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Buying a Business - SCORE 12.00
July 29, 2021
A Woman Looking at a Business Plan
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It is a fair assumption that when an operating business is purchased, the intent of the buyer is to acquire a present or prospective profit generator – a known entity that will provide a reasonably predictive return on the investment.

Buying a company is much like courtship. It is a process not known for rapid conclusions. Done correctly it is a long process that requires a great deal of effort and analysis. The following is a very general guideline. Items of great importance will be different based upon the business being considered for purchase. Size, structure, industry, competitive set, product/services offered will greatly influence your areas of concentration.


The first step is to clearly define in writing the objectives to be met in acquiring the business, i.e., earnings, cash flow, revenue, market share as well as to state what constraints must be dealt with, i.e., purchaser’s knowledge of the business, purchaser’s time availability (able to work full or part-time), purchaser’s professional strengths and weaknesses, purchaser’s financial resources.

The next step is to gain an understanding of the industry(ies) of interest. What are the trends? Is the industry expanding, consolidating, declining? What is the industry’s competitive set? Is there a dominant player that sets the standard for the rest of the competition such as Wal-Mart? What about international competitors? What are the barriers to entry? Generally speaking, what’s the health of the target industry? Once you’ve completed this analysis, you’ll know which industry(ies) are attractive, given your objectives.

Sources of information to assist in your analysis include websites such as Google and CEOExpress. The public library also can provide extensive information. Industry/trade associations can be extremely valuable for industry and company level analysis. This can be supplemented with Chambers of Commerce and trade publications.

As your analysis of the industry nears conclusion and you’ve identified industries that offer the kind of opportunities you want to pursue, shift your investigative focus to investment banking firms, business brokers, turnaround specialists, and business development organizations in order to build your “short list” of individual companies for potential purchase.

Before you initiate substantive discussions with the owner(s), there are a few areas that need to be resolved. These include:

Sources and capacity to finance the purchase

  • Assets of the buyer
  • Bank loans
  • Sales of bonds or equity
  • Partial or total financing by the seller
  • Contributions of partner(s)
  • Funds provided by business development organizations


A. First Steps

  • Check out the company’s website. What can be learned about the culture of the company? It’s product breadth? Professionalism? Quality and service?
  • An informal discussion with the owner/broker is an excellent next step. What are the owner’s reasons for wanting to sell? What sort of timeline is desired? What role, if any, is the owner willing to play post-sale? If you are so inclined, having an informal dinner with the owner may reveal a great deal about the business itself, the owner’s hopes and concerns, opportunities and threats, strengths and weaknesses, key personnel evaluation.

B. Financial Evaluation

  • Obtain copies of 3-5 years of financial statements, i.e., P&L, balance sheets, Tax filings, most recent bank statements, inventory turnover, aging of receivables and payables, corporate charter, partnership agreement, existing contracts, etc. It is best if revenue and expense information can be obtained on a quarterly basis for the 3-5 years. This will enhance your ability to understand developing trends and whatever seasonality there might be in the business.
  • Secure the services of a professional accountant to assist in analyzing the financial information, developing critical ratios and comparing them to trade norms in the industry. An attorney should review all contractual agreements including leases or any liabilities.
  • Secure a Dun & Bradstreet report on the company. This will provide credit history, bankruptcies, lawsuits, liens, etc. These reports are available here.

C. Physical Factors

  • Condition and appraised value of plant, including replacement cost, equipment, furnishings, their age and depreciation rate and status. Condition of the roof, plumbing, HVAC systems, electrical facilities.
  • Age, value, condition and salability (turnover rate) of inventory. Watch for slow moving and dead inventory items. Although this varies by industry, generally inventory beyond one-year’s supply is considered excessive and is often written off during the sale. Same with dead inventory.
  • Location of the manufacturing plant – access to supply, economic shipping distance to customers. Is the number of suppliers too limited?
  • Location of the retail store – traffic flows, disposable income in the area, competing businesses, and general quality of the neighborhood.
  • Is the company situated on owned or leased property? If owned, is the title guaranteed? What are the real estate taxes? Any zoning restrictions? Are there any changes pending which could disrupt continued occupancy? If leased property, when is the owner likely to raise the rent and by how much?
  •  Any environmental issues or concerns, hazardous waste, air quality?

D. Market Considerations

  • If your goal is to make money with your business purchase, you absolutely have to understand the revenue side of the equation. It is frequently the most under analyzed factor in the business. Get inside the total sales number. Understand the customer list and the contribution each makes to total sales. It’s very common for 20% of the customers to generate 80% of the sales. Even greater concentrations are common…and dangerous. Everything is fine until that customer is lost for whatever reason. Look at the trends for each of the top 40 customers over time (2-3 years minimum). Ideally, look at the sales numbers by quarter. Which of the most important customers’ sales are trending up, remaining flat, or declining?
  • Discretely speak with each of the top customers. Are they happy with the relationship? Are they considering a change? Do they expect their purchase volume to change? In what direction and by how much? Who do they believe your top competitors to be?
  • Generally, what is happening to market share? How are key competitors fairing?
  • Project sales for each of the next 3-5 years under three scenarios:
    o Sales volume for company and industry will continue at same rate as for the past five years.
    o Volume will grow at a 10% lower rate than in the past five years.
    o Volume will grow at a 10% higher rate than in the past five years.
  • It is also a good idea to look at sales by product, or product category over time. See which ones are growing, remaining stable, declining. Then look at the profitability of each product category. What’s happening to margins due to product sales mix?

E. Personal Considerations

  • Experience and education of the buyer. If the buyer is inexperienced in the business of the target company, this can be offset by taking a job in the industry or the target company for a year or two before risking the purchase.
  • Decide what role, if any, you want the current owner to play in “newco”. This could span such assignments as consultant, senior management position reporting to the new owner, or any other that makes sense, or no relationship at all.
  • Should you decide to have the current owner play a role in your newly acquired company, this should be in writing, spelling out title, compensation, reporting relationship, duration, role and responsibilities. This should be reviewed by your attorney.
  • What changes, if any, are desired in key employees? Which ones are likely to move on after the sale? What would the impact of this turnover be on the business and its earning power at such a critical time as a sale?

F. Pro-forma Profit Projection

  • Using the financial data gathered, and the three sales estimates calculated as per above, project the cash flow and profit for each of the next five years.
  • Compare these projections with the financing ability and the objectives of the buyer as laid out in the very beginning. Does the business satisfy the requirements?
  •  If the requirements are satisfied, the purchase should proceed to prenegotiation point.

G. Determining a fair price for the business.

  • “Comparable sales” method. If you’ve ever bought or sold a home, you know that one of the first things a real estate agent does to determine your listing price is to look at comparable home sales in your neighborhood to see what they sold for. The same approach can be used for valuing a company. Can you identify a comparable business that has changed hands? What did it sell for? Are there publically traded companies in the same industry as yours? If so, what’s the Price/Earnings ratio of their stock? What would the value of your company be if you applied that ratio to your earnings? Although simple in concept, no two companies have exactly the same scope, market presence, distribution channels, product line, etc. So be prepared to make adjustments to accommodate for the changes.
  • A multiple of EBITDA. Many businesses are sold using a multiple of EBITDA. EBITDA is a term that relates to Earnings Before Interest, Taxes, Depreciation and Amortization. It is essentially the cash flow of the business from operations. It can be calculated by taking Net Income and deducting the items mentioned above. That is the cash flow generated by operations. The multiple can range from two (like a window manufacturer in these times of severely depressed home construction) to over 12 times (like a successful social media company). The multiple is a measure of the attractiveness of the company in terms of its strategic positioning and industry. Those with high growth potential will carry a higher multiple.
  • The “net present value” of projected cash flows. This method uses projected cash flows as a valuation base rather than historic of current earnings which can be influenced by discretionary changes by the owner. It is best to have your accountant do these calculations as they are complex.


At this point, the negotiations between buyer and seller on the price and terms of sale will begin. If agreement is reached, a Sales Contract is essential. All contractual understandings between the buyer and seller should be in writing and mutually approved by attorneys representing both sides. The sales contract should include such detail as the seller’s commitment not to compete for a specified timeframe, notification of the sale to suppliers, employees, bankers, creditors, etc., and the seller’s guarantee that full disclosure of current or threatened liabilities has been made. It is advisable to provide for reappraisal of inventory value as well as an adjustment for accounts receivable that may not be collectible at the time of closing. This may require an appropriate adjustment of the final purchase price for the business.

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