Question:
I am in the process of negotiating to buy a business directly from the seller. The seller is absolutely refusing to carry back a note. I have explained to him that most deals are done this way, but he says he is seeking an all-cash sale, and has priced the business accordingly. In my research, valuations for this type of business are usually about 2.5 times the seller cash flow and his price is $270,000 (the SDCF is $100k). Should I offer to pay more in order to get a carry-back? I'm not sure I can get the business financed otherwise. If I pay cash, what is the right multiple? Also, what are good terms for a seller note?
Answer:
This is a great question and I truly admire your thought process in potentially offering more to get the terms you need - excellent strategy. The first step, is to determine that the seller has truly priced it accordingly for an all -cash deal.
While there are no hard rules, generally speaking an all-cash deal will usually translate into a 15-25% discount off the asking price when seller financing is being offered. As such, if your 2.5 multiple is correct, this would mean a $250,000 price. As such, he hasn't priced it accordingly at all. Unless there are extenuating circumstances that you have not revealed, you should look to pay around $200,000 for an all-cash transaction.
Insofar as seller financing is concerned, you are correct: the vast majority of small business acquisitions involve seller financing. In fact, it’s estimated that over 80% include some form of financial aid from the former owner. While the percentages vary, it’s generally 30% to 50% of the total purchase price. When you think about the situation, it makes perfect sense. First of all, by providing financing, the seller validates the viability of the business itself. Also, the seller is able to get the highest price possible by funding part of the acquisition.
From a buyer’s perspective, it serves to reinforce that the seller is also at risk in the transaction. It’s a perfect mechanism to help ensure that what you’ve been told by the seller is true and accurate. It also serves as a mechanism to deal with situations that may arise later on that come about as a result of their actions where you may need the ability to offset their financing.
The seller NEEDS to realize that this is a common deal structure. Further, if he or she is not prepared to do so then they will either have to wait for a very specific buyer, the business may not sell, or, they have to understand the discount inherent with these type of deals. They can't have it both ways. If they want all cash, the price must reflect it.
Question:
I am interested in buying a business, but the seller is looking for a valuation that is more than three times the average earnings multiple for his industry. How can I convince him that he is simply asking too much? He has listed the business himself and there are no attorneys or business brokers involved in the deal.
Answer:
This is a perfect example of why a seller should engage a competent business broker to assist them with the sale of their business! A broker would provide him with the education needed to effectively market the business. Since that is not the case, it's up to you, although you should realize that you may not be able to convince him that he is simply asking too much.
If this seller is not motivated to sell the business, then it really doesn't matter what you say or do, there's no deal here.
Has the seller identified how he actually established the price? Did he have a professional appraisal done or has he simply priced it based on what he thinks it is worth or what he wants to get from the sale? Chances are it's a shot in the dark valuation and so the first step is to understand his logic and possibly suggest a professional valuation by a Certified Business Appraiser. It's possible that the seller may not want to have an appraisal done, so you should provide him with some industry statistics of comparable businesses that were sold so he begins to understand the marketplace.
You should also have your CPA compile a valuation based upon the financials presented to you at a multiple that is in line with the industry and what you feel the business is worth.
If you truly believe that he wants to sell the business, then he will have to demonstrate some flexibility on the price and/or terms. I would recommend that you compile your data and present it to him. Then, you may even want to present an offer to him at your valuation. If the seller does not counter your offer, or show any flexibility whatsoever, then move on to the next deal because it will then be abundantly clear that he does not have the level of motivation needed to sell his business.
Question:
I am buying a local distributor in Dallas, Texas. The owner says he is leaving the state and retiring to Arizona. But the business broker listing shows a non-compete offer of 30 miles for three years. Seems fishy to me. What are your thoughts? Also, what should I ask for since I do not want him to become my competitor in three years.
Answer:
The first thing to understand is that non-compete clauses are very negotiable. Give the seller and broker the benefit of the doubt initially because the listing sheet terms for this part of the deal probably weren't given much thought. Notwithstanding this, I agree with you completely that the 3o-mile/3 year offer is ridiculous and VERY suspicious. Before getting concerned, ask the broker about this. If he says anything other that it being "negotiable" or "flexible", you will want to address this with the seller.
The terms of the non-compete agreement should be such that they offer you full proof comfort and protection that the seller will not go back into business. But, the terms must also be reasonable if this is ever challenged or breached. if the distributor does business in Texas only, then the non-compete should be state-wide. While you can try to negotiate a bigger region, chances are it will not hold up in court and may be adjusted.
Regarding the number of years, I believe that a five- to seven-year period is the least that should be negotiated.
Any seller who is really sincere about retirement, and genuinely wants you to be successful, will agree to non-compete terms that makes you comfortable. In my experience, any seller who turns the non-compete into a "deal breaker" is someone who clearly has a hidden agenda and most often is not to be trusted.
Question:
Here's my dilemma: I'm looking at a business that's been around for 18 months. There are three huge pending contracts that the seller says will come in over the next 12 months. They are factoring these into their asking price and won't budge. It's a great business but if those three don't materialize how can I protect myself?
Answer:
Present two offers: one based upon the hard data of what the business is like today and a second whereby you'll pay more based upon the value of the new business in the form of an earnout. However, the "premium" has to be weighed against who will do the work to secure the business. If the seller will remain active to get the new business then they should receive appropriate compensation, but if you're going to do all of the work then they should only be rewarded with a portion of it. Likewise, if the so-called new business is imminent and can soon be realized, then the seller's percentage can be adjusted accordingly.
When all is said and done, it's OK to pay for "blue sky", but you cannot do so until you see for yourself that the sun is shining!
Question:
I'm thinking about buying a 20-year-old wholesale/distribution business. They have many longtime clients. I have some experience with this type of business. The current owner will be retiring to Europe from Florida. He is scheduled to leave in three months. I know that if I wait for 60 days or so to finalize the deal, I'll be able to negotiate better terms. How can I lock up the seller now so nobody comes in and scoops the business from me?
Answer:
The key question here may be why would you want to wait for 60 days? Good businesses sell quickly, and if this is a solid business, chances are it will be gone in far less time to another buyer. Besides, the seller is probably highly motivated right now given that he wants to leave in 90 days.
The other thing to consider is whether you may be shooting yourself in the foot by waiting too long. Given the time it takes to close a deal, and I'm certain you'll want to have a proper transition and training period, you can do more harm than good by waiting.
Sure you can be a bit "sneaky" and negotiate a deal now and then try to revise it, but that is never a tactic that I would recommend. Besides, with many long-term clients, you will want the owner to stay for a smooth transition period so that all of the accounts and employees are comfortable with you as the new owner.
In getting back to your original questions, my recommendation to "lock up" the seller is to aggressively negotiate the deal now, get a duly executed agreement in place, conduct your due diligence, and if there are any major issues, you can revisit them. Do a thorough job investigating and researching the business, allow for an adequate transitional period, and close the deal.
Question:
I want to use a Letter of Intent to make my offer on a small auto repair business. The seller's broker insists that I use his full Offer to Purchase agreement. I like the business, have completed my valuation, and my offer will be close to the seller's price, but it just seems more reasonable and customary to use an LOI as a first step, don't you think?
Answer:
There's no question that an LOI can be a logical approach as a first offer but by no means is it a standard step. In fact, it should be the exception. Personally, I like to move forward with a full-blown Offer to Purchase contract versus an LOI wherever possible because it gets all issues onto the table for resolution versus a non-binding LOI.
An LOI is best used for:
Insofar as the broker contract is concerned, the vast majority of agreements I have seen used by brokers are satisfactory as a template but almost always need some revisions to reflect the particular acquisition. My suggestion is that you first get a copy of the agreement the broker would like you to use. Review it and note your comments as well as any additional conditions/contingencies that you need to have as part of the contract. Then, send it to your attorney for review. Try to get it in "Word" format so your attorney can work off it as it will save you a ton of money versus having them redraft it.
By: Richard Parker: President of The Business Buyer Resource Center and author of How To Buy A Good Business At A Great Price©