Buyers Beware
Sue Prestney's May article
A few months ago I wrote about selling a business, but for every seller there is (hopefully) a buyer. If you are considering buying a business, before you make any decisions there are some essential things you need to understand.
1. What is the value of the business?
Value is a function of maintainable earnings and the relevant capitalisation rate for these earnings.
The key to understanding value is not to accept standard, or rules of thumb, formulae but to critically examine the profitability of the business to determine its drivers and the risks to its sustainability.
When it comes to what level of profit is maintainable the vendor will apply ‘normalisation’ adjustments to reported profits. Apply a healthy level of scepticism to normalisations. For example, almost inevitably the cost of remunerating the current owner will be added back to profit, with little or no offsetting cost for someone else to perform the duties.
Common profit drivers include location, trademarks, domain names, websites, sources of product and personal goodwill. An assessment of strengths, weakness, opportunities and threats (SWOT) in relation to these profit drivers will help determine an appropriate capitalisation rate.
2. Where in the business or industry lifecycle is this business? How sustainable is it? Are the figures being presented by the vendor realistic?
Pay experienced advisors to do a thorough due diligence. This not only allows you to make an informed assessment of value but assists in negotiating price and terms if you decide to proceed.
Spending money on due diligence may save you making a vastly more expensive mistake.
3. Recognise that the value of the business does not necessarily reflect what the vendor wants for it. If the vendor feels they have a strong negotiating position they may demand the amount they need (eg to retire on) without it being justifiable on the basis of sound valuation methodology.
Which brings me to the next point.
4. Assess your negotiating position.
Try to find out why the vendor is selling. Vendors simply looking to retire may be able to take their time and wait for a purchaser willing to pay the asking price. However vendors with family or financial pressures may be anxious to sell and be prepared to negotiate on price and terms in order to achieve a quick sale.
Never show too much enthusiasm to buy and stick to a price that represents value for you. Beware of buying a business whose vendor is desperate to get out of it.
5. Don’t assume that retaining the services of the vendor for a period will result in a smooth transfer of goodwill.
It may seem to be the logical answer to the critical issue of maintaining relationships with key stakeholders, but while the previous owner remains in the business, customers, staff and suppliers may continue to deal with them rather than the purchaser. As purchaser you need to be clear what you want the vendor to do to transfer relationships and know-how after the sale. Develop a transition program, stick to it and let the vendor leave as soon as possible.
Remember that if relationships and know-how are going to be difficult and time consuming to transfer it is likely that the goodwill is personal goodwill, not an asset that a purchaser can readily acquire.
6. Purchasers should not only conduct a SWOT analysis of the business but also of themselves.
Buying a business is like a marriage – you need to be compatible with it. For example, you are unlikely to succeed by buying a business that requires you to interact with the public if dealing with people is not one your strengths. Beware of relying on employees to substitute for your own weaknesses in critical aspects of the business. This means that, for you, there is a higher risk of not maintaining the earnings of the business than for someone with strengths in these areas.
7. Make sure you understand the difference between buying yourself a job and embarking on an entrepreneurial venture.
Some people are comfortable with the lower risk/lower reward option of businesses such as franchises. There is nothing wrong with buying yourself a job as long as you realise that is what suits you. It would be far worse to buy a business requiring entrepreneurial flair and risk taking if what you want is security and support.
8. Understand what you are buying. Is it the assets of the business or the entire legal structure, such as the company which owns the business? Understand how the value is determined in that particular case.
9. Understand the tax position of the vendors. They may wish to sell shares in their company rather than the assets of the business and you may be able to use this as a negotiating point.
(Always bear in mind the possible operation of Part IVA anti-avoidance rules of ITAA 1936 when any deal is structured to minimise tax.)
Buying a business is a huge decision – it can consume not only your financial resources, but also your personal and emotional resources, for a very long period. The rewards of building a successful business in terms of wealth, personal achievement and satisfaction cannot be underestimated. But getting it wrong is devastating on every level. Before you buy a business surround yourself with the most experienced professional team you can assemble and look critically not only at what you are buying but also at yourself. Make sure this is your perfect match.
Sue Prestney | EXECUTIVE CHAIRMAN MGI AUSTRALASIA
[email protected]
May 2013
Article written by Sue Prestney for 'Charter', the magazine of the Institute of Chartered Accountants in Australia
Sue Prestney is a Senior Partner with MGI Melbourne and current Chairman of MGI Australasia.
Article reprinted with the permission of the Institute of Chartered Accountants in Australia, www.icaa.com.au