ALTERNATIVE ROUTES

TO ENTREPRENEURSHIP
BUYOUTS- BUYING AN EXISTING BUSINESS
Alternative Routes to Entrepreneurship
• You can be an entrepreneur basically through
4 routes:
1. Greenfield Start-up or just Start-up
2. Brownfield entry
1. Buying a Franchise
2. Buying an Existing Business
3. Joining a Family Business
• We will examine all brownfield entry methods
in the following 3 topics
Taking Over an Existing Business
 Learning Outcomes
• After doing this topic, you should be able to:
1. Compare the advantages and disadvantages of buying an existing business.
2. Propose ways of locating a suitable business for sale.
3. Explain how to measure the condition of a business and determine why it might
be offered for sale
4. Differentiate between tangible and intangible assets, and assess the value of
each.
5. Calculate the price to pay for a business.
6. Understand factors that are important when finalizing the purchase of a business.
7. Describe what makes a family business different from other types of business.
 For sale

MMS401 Entrepreneurship and SBM 2018

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Buying an Existing Business
• Another option for making your dream a reality is buying an existing
business.
• You can be just as entrepreneurial buying an existing enterprise as
creating one from scratch
• The opportunity to buy a firm already in operation is appealing for a
number of reasons.
• Like franchising, it offers a way to avoid some beginners’ hazards.
• The existing firm is already functioning—maybe it is even a proven
success.
• Many of the serious problems typically encountered by start-ups should
have been either avoided or corrected by now.
• Buying an existing business is a popular way for would-be owners to
acquire a small business.
• There are several advantages to buying an existing business as compared
with the other methods of getting into business.
Reasons of Buying an Existing Business
Reduction of
Uncertainties of
Startup

ic k S tart
A Qu
Reasons for Buying an Existing Business
• The reasons for buying an existing business can be condensed
into the following four general categories:
1. To reduce some of the uncertainties and unknowns that must
be faced when starting a business from the ground up
2. To acquire a business with ongoing operations and established
relationships with customers and suppliers
3. To obtain an established business at a price below what it
would cost to start a new business or to buy a franchise
4. To get into business more quickly than by starting from scratch
Pros and Cons of Buying an Existing Business
Advantages
⁻ Quick entry is available and high chance of success
⁻ Bargain price
⁻ Customer base is established.
⁻ Location is already familiar to customers
⁻ Planning can be based on known historical data and is less
rigorous.
⁻ Supplier relationships are already in place.
⁻ Inventory and necessary equipment are already in place.
⁻ Employees are experienced.
⁻ Possibility of owner financing exists.
⁻ Records and control systems are already in place (e.g.,
accounting, inventory, and personnel controls).
⁻ Business image and goodwill is already set in minds of
customers.
Disadvantages
⁻ Taking over existing problems
⁻ Business image may be difficult to change.
⁻ Employees may be ones you would not choose.
⁻ Business may not have operated the way you like and could
be difficult to change.
⁻ Inventory or equipment may be obsolete needing
modernization
⁻ Financing costs could drain your cash flow and threaten the
business’s survival.
⁻ Business’s location may be undesirable, or a good location
may be about to become not so good.
⁻ Potential liability exists for past business contracts.
⁻ Purchase price based on inaccurate data
⁻ Misrepresentation is possible (yes, the person selling the
business may be lying).
Guidance on Finding a Business to Buy
1. Identify your interests: At a minimum, eliminate
businesses that hold no interest for you.
2. Consider your talents: You have to give this business
your all, so be honest with yourself about your skills
and experience.
3. List conditions for your business: Does location matter?
How about working hours? How big do you want it to
be?
4. Quantify your investment: How much can you afford?
How Do You Find a Business for Sale?
• If you have decided that you’re interested in purchasing an
existing business and have narrowed your choices down to a few
types of businesses, how do you locate one to buy?
1. Insider information (as an employee, manager or director)
2. Newspaper advertising
3. Direct approach to finding a business by asking current owner
4. Relying on Professionals: people who counsel small businesses
on a regular basis, such as bankers, lawyers and accountants
5. Suppliers, distributors and trade associations.
6. Real estate brokers
7. Business brokers- business intermediary that brings sellers of
their businesses together with potential buyers.
8. International Business Brokers Association (www.ibba.org)
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MMS401 Entrepreneurship and SBM 2018

Investigating and Evaluating Available
Businesses
• For the buyout entrepreneur, preparation is the key to a successful business
purchase.
• Regardless of the source of the lead, a business opportunity requires careful
evaluation— what is sometimes called due diligence.
• You need to analyze your own skills, find good advisors, write a business plan, and,
most importantly, do due diligence.
• Due diligence means the disclosure and assimilation of public and proprietary
information relating to the business for sale.
• It begins by addressing the overall financial health of the company.
• As a preliminary step, the buyer needs to acquire background information about the
business, some of which can be obtained through personal observation or discussion
with the seller.
• Talking with other informed parties, such as suppliers, bankers, and employees of the
business, is also important.
• The list of documents that you will need to evaluate may appear long and
intimidating, but this assessment is necessary.
Finding out why a business is for sale
Owner’s Reasons for Selling
• The seller’s real reasons for selling may or may not be the stated ones.
• When a business is for sale, always question the owner’s reasons for selling.
• There is a real possibility that the firm is not doing well or that there are underlying problems
exist that will affect its future performance
– Old age or illness
– Desire to relocate in a different section of the country
– Decision to accept a position with another company
– Unprofitability or failure of the business
– Loss of an exclusive sales franchise
– Maturing of the industry and lack of growth potential
– Retirement
– Partnership or family disputes
– Burnout
– Lack of capital for growth potential
Due Diligence for Purchasing a Business
• Licenses and Permits: Most businesses need licenses and permits to operate. The type of license or permit you
need depends on your industry and the state in which the business is located.
• Environmental Concerns: If you are acquiring real property along with the business, it is important to check the
environmental regulations in the area (EMA).
• Letter of Intent: The letter of intent should spell out the proposed price, the terms of the purchase and the
conditions for the sale of the business.
• Confidentiality Agreement: A confidentiality agreement indicates that you will not use the information about the
seller's business for any purpose other than making the decision to buy it.
• Contracts and Leases: If the business has a current lease for the location, be aware that you may have to work
with the landlord to assume any existing lease on the business premises or to negotiate a new lease. Contracts
with suppliers and clients may need to be renegotiated as well.
• Financial Statements/Tax Returns: Examine the financial statements from the business for at least the past three
to five years. Also examine the business's tax returns from the past three to five years. This will help you
determine the profitability of the business as well as any outstanding tax liability. Also make sure that an audit
letter from a reputable audi firm accompanies the statements
• Important Documents: Numerous documents should be checked during your investigation. Examples include
property documents, customer lists, sales records, advertising materials, and employee and manager information
• Professional Help: A qualified attorney should be enlisted to help review the legal and organizational documents
of the business you are planning to purchase. Also, an accountant can help with a thorough evaluation of the
financial condition of the business.
 What should you look for?
• History—How long has the business existed? Who founded it? How
many owners has it had? Why have others sold out?
• Inventory—What is the current status of all products and materials?
What is present now?
• Tax returns for the past five years—Investigate how comingled the
seller’s personal and business dealings had been
• Financial statements for the past five years—Compare these with
the seller’s tax returns to determine the true earning power of the
business. What is the profit record?
• Sales records— You need to evaluate sales by month for the past 48
months. Analyze by product line and by other factors such as cash
sales versus credit.
• Contracts and legal documents — This would include all leases,
purchase agreements with suppliers, sales contracts with customers,
union contracts, and employment contracts.
• Industry and market region trends —What about present and future
competition?
• List of liabilities— You are looking for liens by creditors against any
assets. There may by claims such as employee benefits or out-of-
court settlements still being paid off that do not show up on financial
statements
• Buy or build— How does this business, in its present condition,
compare with onethat you could start and develop yourself in a
reasonable amount of time?
• List of accounts receivable —While A/R are on the balance sheet, you
need to see an aging schedule breaking them down by 30, 60, and 90+
days.
• List of accounts payable —You need to see a schedule just like accounts
receivable because of the impact on cash flow.
• Value-Added taxes —When buying the assets of a business, you can avoid
responsibility for the seller’s debts and liabilities—except sales taxes
• Furniture, fixtures, and equipment —ff&e is a standard comparison for
what you are physically buying.
• Marketing —How has the seller communicated with customers? Get
copies of all advertising and sales literature. This will give you insight into
the image of the business and how customers perceive it.
• Suppliers —Are there dependable sources of supply for all the inventory,
supplies, or materials that the company needs? Evaluate current price lists
and discount schedules.
• Organizational chart of current employees —Since employees are a
valuable asset, you need to understand how they work together. You need
to be especially careful to see if key people are willing to remain.
• Key ties —Does the present owner have family, religious, social, or political
connections that have been important to the success of the business?
• Seller’s plans —Why does the present owner want to sell? Where will the
owner go?
 Examining the Financial Data
• Review its financial statements and tax returns for the past three to five
years or for as many years as they are available..
• Recognize that financial data can be misleading and may require
normalizing to yield a realistic picture of the business..
– Assets overvalued
– Expenses overstated/understated
– Income underreported in an effort to minimize their taxes.
– Unrecorded debts
• Adjust asset valuations to reflect the true state of the business.
• Adjust personal expenses and wage or salary payments.
• Compare the seller’s balance sheet to actual assets and liabilities.
Quantitative Factors in Valuing the
Business
• Once the initial investigation and evaluation have been
completed, the buyer must arrive at a fair value for the firm.
• In valuing a firm, the buyer will rely heavily on much of the
financial information acquired during due diligence.
• It will require more than just getting copies of the financial
statements (income statements, balance sheets, and cash flow
statements).
• The buyer will want to review supporting materials that
validate the accuracy of the financial statements by
scrutinizing such documents as tax returns, state sales tax
statements, supplier invoices, and customer receipts, as well
as the company’s bank statements
Valuing the Business
• There are numerous techniques used for valuing a company, but
they can be grouped into three basic methods:
• Balance-Sheet/ Asset-Based Valuation
– Estimates the value of the firm based on the worth of its assets; does not
reflect the value of the firm as a going concern.

• Market-Comparable Valuation
– Considers the sale prices of comparable firms; difficulty is in finding
comparable firms.

• Cash-Flow-based Valuation/ Income-Statement Methods of

Valuation
– A method of determining the value of a business based on its profit potential.
– Compares the expected and required rates of return on the amount of capital
to be invested in Entrepreneurship
MMS401 the business. and SBM 2018
Non quantitative Factors in Valuing a
Business
• You should also consider a number of non-quantitative factors in evaluating an existing business.
1. Competition-the prospective buyer should look into the extent, intensity, and location of
competing businesses.
2. Market-The ability of the market to support all competing business units, including the one
to be purchased, should be determined
3. Future community development- Future developments in the community that could have
an indirect impact on a business include a change in zoning ordinances already enacted but
not yet in effect, a change from a two-way traffic flow to a one-way traffic flow, and the
widening of a road or construction of an overpass.
4. Legal commitments-may include contingent liabilities, unsettled lawsuits, delinquent tax
payments, missed payrolls, overdue rent or installment payments, and mortgages of record
on any of the real property acquired.
5. Union contracts- The prospective buyer should determine what type of labor agreement, if
any, is in force, as well as the quality of the firm’s relationship with its employees.
6. Buildings-The quality of the buildings housing the business should be checked, with
particular attention paid to any fire hazards, title deeds and restrictions on access to the
buildings.
7. Product prices: compare the prices of the seller’s products with those listed in
manufacturers’ or wholesalers’ catalogs and also with the prices of competing products in
the locality. This
 What Are You Buying?
• The purchase price of a business is determined by
negotiation between buyer and seller
• Are you buying assets only or the total entity as a going
concern?
• When buying an existing business, you need to realize
that the value of that business comes from what the
business owns (its assets and what it earns), its cash flow,
and the factors that make the business unique, such as
the risk involved
• The Price You Offer for a Business Should Begin with
Adding the Value of Tangible and Intangible Assets to the
Profit Potential of the Business.
• Intangible assets- are assets that have value to a business
but are not visible and include goodwill; favorable leases
and other advantageous contracts; and patents,
copyrights, and trademarks.
 Negotiating and Closing the Deal
Terms of Sale
• After a price for the business has been agreed upon, the terms of sale need to
be negotiated.
• Few buyers are able to raise the funds required to pay cash for a business. A
lump sum payment may be in neither the buyer’s nor the seller’s best interests
for tax reasons, unless the seller intends to reinvest in another business.
• Paying in installments is often the most practical solution.
Closing the Deal
• Closing can be handled by using either a settlement lawyer or an escrow
settlement.
• In an escrow settlement, the buyer deposits the money, and the seller provides
the agreement of sale and other documents to an escrow agent. The escrow
agent holds the funds and documents until proof is shown that all conditions of
the sale have been satisfied
• Indemnification clause