Buying a business. A guide for business operators in South Australia.

Transcription

1 Buying a business A guide for business operators in South Australia

2 Table of Contents 01 Overview Trade-offs when buying an established business Information required to access a prospective business purchase Evaluating the purchase of a business Tips for negotiating the purchase Goodwill Summary Notes Buying a business Page 2 of 23

3 01 Overview There is much more to buying a business than answering an advertisement in a newspaper. It takes time, planning and meticulous attention to detail. Despite the risk, many people enter into this type of transaction without adequate investigation. Often a buyer is tempted to make a quick offer for a business based on emotive rather than objective reasons. It is easy to be overcome by the excitement of purchasing one s own business and overlook the basics. That can spell disaster! Purchasing a business is a complex and intricate operation. It is best performed with the help of professional advisers. Readers are advised: The purpose of this guide is to provide general introductory information. The guide does not purport to contain all the information that would be relevant to any particular business opportunity. The guide is provided to interested persons on the basis that they will be responsible for making their own assessment of that opportunity with the assistance of the information provided. All figures contained in the guide should be regarded as estimates only based on general samples and may be subject to error. The information in the guide should not be relied upon in substitution for professional advice and individual investigation. Persons interested in pursuing any particular business opportunity are strongly advised to fully inform themselves by taking professional advice as to the extent of their rights and obligations - particularly in relation to any proposed investment. The guide is provided subject to the terms of the formal disclaimer, which appears on the last page. Buying a business Page 3 of 23

4 02 Trade-offs when buying an established business If you are thinking of buying a business, consider the following trade-offs you may have to make. ADVANTAGES Proven track record lessens risks, increases the likelihood of success and may make finance easier to obtain. Immediate income available from sales to existing customer base. Proven location. Stock is already in place; suppliers are established. Equipment already exists; its capabilities are known. Present employees may provide invaluable assistance. Vendor may provide experience and possibly finance. POSSIBLE DISADVANTAGES Hard to assess goodwill; could be paying too much for it. Possibility of being misled and ending up with a lemon. May inherit a poor public image. Loss of past owner s rapport with customers may affect trading performance. Existing location may not be adequate. Premises may not be modern enough. Difficult landlord. Stock may be out-of-date, damaged or obsolete. Employees may be unsuitable or poorly trained. Equipment may have been poorly maintained or possibly obsolete. May be difficult to introduce change. If the business is run down, unexpected expenses may arise. WHAT CAN ONE CONCLUDE FROM THIS COMPARISON? Two things firstly, the advantages of taking over an existing business probably outweigh the disadvantages. Secondly, it is generally less risky to purchase an existing business than to start a new one from scratch. Buying a business Page 4 of 23

5 03 Information required to access a prospective business purchase FINANCIAL HEALTH Financial statements balance sheets and profit and loss statements, preferably audited, for at least the past three years. Income tax returns and assessments for the same three-year period, including a reconciliation of taxable income and profits for each year. Present value of assets e.g. real value of freehold. Details of any liabilities not included in the latest balance sheet e.g. long service leave. Financial statements since last year end; if not available, alternative financial data to allow analysis of trend of operations. RESOURCES Source and availability of raw materials or products. Tenure of leased premises and prospects of renewal. State of buildings and equipment and anticipated requirements for replacement. Source of labour and likelihood of it improving or deteriorating. Capabilities, experience and age of key personnel, including compatibility with you, the purchaser. MARKET FACTORS Market situation and influence of competitors. Location of customers and method and cost of delivery. Whether the industry in which the business operates is a growth industry. Where there is reason to doubt the authenticity of information supplied, an effort should be made to carry out an independent check. In many cases, your accountant or business adviser will be in the best position to attend to this task. Buying a business Page 5 of 23

6 04 Evaluating the purchase of a business MAJOR ASPECTS TO EVALUATE Proper investigation of these six factors will take considerable time and effort. You may be tempted to act quickly so that the opportunity is not lost. However, this is a time when sound professional advice is vital. 1 Reasons for selling 2 Profits, sales and expenses 3 Assets of the business 4 Liabilities of the business 5 Taxation matters 6 Other factors This guide tells you what to look for in your evaluation of these six factors. Buying a business Page 6 of 23

7 04 Evaluating the purchase of the business 1 Reasons for selling ISSUES AND QUESTIONS TO ASK May be due to any or a combination of the following: Declining business. Changes in character of neighbourhood. Lack of competitive strength. Impending loss of business due to new competitors. PRACTICAL ACTIONS AND TIPS Seek to determine as early as possible exactly why the current owner has the business on the market. Although it may be difficult to determine, it s a good idea to find out the vendor s level of motivation to sell. Answers to these questions will indicate how much scope you have to negotiate price and terms. The way to find out is to ask a series of well-structured questions. If you feel that you are not getting straight answers, ask the questions another way. Be wary of sellers who are deliberately evasive. Obsolete products. Poor selection of merchandise or materials. Highway construction or re-routing. An expiring lease or franchise. Obsolete facilities. Inability to collect accounts receivable or problems with creditors. Owner s bad reputation which may stay with the business. Labour problems. Marital problems. Ill health. Retirement. Buying a business Page 7 of 23

8 04 Evaluating the purchase of the business 2 Profit, Sales and Expenses ISSUES AND QUESTIONS TO ASK Profit Is the business making a profit or a loss? How much? What trends are apparent in the gross profit margin and how does it compare with the industry norm? What is the trend in net profit? Does the vendor claim to take a certain amount of cash out of the business as undisclosed earnings? PRACTICAL ACTIONS AND TIPS Determine why. Exercise caution with a business doing poorly up to the last profit and loss statement when a good profit is shown. If showing a decline, it may indicate any of the following: incorrect stock figures proprietors may be living out of the business prices may be heavily discounted correct margin may not be added to the cost of goods there may be a high level of pilfering. Identify reasons to explain any trend sales lower, expenses higher? Calculate the net profit margin on sales. Are profits adequate to warrant taking the risk? Remember at all times that a business can only be truly assessed on figures that can be verified. Ignore black money or undeclared income which the vendor may claim is taken out of the business regularly. Buying a business Page 8 of 23

9 04 Evaluating the purchase of the business Profit, Sales and Expenses...continued ISSUES AND QUESTIONS TO ASK PRACTICAL ACTIONS AND TIPS Obtain a detailed breakdown of sales. Seek explanations. Did 20 per cent of customers account for 80 per cent of sales? Could this be improved under your ownership? Verify figures by: inspecting invoices and statements from suppliers. Sales inspecting daily cash books, bank statements and income tax assessments. asking employees how many customers they serve daily and what the average sale is. asking neighbouring businesses how busy the operation is. surveying numbers of customers patronising the business over a given period. What is the sales trend? Is the product or service likely to maintain or improve its marketability or is it in danger of becoming over-sold, out of style or obsolete? Are sales keeping pace with inflation? Declining? What is selling? What is not? Who is buying? What is the conversion rate of inquiry to sales orders? Old slow-selling stock for which invoices are hard to find can often be included in the stock figure at inflated prices. If so, allowance will need to be made for possible warranty commitments. Does declared turnover of the business solely represent income derived from normal business operations? What is the trend in stock levels relative to sales? What amount of stock is normally carried in relation to turnover of the business? How many stock-turns a year are achieved? Are stock figures accurate and not inflated? Have the goods been supplied with warranty? Buying a business Page 9 of 23

10 04 Evaluating the purchase of the business Profit, Sales and Expenses...continued ISSUES AND QUESTIONS TO ASK Expenses What is the trend in expenses? Have any private expenses of the vendor been shown as business expenses? Are advertising costs in proportion to business turnover? PRACTICAL ACTIONS AND TIPS Be specially alert to expenditure shown for telephone, wages, motor vehicle, advertising and insurance they are areas of frequent abuse. If advertising expenditure shows an upward trend, find out why. A high level of repairs and maintenance could mean the business has an amount of old or unreliable equipment. Make allowance for this in your financial projections. What is the level of expenditure on light and power relative to sales? Do repairs and maintenance contain any oneoff expenditures? Has salary drawn by the vendor been included in wages? Have drawings by the owner been variable or irregular? Are there any additional expenses that would have to be incurred under your ownership? Has the vendor received any unpaid assistance in operating the business? Buying a business Page 10 of 23

11 04 Evaluating the purchase of the business 3 Assets of the business ISSUES AND QUESTIONS TO ASK Stock Arrange for a physical count to be undertaken. Are some goods on consignment, with the right of being returned for full credit? Building, furniture, fixtures and equipment What is their market value? Does the condition of the building and equipment satisfy local council and health regulations? How modern, efficient and usable are they? Are they in good repair? Will any be useless or soon have to be replaced? Are they the type you really want in the business? PRACTICAL ACTIONS AND TIPS Best performed by an independent party. Examine stock for age, quality, saleability, style, condition, balance, suitability and freshness. Be alert for use by dates. Arrange independent appraisal where necessary. An independent assessment may be justified. If there are items you do not want, be prepared to negotiate on this. Check repairs and maintenance expenditures in profit and loss statements. Have this checked by a solicitor. How much has been spent by the vendor to keep the facilities in good condition? What major changes will be necessary? Are all fixtures paid for, or are there moneys owing under hire purchase or lease agreements? Are any assets located elsewhere and, if so, are they subject to a lien? Has the depreciation policy been realistic? Buying a business Page 11 of 23

12 04 Evaluating the purchase of a business Assets of the business...continued ISSUES AND QUESTIONS TO ASK Accounts receivable/debtors Are you proposing to take over outstanding debtors? How long have the accounts been outstanding? How successful has the vendor been in past collections? Is an excessive volume of business coming from credit customers with slow payment records? What are the implications for working capital? PRACTICAL ACTIONS AND TIPS You have no obligation to do so. If you do, ensure that customer lists, business and credit records and mailing lists are included in the contract of sale. Make an assessment of your prospects for collecting based on the quality of debtors and the prevailing economic climate. Determine the average collection period from financial statements. If you implemented a more strict credit policy, what would the likely outcome be? Supplier and credit relations How are business relations with suppliers? Assess whether supply sources are satisfactory and whether they are likely to continue on favourable terms. If not, is the business committed to them by contracts for a lengthy period? Determine whether they should be increased or cancelled. What future deliveries are scheduled? Personnel Will key employees continue to work for the business under your management? Assess how adversely the business is likely to be affected if key personnel were lost. Be alert to potential liabilities for redundancy payouts. Will existing employees be an asset or liability to you as the new owner? Are you contemplating any changes? Buying a business Page 12 of 23

13 04 Evaluating the purchase of a business Assets of the business...continued ISSUES AND QUESTIONS TO ASK Business reputation and clientele Does the business have a good reputation and an established, satisfied clientele? Are there many customers who do business with the vendor out of personal attachment, but would leave if ownership of the business changed? PRACTICAL ACTIONS AND TIPS It may be prudent to allow for a probable loss of a certain percentage of clients when preparing budgetary projections. Take this into account when determining the price you are prepared to pay. Determine whether they are transferable to you. Have any contract of sale checked by a solicitor. Are there contracts in place with key customers? Does the contract of sale prevent the vendor from re-entering business in competition with you? For how long a period of time? Trademarks, patents, copyrights and other intellectual property Are they included in the contract? Are they transferable? Seek professional legal advice. Determine whether they will be as valuable in the future and take this into account in resultant negotiations. Franchises Are exclusive franchises transferable to you? Contact the franchisor to ascertain transfer requirements. Ensure appropriate provision is made in the contract of sale. Assess the Franchise. Pay particular attention to its terms, how long it has to run and its value to you. Buying a business Page 13 of 23

14 04 Evaluating the purchase of a business Assets of the business continued ISSUES AND QUESTIONS TO ASK Lease PRACTICAL ACTIONS AND TIPS Seek professional legal advice before signing a lease. Do the terms of the lease enable the activity envisaged to be carried on? Is it transferable to you? Is it included in the contract of sale so that the legal obligation to purchase depends on availability of the lease? Are all terms and conditions acceptable to you? Buying a business Page 14 of 23

15 04 Evaluating the purchase of a business 4 Liabilities of the business ISSUES AND QUESTIONS TO ASK May be extensive and hidden and can include: unpaid bills chattel mortgages back taxes liens against assets back employee benefit payments (holiday pay, long service pay, sick pay) pending legal actions other creditors claims superannuation commitments and redundancy payments. PRACTICAL ACTIONS AND TIPS Seek professional advice from your accountant, solicitor or business adviser. Any liabilities which you agree to take over should be included in the contract of sale. A clause should be included in the contract to say that all claims not shown and revealed in writing at the date of purchase will be the responsibility of the vendor. Buying a business Page 15 of 23

16 04 Evaluating the purchase of a business 5 Taxation matters ISSUES AND QUESTIONS TO ASK Are there any current disputes with the Tax Office? Are PAYE, BAS, superannuation and other tax payments up to date? Is the market value of plant and equipment different from its written down value? Does the business have significant goodwill? PRACTICAL ACTIONS AND TIPS Refer to the depreciation schedules. Seek professional advice from your accountant, solicitor or business adviser. Any liabilities which you agree to take over should be included in the contract of sale. A clause should be included in the contract to say that all claims not shown and revealed in writing at the date of purchase will be the responsibility of the vendor. Are there any accrued holiday pay or long service leave entitlements? Are any of the vendor s book debts likely to become bad? Do any repairs need to be done? Do retirement payments need to be made? Do you need to borrow to finance the purchase? Buying a business Page 16 of 23

17 04 Evaluating the purchase of a business 6 Other factors ISSUES AND QUESTIONS TO ASK What are the past and future trends of the business and industry? How does the business compare with competitors and similar firms? What is the history of the location over the past few years? PRACTICAL ACTIONS AND TIPS Determine how many businesses have been there. What types? How successful were they? This can offer a source of leverage in subsequent negotiations. Must be adequate to cover working capital, repairs, modernisation, new equipment, new stock, debtors, reserves for taxes, insurance, opening expenses, legal fees, stamp duty plus, say, 10 per cent for unexpected expenses. How long has the business been for sale? What will the total capital requirement be? How does the total capital investment relate to profitability? You should now appreciate that the successful purchase of a business depends heavily on an exhaustive study of the business from many angles. It should also be clear that, during the course of a purchase, you will be confronted with many complex commercial, legal and taxation issues. Appropriate professional advice from accountants and solicitors, as well as from bankers, insurance brokers, trade associations and neighbouring business people, should be sought at each stage in the process. If the vendor cannot or will not provide required information, it is a warning sign. An honest vendor should be willing to provide sufficient information, including income tax returns, records of bank deposits and purchases and sales data. Analysis of these factors should indicate the potential of the business and enable sales, profit and cashflow projections to be made for at least the next 12 months. Buying a business Page 17 of 23

18 05 Tips for negotiating the purchase Very few businesses sell for the asking price. It takes negotiations between you and the vendor to establish price and terms so that both parties feel satisfied. What makes for a successful negotiation? Here are a few handy tips. THE DO S: Gain the vendor s confidence. It is important that you establish a positive negotiating position. The first objective should be to gain the confidence of the vendor. Over a short period of time, you will be asking for considerable information, much of which will be confidential as far as the vendor is concerned. It is easier to obtain the necessary information if a positive relationship and trust have been developed between the parties. To enhance credibility and build favourable rapport, you may wish to: Consider giving the vendor a personal resume; Enter into a confidentiality agreement in relation to all information provided by the vendor; Offer to provide a signed statement that the terms of the sale will be kept confidential. Utilising as many sources as possible, determine why the business is on the market and for how long it has been listed for sale. The vendor may give ill health or retirement as the reason for selling but this may mask the real reasons something that could make it extremely difficult for you to make a success of the business. If you ask for a lot of information, all in the first meeting with the vendor, it can sometimes represent a hurdle to securing the vendor s co-operation. It is often better to obtain the vendor s approval to deal direct with his or her accountant for the information you require. In this way, you avoid vendor resistance. You should make any offer very carefully and in conjunction with your solicitor. If the offer is rejected, the vendor should be asked to justify the asking price. This will hopefully put reality back into the situation and enable negotiations to move forward. You must always remember that the vendor has an ego. Therefore, guard against making changes in the business until you own it. If you constantly describe all the things that are wrong in an attempt to weaken the vendor s bargaining position, it may destroy the negotiating climate. Buying a business Page 18 of 23

19 05 Tips for negotiating the purchase THE DON TS: Don t view the purchase in emotional rather than objective terms. Don t look at the opportunity of owning the business without considering the problems. Don t accept the vendor s representations on face value. You need to be cautious, even sceptical, and ensure that sales and other important data are verified. Don t think that a problem business can easily be turned around. It takes money, energy and time and never happens overnight. Beware of changing some things quickly. Move with care. Customers may not like the changes and may respond negatively. Don t use all of the available cash for the purchase. You need to leave some cash reserves and credit lines for working capital and contingencies. Don t create conflict with the vendor during negotiations. Don t be afraid to seek concessions in price or terms. Most buyers pay too much for businesses. Don t assume that major customers will remain after the purchase is completed. Don t make a career out of looking and investigating, without getting around to buying. Buying a business Page 19 of 23

20 06 Goodwill Goodwill is the success factor of an established business. It is a set of intangible factors that creates the earning power of a business. If an owner has developed a successful and profitable business, with excess earnings over and above a fair salary, then goodwill value exists. However, if a business simply returns a modest income to the owner, goodwill may in fact be limited or nonexistent. Aside from published profit, other factors which affect the valuation of goodwill include the lease of the premises, the potential of the business (which might include the location of the business), competition from other businesses, the business name and the special skills of staff. The value placed on goodwill is usually the most contentious area of business valuations and is best handled by your professional advisers. Buying a business Page 20 of 23

21 07 Summary 1 A major advantage of buying an established business is that it has a proven track record which can be evaluated. 2 Whether or not there is a downside to buying a business depends on such factors as location, reputation and image of the business, condition of physical facilities and the asking price. 3 When evaluating a business, the key considerations are reasons for selling, what has happened in the past, what is the present condition of the business and do past and present trends indicate a favourable future. 4 Throughout the assessment of a proposed business purchase, you should strive to maintain objectivity and conduct all investigations in an orderly manner. 5 The real reason for selling a business may vary from what the owner states. 6 If you are contemplating the purchase of a business, use your most important tool at all times common sense. Buying a business Page 21 of 23

22 08 Notes Buying a business Page 22 of 23

23 Department of State Development GPO Box 320 Adelaide SA 5001 T: E: DSDSmallBusinessStrategy@sa.gov.au W: DISCLAIMER The Government of South Australia gives no warranty and makes no representation, whether express or implied, as to the accuracy of information contained within this guide or the suitability of the information for any purpose. Any use of the information contained in this guide (whether authorised or not) is at the users sole risk and the Government of South Australia disclaims responsibility for any loss or damage incurred as a result of such use. The information is provided solely on the basis that users of the information will make their own assessment of the accuracy of the information and users are advised to verify all information contained within this document. Any information about the law in Australia or South Australia is provided as general information only and is not legal advice. This guide is a starting point only and is not a substitute for legal or professional advice. While the Department has attempted to ensure the information is accurate at the time of publishing, no responsibility will be accepted for any errors or omissions and the Government of South Australia will not be liable for any loss or damage incurred by any person as a consequence of any use, reference or reliance on this information. Any such use, reference or reliance shall be at the sole risk of that person who should seek their own legal and/or professional advice if required. COPYRIGHT Produced by the South Australian Government March 2015 Buying a business Page 23 of 23