BUYING AND SELLING A BUSINESS: Valuing the Business Assets (Part 3)
By Steve Beede and Keith Dunnagan
In determining the Value of a business, the Buyer and Seller face an inherent conflict: the Seller wants to get highest possible value and not walk away from profit, while the Buyer wants to pay the lowest possible price and have room to grow the business and make a profit.
While this conflict exists in virtually every sale, there are key issues that can guide the parties and there advisors in reaching a mutually acceptable valuation.
The first of these is analyzing what is actually being sold, ie: (1) the Assets; (2) the Income Stream; and (3) the Opportunity to Grow. Today’s Article will focus on the Physical and Operational Assets.
1. ASSETS – there are two types of Assets: Physical and Operational
– A. Physical: These are Assets that can be liquidated for value if firm closed
– Real Estate / Lease – Is real estate being sold with the firm or will the Buyer occupy the Property under a Lease with the Seller or a third party. Having a certainty that the Business will not have to be moved is a critical piece of the Valuation determination especially since most companies derive 80% of their income from a 10 mile radius around the existing business location. While ownership of the real estate may be very beneficial in the long-run, the capital outlay required may be too great for many Buyers. Many Buyers negotiate a Right of First Refusal or a Purchase Option if the Seller seeks to later sell the real estate.
– FF&E and Inventory – an on-going business needs a certain amount of equipment to operate such as Furniture, Fixtures, and Equipment (commonly called “FFE”). These would include everything from desks and computers and copiers to file cabinets and wall art. These would typically be valued at a depreciated basis, not at the price of new. Additionally, the business would have a certain amount of material on hand needed to operate such as paper, pens, storage boxes, etc. These commonly would be valued at cost.
– Bank Accounts – on-going businesses will typically have established banking accounts, credit lines, charge card and other payment accounts. The monies in these accounts are monetary assets of the Seller. Some portion of these might be left in the business to fund on-going cash flow requirements. Significantly, some businesses such as law firms and real estate companies may have Client Trust Accounts – these are not Seller assets but rather are Client funds being held in trust for the client’s benefit. Control over these accounts may or may not be transferable to a new owner
– Accounts Receivable – while many businesses such as gas stations, restaurants, and retail stores operate on a cash sale basis (even if credit cards are used), many other businesses bill their clients and get paid typically within 30 days. However, not everyone pays on time and some may not pay at all. It may be reasonable to value client bills that are 30 days or less as being fully collectible, while bills that are 60, 90, or 120 days late will have a progressively worse collection rate. A Buyer should examine the Seller’s collection rate as well as the amount and cause of delinquencies.
– B. Operational Assets: These Assets only have value if firm continues
– Organization – How is the business structured. Is it a Sole Proprietorship, Partnership, Corporation, or Limited Liability Company (LLC). Having an entity structure can provide economic value and liability protection. However, the entity can trigger additional tax liability and accountant expense;
– Client Lists – an on-going business is often evidenced by the number of clients it has. Past and present clients represent potential for repeat business and referrals. Generally it costs substantially more to acquire a new customer than to gain repeat business from an existing customer. How these lists are maintained and marketed to is vital as is protecting their confidentiality from competitors;
– Goodwill – although much harder to quantify, the willingness of existing and prospective customers to do business with the company instead of a competitor is a key factor in valuing the likelihood of the current operation to continue. What percentage of existing customers repeat within a 12 month period; how many referrals did they receive; how many referrals converted to actual customers; how is the Business ranked in Yelp, Facebook, Linked-In; are there posted reviews;
– Brand Name – many businesses, especially personal service businesses, operate under the owner’s name as opposed to a dba or separate entity name. Where the owner took the time to develop a separately identified and recognized Business name (such as BPE Law Group), the clients and the Goodwill is much more easily transitioned to new Owners
– Support Staff – Continuity of a business generally requires that the operational support staff remain with the business and doing their jobs. Receptionists, Bookkeepers, Office Manager, etc. make the business operate and know not only the computer and accounting systems used but more importantly any issues that may threaten the future of the firm. It is critical that the Buyer interview all Support Staff during the inspection period.
– Professional Staff – in many professional service companies such as law firms, dentists, accounting, etc., a substantial portion of the value may be attributable to the Professional Staff, particularly those “rainmakers” that bring in new business. Even more so than with support staff, it is critical that the Buyer interview all Professional Staff and obtain commitments to remain with the Company, particularly since these staff members are the most likely competition if they were to leave.
– Seller – Many Sellers are willing to remain involved in the Company in some capacity. This can be critical for smoothing the transition, retaining existing staff and customers, and where needed assisting the Buyer. For Sellers who may be deriving some of their compensation through the Business’s post-sale performance, on-going involvement can enable the Seller to watch over their security and facilitate the success of the sale.
In our next Article of this Series, we’ll cover the critical issue of Evaluating the Liabilities.
For over 20 years, the attorneys of BPE Law Group, P.C. have been assisting our clients the buying and selling of businesses and providing guidance and representation in the administration and growth of their businesses as well as their estate and succession planning.
If you have questions concerning business, real estate, estate planning or administration, or any other legal matter, give us a call at (916) 966-2260 to schedule a Consultation with one of our experienced attorneys. If you have an immediate question on this topic, please email Keith Dunnagan at firstname.lastname@example.org.
This article is not intended to be legal advice, lending advice, or a specific recommendation of any particular lender or company, and should not be taken as such advice.