978-0134741086 Chapter 7 Part 1

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CHAPTER 7. BUYING AN EXISTING BUSINESS

1. Describe the advantages and disadvantages of buying an existing business.

2. Explain the five stages in acquiring a business: search, due diligence, valuation,

deal, and transition.

3. Explain the three steps in the search stage of buying a business.

4. Describe the four areas involved in conducting due diligence on a business: the

seller’s motivation, asset valuation, legal issues, and financial condition.

5. Explain the various methods used to estimate the value of a business.

6. Describe the basic principles of negotiating a deal to buy a business and structuring

the deal.

7. Understand how to manage the transition stage when a deal is done.

Part 2: Class Instruction

Introduction

While the entrepreneurial experience always involves risk, buying an existing business

(buying a franchise is another way that is covered in Chapter 8) can help reduce the risk

buying as also the price that one pays for it.

Buying an Existing Business LO 1

The process of evaluating a potential business acquisition is standard, and requires a due

diligence process that involves analyzing and evaluating an existing business. If done

correctly, this due diligence will reveal both the negative and the positive aspects of an

 What experience do I bring to the venture?

 What is the success potential?

 What changes are needed — and how extensive are they — to realize the full

potential of the value of the business?

 Should you be starting a business and building it from the group up rather than

buying an existing one?

People buy businesses for different reasons. As described in Figure 7.1, Types of Business

Buyers, buyers can be categorized into four areas:

1. Main street buyers

2. Corporate refugees

3. Serial entrepreneurs

4. Financial buyers

The Advantages of Buying an Existing Business. Advantages include:

 A successful existing business may continue to be successful.

 An existing business may already have a superior location.

 Employees and suppliers are established. Equipment is installed and

 High value is possible if the current owner must sell quickly.

Disadvantages of Buying an Existing Business. Disadvantages include:

 Cash requirements may be higher than if starting a new business.

 Business may be losing money.

 Paying for ill will if the previous owner used improper business behavior or

 Inventory may be outdated or obsolete.

 Accounts receivable may be worth less than face value.

 The business may be overpriced.

The Search Stage LO 3

The Search Stage. When buying a business, entrepreneurs must ensure that what they are

buying fits their background and personal aspirations. Three steps are necessary to ensure

this.

Step 1: Self-Inventory: Analyze Your Skills, Abilities, and Interests. Conduct a self-

Step 2: Develop a List of Criteria. Develop a list of criteria that define the ideal

business for you. Use your answers to the self-inventory to develop a list of criteria that a

potential business must meet.

Step 3: Prepare a List of Potential Candidates. List companies that meet your criteria.

Do not limit your search to businesses that are advertised as being for sale, as there is a

The Due Diligence Stage LO 4

Due diligence involves studying, reviewing, and verifying all the relevant information

concerning an acquisition. This is like kicking the tires of a car prior to buying it. The goal

in doing this is to know exactly what one is purchasing and avoid any unpleasant surprise

after the deal is closed and it is too late to do anything about it. Investing in the due

retirement (40 percent), burnout (21 percent), and the desire to own a bigger business (20

percent).

Asset valuation. A prospective buyer should evaluate the business’s assets to determine

their true value. Three questions are helpful here:

 Lease arrangements

 Business records

 Intangible assets

 Location and appearance

Legal issues. The most significant legal issues involve: liens, contract assignments,

Consider using You Be the Consultant: fiThe Power of Seller Financing” at this

point.

The Valuation Stage LO 5

The valuation stage includes not only a valuation of the business but also signing a non–

disclosure agreement. There are several methods to value a business. There is no single

(Refer to Figure 7.5, Balance Sheet for Kuyper Electronics, June 30, 20XX, and Figure

7.6, Adjusted Balance Sheet for Kuyper Electronics, June 30, 20XX).

Earnings approach. This method considers the future income potential of the business.

This method is preferred by many finance professionals and experienced entrepreneurs.

Market approach. This approach uses the price/earnings ratios of similar businesses to

estimate the value of a company. The buyer must use businesses whose stocks are publicly

Chapter 7, Page 114

traded to get a meaningful comparison. Figure 7.7, Business Valuation Methods indicates

what the popular methods are.

The Deal Stage LO 6

The structure of the deal – the terms and conditions of payment – is more important than

the price the seller agrees to pay. A buyer’s primary concern is making sure that the terms

of the deal do not endanger the company’s future financial health and that they preserve

the company’s cash flow.

Consider using You Be the Consultant: fiWould You Buy This Business?” at this

buyer should go into the negotiation with a list of objectives ranked in order of priority,

and anticipate what the seller’s priorities are in order to determine where the two mesh

and where they conflict. The key is to use this analysis to look for areas of mutual benefit

and use them as the foundation for the negotiation.

The Transition Stage LO 7

Once the deal stage is completed, the transition stage begins with the actual closing of the

purchase. Closing the sale of a business is a complex legal process. A number of closing

documents are involved.

Conclusion

Part 3: Chapter Exercises

You Be the Consultant: fiThe Power of Seller

Financing”

1. Suppose that you and a friend have recently graduated from college when you

discover the ideal business for sale by the founder, who is ready to retire. The asking

price is $550,000, but you and your friend have only $15,000. Put together a brief

plan for assembling the remaining balance needed to purchase this business. (LO 4)

(AACSB: Application of knowledge)

You Be the Consultant: fiWould You Buy This

Business?”

1.. Assume the role of a prospective buyer for these two businesses. How would you

conduct the due diligence necessary to determine whether they would be good

investments? (LO 5) (AACSB: Application of knowledge)

2. Do you notice any fired flags” or potential problems in either of these deals?

Explain. (LO 5) (AACSB: Analytical thinking)