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Price or Terms – The Structure of the Deal

An old saying in negotiating the sale of a business goes like this: The buyer says to the seller, “You name the price, and I get to name the terms.”

Another saying used to explain the actual value of the term full price: “If we could find you a business that nets you $250,000 a year after debt service, and you could buy it for $100 down, would you really care what the full price was?”

It seems that everyone is concerned only about full price. And yet, full price is just part of the equation. If a seller is willing to accept a relatively small down payment and carry the balance, a higher full price can be achieved. On the other hand, the more cash the seller wants up front, the lower the full price. If the seller demands all cash, barring some form of outside financing, full price lowers – and, in most cases, the chance of selling decreases as well. Even in cases where outside financing is used, such as through SBA, etc., the lender will do everything possible to ensure that the price makes sense.

Sellers should understand that both what they hope to accomplish in the sell of their business and the structure of the actual sale can dramatically influence the asking price. Price is obviously important, but other factors may be even more important. For example, consider a seller with health issues who needs to sell as quickly as possible. In his case, timing becomes more essential than price. Another seller may place more importance on her business remaining in the community. In her case, finding a buyer who will not move the business may supersede price or certainly influence it.

Likewise, the structure of the deal can both influence price and be a more significant factor than price to either the buyer or the seller. The structure can dictate how much cash the seller receives up front, which may be more important than price for some sellers. On the other hand, sellers should also be aware how much the interest on their carry-back can add up to. If cash is not an immediate concern, monthly payments with an above-average interest rate may be enticing.

These examples all demonstrate the importance of the business broker professional sitting down with the seller prior to recommending a go-to-market price. During this meeting, the broker should find out what is really important to the seller, as these issues may have a direct bearing on the price.

Sellers should look at the following factors and rank them according to importance on a scale of one to five, with five being extremely important.

  • Buyer Qualifications
  • Full Price
  • Amount of Cash Involved
  • Financing
  • Confidentiality
  • Commission/Selling Fees
  • Closing Costs
  • Exclusive Listing
  • How the Business is Shown
  • Advertising/Marketing
  • How a New Owner Continues the Business

By ranking these items and discussing them with a professional Business Broker, a seller can receive helpful advice from the broker on price, terms, and structuring the sale.

Thinking About Selling?

Here are some tasks business owners should consider completing before going to market to help their
businesses sell.

  • Remove any items not included in the sale. That family heirloom portrait behind the counter of Grandfather William, founder of the business, should be removed.
  • Remove or repair any non-functioning equipment.
  • Prepare an operations manual to show a new owner all the functions of the business, how things are done, the major customers and suppliers, samples of advertising, and any other information that would help a new owner manage and operate the business.
  • Take care of any outstanding bills and resolve any legal, tax, or governmental issues.
  • Bring your financial statements up to date, and have your accounting professional prepare them for a
    buyer’s inspection.
  • Clean up the business inside and out. Fill the shelves, clean up the inventory, and paint the interior if necessary.

The Numbers Don’t Tell the Whole Story

You’re considering selling your business. Your accountant or financial advisor has reviewed your profit and loss statement, and told you what he or she thinks your business is worth. Is this a valid figure? Do the numbers reflect the real value of your business? Below are some other factors to consider regarding the true value of your business. These factors may not have a specific dollar amount attached to them, but they certainly influence value and the price a business maysell for.

  • Are you serious about selling, and is it the right time? (Use this only if selling is the reason for the valuing.)
  • What are the two or three biggest obstacles to growing
    the business?
  • Why is your business different than the competition?
  • If you don’t own the real estate, what is the status of your lease?
  • What is the short-term and long-term trend of your business and the industry?
  • Does, or can, international competition impact
    your business?
  • Why do customers patronize your business, or why do clients use your services?
  • Have you increased prices recently, and if not, why not?
  • How much will you need to invest in your business over the next three to five years to maintain your customer/client base? How much to increase it? How will you spend it?
  • Are there any legal or governmental issues facing
    the business?
  • If you got hit by the proverbial truck, is there someone who could run the business?
  • Can the business be relocated? Should it
    be relocated?
  • What are the secrets to the current success of
    the business?
  • What prevents the business from growing?
  • If the business is based on your personal goodwill with customers, knowledge of the product or services, etc., are you willing to stay for a fairly long period of time to assist in transferring this personal goodwill?
  • If you were given an additional $100,000, and you were much younger, what would you do to grow the business?

Personal Goodwill – Who Owns It?

Personal Goodwill has always been a fascinating subject, impacting the sale of many small to medium-sized businesses – and possibly even some larger companies. How is personal goodwill developed? An individual starts a business and during the process builds one or more of the following:

  • A positive personal reputation
  • A personal relationship with many of the largest customers and/or suppliers
  • Company products, publications, etc., as the sole author, designer, or inventor

The creation of personal goodwill occurs far beyond just customers and suppliers. Over the years, personal goodwill has been established through relationships with tax advisors, doctors, dentists, attorneys, and other personal service providers.

While these relationships are wonderful benefits, they are, unfortunately, non-transferable. There is an old saying: In businesses built around personal goodwill, the goodwill goes home at night.

It can be difficult to sell a business, regardless of size, where personal goodwill plays an integral role in the business’ success. The larger the business, the less likely that one person holds the key to its profitability. In small to medium-sized businesses, personal goodwill can be a crucial ingredient. A buyer certainly has to consider it when deciding whether to buy such a business.

In the case of the sale of a medical, accounting, or legal practice, existing clients/patients may visit a new owner of the same

practice; they are used to coming to that location, they have an immediate problem, or they have some other practical reason for staying with the same practice. However, if existing clients or patients don’t like the new owner, or they don’t feel that their needs were handled the way the old owner cared for them, they may look for a new provider. The new owner might be as competent as, or more competent than, his predecessor, but chemistry, or the lack of it, can supersede competency in the eyes of a customer.

Businesses centered on the goodwill of the owner can certainly be sold, but usually the buyer will want some protection in case business is lost with the departure of the seller. One simple method requires the seller to stay for a sufficient period after the sale to allow him or her to work with the new owner and slowly transfer the goodwill. No doubt, some goodwill will be lost, but that expectation should be built into the price. Another approach uses some form of “earnout.” At the end of the year, the lost business that can be attributed to the goodwill of the seller is tallied. A percentage is then subtracted from monies owed to the seller, or funds from the down payment are placed in escrow and adjustments made from that source.

In some cases, the sale of goodwill may offer some favorable tax benefits for the seller. If the seller of the business is also the owner of the personal goodwill, the sale can essentially be two taxable events. The tax courts have ruled that the business doesn’t own the goodwill, the owner of the business does. The seller thus sells the business and then also sells his or her personal goodwill. The seller’s tax professional will be able to give further advice on this matter.

This newsletter is not intended to render accounting, legal or other professional service; the publisher and sponsors assume no liability for a reader’s use of the information herein.

Copyright © 2007 Business Brokerage Press, inc.