited or under audit and may have ongoing tax issues
earnings may be overstated or the inventory may be overvalued
- The business may have pending lawsuits
- The business may have large accounts receivable part of which may not be collectible
- The money obtained by selling the business must be declared to IRS in the US or Revenue Canada if the deal was completed in Canada.
tangible and intangible assets purchased more than 15 years ago can be written
business seller may need to compensate the buyer of any tax liabilities not in
- Some authorities require a transfer tax when the business or commercial real estate changes hands,
Knowing the tax code is important to complete a business deal and operate a business.
Management buyout (MBO)
A management buy-out is the purchase of the business by the management team of the business. It is a feasible exit for the business owner and an opportunity for the management team and key employees. Buyouts vary in sizes. Management buyouts are usually completed with financial support from other businesses, bankers, or venture capitalists. In a small business, outside organizations and syndication may not be needed. If a banker or venture-capitalist does invest in a management buyout, they expect important investment in the business from the management team.
In many cases, a specific area or division of a business may not be of strategic interest to the owner and the owner may decide to divest it, creating an opportunity for the employees or the management team to acquire it. There are several advantages to management buyouts including:
- It assures continuity when the business extensions from the business buyer to the business seller.
- Knowledge stays inside the company and the business is more
likely to keep its existing clients and business partners.
- Opportunities or success is high because the management team has a stake in the business and understands the business.
The value assigned to a business by the valuation process offers a useful benchmark to start the negotiation process. It will however not be the final purchase price. The final price may be higher or lower than the valuation
Business buyers are usually of two types:
1. Financial Buyers or Investors: Investors buy a business to increase their assets. They are looking for investments that will provide them a certain return on investment (ROI) overtime. These buyers typically don’t want to spend too much time running the business and taking care of operations from day today.
2. Business Owners: Business Owners are motivated to participate in a specific market and operate a business on a day to day basis. Most business owners like to buy businesses because they like the market and are motivated to operate their own businesses. Spending some time to understand what motivates your potential buyer can help you position the business for sale correctly.
After promoting business for sale, the business owner can receive several expressions of interest to buy the business. Negotiating with buyers is time-consuming and hence the seller must first qualify buyers that she will work with.
After the first few meetings with potential buyers, the buyer can be classified as:
- Newbie, are individuals with neither the resources nor the business management experience. Typically, they are looking to learn from the buying experience and may not be interested in actually buying the business.
- Individuals looking for
bargain-basement prices or fire sales. These individuals are also known as
Sharks and one must be careful when dealing with them.
- Other businesses, looking to buy a
business for strategic reasons such as growth, the area covered, and more.
These buyers can be classified as strategic acquisitions.
- Individuals or groups of
individuals (syndicates) interested in acquiring businesses. most of the buyers
or investors like to hire professional managers to manage the business
or individuals who want to buy the business and operate it. Owner operated
businesses are common. Typically,’ these are individuals with resources and
experience and must be taken seriously.
Create a Sales Agreement
The business buyer and seller must put the details of the deal in writing after due diligence and negotiations are completed. The agreement must list the value of the deal, all assumptions made by the buyer and the seller, and any protections that have been introduced to see the deal through. Typically, the sales agreement is exchanged between the buyer and seller until all aspects of the business transaction have been captured to the buyer and sellers' satisfaction. the business buyer and seller may include either buying of assets or securities in the company. The sales agreement must include all terms finalized during the negotiation process. Typically, the sales agreement must be reviewed by an attorney because it’s a legal document. The sales agreement includes business assets, securities of the company which have been purchased, or both. Some items that will be included in a sales agreement:
- Business buyer details
- Assets and securities being sold
- Purchase price
- Payment terms
- List of items included with the sale but included as assets
or securities (inventory)
- Warranties provided by the buyer and seller
- Clauses accepted by the buyer and the seller for making the
- Date of closing