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Rich and Co.

Deal Tips: Structuring Your Business Sale or Purchase

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Whether you are looking for a business to buy or planning on selling your business, your success depends upon both sides agreeing to an acceptable deal. Having an objective reference of key deal parameters available during negotiations helps all parties focus on working out a successful business purchase. Typical financing schemes for small business acquisition involve

  • Down payment from the buyer.
  • Seller financing.
  • External financing by a lender, offering a government backed, e.g.U.S. SBA (7a) or commercial loan.

As you go through the process of buying or selling a small business, you may review many proposals. Experienced business brokers will prepare a confidential memorandum containing:

  • the business details,
  • including its historic financial performance
  • operational data
  • competitive position
  • ownership structure.

Frequently, the memorandum will also contain a proposed deal structure. You need to determine a deal structure that makes sense for you, given your business buying or selling goals. By constructing Deal Check scenarios you can quickly verify the proposed deal structure, compare it to your own objectives, and craft proposals to use during the business acquisition negotiations.
Bear in mind that the business purchase price is only part of the overall deal:

Most small business acquisitions are asset purchases where the buyer acquires the underlying business assets without the assumption of its liabilities. If you buy the business as a stock purchase, it is important to establish the total project costs, reflecting the funds required to successfully complete the business purchase.
Business historical financial data, when properly presented, will allow you to determine key elements to use in defining the working capital and capital investment requirements:

  • Historical revenues.
  • Levels of inventory maintained by the business.
  • Accounts payable and receivable and their respective turnover.
  • Amount of liquid capital required to operate the business.
  • Type and levels of capital reinvestment needed to keep the business operating smoothly.

In addition, you need to have a good sense of the transaction costs involved in purchasing a business. Key transaction cost elements include:

  • Closing costs.
  • Professional fees charged by your CPA and attorney.
  • Professional business appraisal fees, if required.
  • Lender’s fees.
  • Business licenses and permits.
  • Any costs you incur as part of your due diligence effort.

To get a realistic assessment of what the deal is worth to you as a buyer add the expected business purchase price, working capital, and business purchase transaction costs together. This is your project cost estimate. Now decide what you are willing to inject into the deal as a down payment and what type of return you would need on the down payment annually. In financing the remainder of the purchase, you need to negotiate acceptable terms, including the note or loan principal, interest and amortization time. Part of your negotiation will focus on obtaining acceptable seller financing. Get an idea of what you would like to see from the seller to make the deal worth while. If an external lender is considered, discuss the loan terms early to decide how this fits your needs. If you expect to work in the business, you need to establish a reasonable compensation for yourself.

If you are selling your business, factor in your asking price, estimated transaction costs, and working capital requirements into the project cost. Determine what down payment you need to see from the buyer to close the deal. If the business is prequalified for lender financing you must account for the loan terms. Use your business operations knowledge to specify the capital investments required to run the business. A good source of historic investment information is the Investing Activities section on your accounting “Statement of Cash Flows”. Finally, if you plan to offer seller financing as part of your business sale enter the terms of the seller’s note as well.

Armed with this information, you can use Deal Check to decide if the business has sufficient cash flow to meet your goals. The actual cash flow numbers should be available from the historical financials provided by the seller. Check if the statements have been properly recast to provide a solid appraisal of the seller’s discretionary cash flow.

Your Project cost estimates

  • Business purchase price. You can test your asking price if you are selling a business, or the price you intend to offer to buy a business.
  • Transaction costs.
  • Working capital.

Your business purchase or sale deal structure elements

  • Down payment — the percentage of project costs the business buyer is prepared to inject into the business purchase.
  • Seller’s note — the percentage of project costs the seller is prepared to finance.
  • The length of time and interest rate for both the seller and external lender financing.

The deal financial requirements, including

  • The return on down payment the business buyer should expect to receive yearly. This effectively sets your payback period. For example, 20% return on down payment means you get your money back in 5 years.
  • New owner’s compensation — the amount you would need to receive from the business as its new owner.
  • Capital reinvestment — the amount that you, the new business owner, would need to reinvest into the business to keep it running every year.

Written by Rich and Co.

August 16, 2012 at 6:46 pm

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  1. […] Deal Tips: Structuring Your Business Sale or Purchase (richandco.wordpress.com) […]


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