Business Brokers – South Africa – Kwazulu Natal, KZN, Lower South Coast, selling Businesses,
commercial properties as well as letting of commercial properties on the lower south coast of KZN.

Why buy an existing business back to top

There are many reasons why people buy businesses - They can’t find employment, they want to satisfy a dream, get out of the corporate world, do more than just be a housewife, acquire an “investment” etc. Whatever the reason buyers look for a sound business with a track record and provable figures.

Successes and failures occur mainly because buyers are unprepared for the minefields that lie ahead. US surveys tell us that of the 500,000 Americans buying or starting businesses each year, 60-70% select the wrong type. Most have not asked the crucial question: What business am I best suited for? Instead they choose a business which is easy to get into or which looks highly profitable. Choice is critical. It should be in a field about which you know something. Don’t buy if you have to rely completely on staff expertise. Don’t go for hairdressing if you are not a hairdresser, a restaurant if you can’t cook or a workshop if you have no mechanical background. No matter how good the profits are, you are completely in the hands of the staff. To prove the point, nine times out of ten you will find that the seller has the expertise.

Advantages of buying an existing business?

* You don’t have to wait to establish profits. You have and income from day one. The average time to establish a new business and get it to profitability is approximately 18 months.

* The success of the business is proven. Your drive and enthusiasm can be channeled into increasing profits as opposed to trying to get achieve break-even.

* There are no start-up problems – you have customers, employees, suppliers, physical plant and premises.

* Occasionally the seller is prepared to provide financing at a lower cost and with less security than would be required by a financial institution.

* Sellers sometimes allow purchasers in to verify certain aspects of the business. This gives an opportunity to see if the business suits you.

* You may be able to buy a profitable business for less than it would cost to set up a similar concern. Internationally, 9 out of 10 new businesses fail in the first 2 years.

Reasons you might not buy an existing business?

The business may not be exactly as you would like it to be. Size or location could be wrong, you may be buying problems of someone else’s creation, you may not agree with the value put on the "goodwill" of the business.

There are really only two cases where it may be better to start your own business as opposed to buying a going concern. They are:

* When you have a product so good it must be a winner; and

* When you are able to secure prime premises with enormous passing trade so that virtually any business would be a winner. Even so, you would need to tread very carefully.

Forget about being the boss - and getting others to do the work! back to top

If you are serious about getting the most out of any business you buy, you must be prepared to work as hard if not harder anyone else around you. If you have been used to a regular monthly salary, think long and hard about whether you can make the change to a scenario where you’ll never know how much you will be able to draw in salary at the end of the month. Do you have the mental strength and entrepreneurial flair to live with considerable strain, stress and worry about any number of things: Will staff turn up for work; will equipment be reliable; will customers come through the door; will suppliers deliver on time; how much will electricity cost next month; will depreciation of the Rand make the products I import too expensive; will interest rates increase and affect my loan repayments. The list is endless!

Being able to manage cash flow is critically important. Do you have the discipline to put money away after a spectacular summer at your restaurant on the coast. Winter months will bring in very little cash flow.

Think carefully then about whether owning you own business is really for you. Sacrifices will have to be made, hours will be long and you will have to think on your feet and be decisive if you are to succeed. With this success will come great rewards for you hard work and considerable satisfaction.

Where to start?

First answer the following questions:

* What expertise or skills do you have? - Do your strengths lie in management, marketing/sales, or on the technical/financial side?

* What are your weaknesses? - Generally most small businesses require the owner to be a "jack of all trades", to have all round business skills like management, financial, marketing and technical. Identify skills you lack and take a short course to overcome that problem., ie, "How To Run A Business".

* What would be the minimum income ( profit/salary ) you would need from the business to live on? - Your idea may be to buy a smaller or less profitable business and build it up. That’s fine, but you must know the minimum income you need to survive on from the start.

* What type of business would suit you? - Retail, service, manufacturing etc. If you have a problem communicating with people, don’t get involved in a business where you have to deal with the public on a day-to–day basis as you will end up hating every minute of it.

* How far are you prepared to travel each day to and from your business? - Try to find a business not too far from where you live, unless you intend to relocate or are willing to put up with a long commute day after day.

* What hours are you prepared to work and how will this affect you family life and leisure time? - Often buyers get involved with the disastrous consequences in businesses that operate seven days a week with long daily hours. Retail outlets in shopping malls are a prime example. If the business seems attractive, but the hours too long, consider buying with a partner or family member. This could give you the time off that everybody needs.

* How much money can you raise? Cash , insurance policies, loans from family, a second bond on a property (establish market value and how much you could borrow).

With the answers to these questions you will be able to draw up an assessment of what sort of business might be right for you and where it should ideally be located.

How To Buy A Business Safely back to top

When you know what sort of business you are after, feel confident you could run it , how much you can afford to pay for it and the profit you require, it’s time to get looking.

Where to start.  back to top

* Watch the Businesses for Sale columns. Every week the papers run many adverts, most placed by brokers and some by private sellers. Search the Internet for brokers’ web sites and others such a www.businessesforsale.com. Most have useful search facilities which enable you to narrow the field using criteria such as location, industry type, price, profit etc.

* Approach a reputable broker, who should be able to help you in your search. There should be no cost to you as Sellers normally pay brokers’ commission.

* Place your own simple advert in the newspaper or on the internet. It’sinexpensive and effective.

* Seek out businesses that appeal to you, then ask the owner if he would consider selling. Don’t do this in front of his staff though as your interest must remain confidential at this stage.

* Speak to suppliers in the industry. It is amazing how much their reps hear about businesses for sale.

* Let your accountant, bank manager, attorney, insurance broker and friends know you are on the lookout for a business to buy.

Advisers / Acquisition Team

Even if you are a seasoned entrepreneur you will need some sound advice. So start now by putting your team together. Choose only people who are experts in their respective fields. Forget about your brother-in-law and other suspect advisers, unless they have both the knowledge and experience in their own business and may be of assistance to you. Many potential buyers lose first class opportunities through poor advice from unqualified advisors. Everybody you speak to likes to think that they are an expert on business acquisition, but most have not the faintest idea what they are talking about. Have these people on your team;

* An accountant with hands-on experience in business acquisition and prepared to view the business of your choice, prepare cash-flows and go with you to see your bank manager.

* An attorney specialising in drafting business agreements.

* A consultant, especially for first time buyers, who has knowledge of the industry you are interested in. He could be a someone who has owned a similar type of business.

Buying a business is a major decision that will affect your future and your bank balance. It has been said that 80% of businesses are purchased on emotion and not logic. Do not be hurried, but rather work quickly, systematically and investigate thoroughly.

Beware

Many sellers believe their business is worth far more than its’ performance would indicate. They have become emotionally attached and often need a certain amount of money to retire on or for some other purpose. Stick to the facts relevant to the case. Profit is the major driver in business value and the seller must constantly be reminded of this. The message should eventually get through, especially as time passes and no one is prepared to offer what he wants.

Misinformed Sellers Are In For A Big Surprise back to top

Everyone who owns their own business believes their little empire is a gold mine. Never mind that it isn’t making any money. When the time comes to sell it, they firmly believe some "naive little buyer" is going to come along and pay them an enormous price, in cash, and how dare he doubt the profit and ask to see provable figures. However one has to have some sympathy with sellers. They are expected to give potential buyers confidential information about their business before getting any commitment at all. Understandably, they fear financial ruin should the information fall into the wrong hands and they don’t make the sale. It makes no difference at all that the house next door is for sale. But it’s very different when the “for sale” signs are up on the business next door. Competitors cash in, creditors withdraw their credit, their staff become unsettled and look for other jobs. Ironically, it is this very lack of information that stops a seller getting top value for his business. If financial details are not forthcoming, buyers grow suspicious and doubt the credibility of the seller. Often sellers are remiss in not declaring all cash sales. But you can’t have your cake and eat it. If you are unable to prove certain profits, you can’t expect to be paid for them.

How to break the deadlock

Onto the scene a comes a prospective buyer who has made a personal assessment as set out in “Where to start” (above). The seller can now see that the buyer is genuine, has the necessary skills and can raise the finance. Next, the buyer signs a confidentiality agreement undertaking not to disclose information to anyone without the seller’s permission. Now the seller can safely reveal the business details.

Getting top dollar

Estate agents decree that, to get the best selling price for your home, you must prepare it for sale. Clean, paint, fix, tidy and see the buyers’ eyes light up. Businesses are no different. Here are some pointers to getting top value for your business. Remember;

* You are in competition with all other businesses for sale within your profit range; * The provable net profit will be the major driver in determining the selling price; * Overprice it and it will not sell; * The longer it is on market, the less chance you have of getting your price; * Cash buyers are like hen’s teeth – but less common; * Provable figures are essential for a buyer to raise finance; * The more information you provide the better your chances of achieving a good price;

Sellers should build up prospectuses on their businesses, detailing; * Immediate history; * Present market conditions; * Opportunities that exist; * Provable figures to date; * Budgeted forecasts: * List of all assets - plant & equipment, furniture & fittings, vehicles etc. * How the price was determined.

Buyers are not fools. Don’t treat them as such. If you want Top Value, you must present comprehensive “quality” information.

What Good Brokers Really Do For You back to top

Business Brokers These are the people you approach to buy or sell a business. They operate in a similar way to estate agents. They also fall under the Estate Agents Act and must be registered with the Estate Agents Board and hold a valid fidelity fund certificate. They work on a commission only basis, paid usually by the seller on conclusion of a sale. Their function is to bring a willing buyer and seller together, not to check the business out or give guarantees or undertakings. That is for you, your attorney, accountant and advisor. Brokers do not earn enormous commissions for very little work. If they are good, they might earn commissions (before expenses) of R20,000 – R35,000 a month in return for long hours and high risk. Commission is only paid on successful conclusions of a sale and sales often collapse!
Buyers Perspective All you want to know on the first call to a broker is where an advertised business is so you can drive by and take a look. This is not on. The broker’s duty to the seller is to be confidential and give information only to “qualified” buyers. He also has to protect his claim to commission. Up front there is no way of knowing whether the “buyer” is genuine or in fact a competitor of the business or another broker touting for work.
Sellers Perspective You expect the broker, armed with limited information, to find a suitable buyer. Last week, the would be seller of a successful restaurant withheld provable figures, set an inflated cash price, listed with every broker in town and stipulated a 5% commission. Forget it. The broker’s biggest costs are time, advertising and travel. Only businesses with the best chances of selling, because comprehensive information has been made available and the seller is totally comitted, are worth the the effort.
Broker Becomes Bloodhound Shop around for a broker with experience and a track record. Candid provision of business information or your requirements will convince him you are a genuine buyer or seller and the commission is there if he performs. Buyers: Don’t look only at the latest listings of businesses for sales. Often the best fail to be snapped up for months. They may have been over priced, listed as "cash only", or figures may have been withheld. A genuine seller will drop the price, open the books and negotiate terms.
What can a Buyer expect from a broker? * Correct qualifications; * To be offered opportunities meeting requirements and his pocket; * All the information needed for an educated assessment; * Help with additional information; * Assistance in negotiating with the seller; * Preparation of a sale agreement; * Help raising finance; * Advice on documentation.
What can a Seller expect from a broker? * Advice on determining the value of his business and fixing a selling price; * A list of information required; * Confidentiality in negotiations; * Qualified buyers; * A marketing / selling plan; * Feedback on buyers; * Viewing by appointment; and, * Best Price and Terms.

Narrowing The Field back to top

In order to focus your search and use your time effectively, prepare a checklist of likes and dislikes, wants and don’t wants. Use it to eliminate unsuitable businesses. A broker could show you any number possibilities, but at the end of it, you could be confused and frustrated. Discard anything that doesn’t fit your requirements and discuss the “possibles” with your acquisition team.

Preliminary list

* Do I have a gut feel for the business? Would I like to run it day in, day out?

*Do I have the skills to run the business and make profits? The most underestimated type of businesses are those in food. Everyone who can boil an egg thinks they’ve got it made here. It can be very profitable, but it’s highly demanding and you need eyes in the back of your head, or your profits walk out of the door. It’s amazing the places people think of to hide a chicken.

*Will I be able to secure a lease for a reasonable term with an option to renew. No lease, no business.

*Is the profit adequate to meet my requirements or at least will it be so within a short period? Will the business expand to meet my needs?

*How will the profit be proved and will this basis be acceptable? There must be a set of books which accurately reflects financial performance. Virtually all businesses that brokers deal with, be they companies, close corporations or sole proprietorships, have to supply SARS with a certified set of financials. Sellers will say that these do not reflect the true position. However they are the best point from which to a buyer can start his investigation. Personal expenditure can always be established and the figures adjusted to reflect true business performance.

*Location: Will I have to move house? Will I have to travel long distances?

* Business commitment. Everyone needs time off, so be pragmatic about what hours you can work. You don’t want to end up forced to live on the premises.

Time To Check Your Lease back to top

Once you have selected one or a small number of prospective businesses to buy which meet basic requirements, the time has come to look in more depth at various aspects of their operation.

The lease on the premises

There is a very true saying "If you don’t have a lease, you don’t have a business". Going concerns that can be from home or just about anywhere are the exceptions. Most must have proper premises and a sound lease. Much time and money is wasted examining the books and seeing how to improve profits when viability is often being undermined by nothing more nor less than the lease. Obtain a copy of the lease Most are for a three year period, with an optional further three and a rental escalation of 12 to 15% a year. Further periods have to be negotiated with the landlord.

Some pitfalls * Onerous clauses, for example, stipulated as little as six months notice of sale or intended renovation of the building. Some years ago, a few businesses came on the market in a 14 storey West Street office block. A six months demolition notice clause was effected. CBD office and trading space was at a premium and no tenant dreamed the landlord would demolish a building that size in West Street. But down it came to make way for a 30 storey block from West through to Pine and Field street. Moral of the story: Check with the landlord what his intentions are; he has no reason to lie as he already has a tenant. * Check costs additional to basic rental, such as a proportion of the rates, exterior electricity, promotions, budget and security. You may find you’re just working for the landlord. * Turnover clauses which push up the rent when your turnover tops a certain level are, to me, criminal. The harder you work and build up your business, the more you pay the landlord. There clauses turn honest shop keepers into petty criminals, forced to conceal their true figures. * Does the lease specify trading hours? Don’t assume so. A couple bought a gift shop that opened 5.5 days a week, despite the fact a co-tenant, a large supermarket, also opened on Sundays. No one had realised the lease stated the landlord could extend the hours. The couple now slave away seven days a week. * Does the seller have the right to cede or sublet the premises? Most leases will require the landlords permission, which should also state that this should "not be unreasonably withheld". * Some smaller unscrupulous landlords demand an up-front cash payment from the proceeds before agreeing to transfer the lease to the purchaser. * What does the lease allow you to do in the premises? You may want to widen your product range or change some basic concept of the business. Check that doing so does not contravene lease conditions.

So important is the lease that you make it a condition of purchase that your attorney first approve the document.

Confirm Sales Before Buying back to top

Turnover, or sales, is the second biggest problem area for the buyer to overcome. Not only must he be able to verify that the business is doing the turnover claimed, but that it will continue to do so after the seller has handed over to a new owner. Most other sections of the financial side of the business you will be able to clarify, but it is the element of cash sales which starts in the turnover that causes the headaches.

If all, or a large part, of the sales are on account then all you need do is obtain a list of the clients and start checking them out. The real problem is with the cash sales. How are you going to confirm them? Ideally, you would stand next to the till for a couple of weeks and virtually count the money as it comes in. But who has the time? You could check the seller’s bank accounts for the last year to see how much cash was deposited, but it’s unlikely this will show all his takings. Then you would look at his purchases over the year to see if, based on claimed markup and gross profit, turnover is borne out.

A wise buyer will have his accountant help him recreate an income statement on the business from these investigations. But that’s still not foolproof. As the buyer you are going to have to make a decision on the evidence at hand. If your advisor can verify at least 80% of the turnover, then there is a good chance that the balance is true.

Having established that the sales are there you must now examine the following aspects: * VAT. First find out whether turnover is inclusive or exclusive of VAT. Often a seller is inclined to forget to take off the 14% VAT, which has the effect of inflating profitability. * Monthly turnover. Obtain the monthly turnover for the last two years. This will show if there is a steady increase in sales over and above pure price increases. You may not want to get involved in a stagnating or declining business. You will also be able to tell whether sales are affected by seasonal patterns, which could greatly affect your cash flow. This is particularly dangerous with businesses in holiday areas where turnover fluctuates enormously. * Breakdown of turnover per product. Calculate sales of food, sweets, cold drinks and cigarettes. This helps ascertain whether effort and shop space are proportionate to the turnover. Later we will also check if it is contributing to the biggest profit. * How is turnover achieved? It may be from over the counter sales, from the representatives calling, or from advertising. Is the business spending its money on areas that are producing the sales and are other sections exploited enough? * Client spread. If you rely on passing trade, no problem. But ideally one wants a breakdown of clients and how much each contributes to turnover. If most sales are to only a few clients, you want to be able to check them out. We were asked to sell a very profitable little business allied to the motor trade as the seller wanted to retire. The business had been established for 12 years and for many years one large motor group had given them more than 60% of their income. The seller said there were no problems and the turnover would continue to come in as it had done in the past. He neglected to mention that this large client had decided to do all the work themselves and not send it out anymore. If this has not been discovered, an unsuspecting buyer would find profits going down the tubes as 60% of the turnover walked out the door. * Stable clients. Depending on how important they are to the business, you may want to make some inquiries as to how solid their businesses are.

Understanding Mark-Up and Gross Profit back to top

So often in the process of buying and selling a business, either the buyer or the seller gets confused with the aspects of mark-up and gross profit, sometimes with disastrous effects. The importance of understanding the difference can be seen in this simple example:

After buying a stock item for R100 a shopkeeper adds R15 to the sale price to cover his expenses and a further R15 mark up to provide the necessary profit. A cash buyer is then offered a 20% discount which reduces the price of R130 to R104. This leaves the shopkeeper with a R4 gross profit from which he still has to deduct his expenses of R15. The end result is a loss of R11 on the sale.

The problem arose because he mistakenly thought that as he had added 30% onto the cost of the product, he would still make 10% if he gave away 20%. He didn’t understand mark-up and gross profit.

Mark up is what is added to the cost price of the item to cover expenses and provide a gross profit. Gross profit is what is left after deducting the costs of the item from the selling price. Running expenses need to be deducted to reach the net profit.

This is a very common mistake and will lead the business to financial ruin. Obviously the seller will sell more than one item to contribute to covering the expenses, but the point is to be careful. In your investigations you will also want a breakdown of the gross profit percentage for each item. This will help to determine which items are contributing the most to the gross profit.

It should be possible to determine whether these percentages are average for the industry. For instance, why should a particular hardware store be showing a 40% gross profit when the average for that business is 35% ? The answer could be that the store is in a monopolistic position and can therefore sell at a higher price or maybe the owner gets bulk discount from the wholesaler. Conversely, if he only achieved a 30% gross profit, was the cause poor buying or perhaps pilfering?

This could be an opportunity for a buyer to find the problem and turn it round into a larger profit. In 99% of small to medium sales, the buyer would not take over the seller’s debtors and creditors. He would buy the business as a going concern and the seller would collect all the money due to him and pay all his accounts up to date. In regard to the debtors the buyer needs:

*An age analysis to determine how much time clients have been given to settle accounts. The longer the period, the greater the working capital needed. *A breakdown of bad debts. It’s one thing making a sale, it’s another getting paid. *With regard to creditors, a buyer needs to know:

Are there any special terms of payment that the seller receives from his suppliers?

What Do You Really Mean When You Talk Of Net Profit back to top

In small to medium sized businesses when we talk about net profit, what we really mean is, what are the total of all the perks that the owner derives from the business. Unfortunately, many of these perks are not legitimate business expenses and are therefore lumped together with other legal expenses in the income statement.

These could include: home bond repayments, credit card purchases and vehicle costs. The list could be endless. So to determine the true net profit, a buyer would add together the net profit shown, the owners salary plus all the perks he gets that are not actual running expenses of the business.

For instance, in the case of a restaurant, the owner would pay for all his family’s costs such as food and clothing. He would probably pay for the running of his car, his retirement annuity, home and life insurance, along with a host of other personal expenses. This is one of the benefits of being your own boss, an employee would have to cover all these costs out of the net salary he receives.

The problem comes in verifying the actual net profit. Even when presented with an audited set of financials, a prospective buyer or his financial advisor may have to reconstruct the income statement removing the perks from the expenses to establish the net profit the seller claims he is making.

This is the easy part. The difficulty comes in verifying the cash sales the owner claims he is doing and not declaring. My feeling is that you can’t have your cake and eat it. It it’s not verifiable, then it should not be taken into determining the price. Confusion with what’s included in the price often is a problem in business sales. So before a buyer gets his knickers in a knot, he should establish what the seller has included and how he came to that figure. He is then in the position to do his own assessment of what he would be prepared to offer for the business. All sellers are inclined to place a premium on the value of their businesses. What regularly happens is that a price is quoted which on the face of it sounds high but when broken down is not.

For example, let’s say you come across a business that is just what you are looking for, but the price sounds excessive. So first get the seller to give you a breakdown of the price as follows: fixtures and fittings, plant and equipment, goodwill, price plus stock ( at cost ) and debtors less creditors. Now on closer examination you find that the seller intends to settle all the equipment leases/hp’s of the business with the money he receives from the sale. That’s fine, but in your case it may be far better to negotiate to take over these commitments, thereby reducing your capital outlay. You would then be able to decrease the price by what is still owing on the equipment bearing in mind that the monthly payments for these items are already included in the expenses of the business. The terms of payment for the business also raise issues for the buyer.

All sellers initially require cash but in most cases they end up accepting some sort of terms. Although there are no hard and fast rules, normally payment would be 60% in cash and the balance paid off over a period of 18 months out of earnings of the business. Obviously for both parties there are risks involved. From the seller’s side he has no guarantees that the buyer will succeed in the business and be able to meet his monthly repayments. If the buyer defaults, the seller may have to take a business back that has been run down and now difficult to resell.

On the buyer’s side, he may have one hiccup along the way and if his cash flow is wrong and he can’t make the payment, the seller could foreclose and he could lose everything he has built up. From this one can observe that it is critical that a buyer receives sound advice from his financial advisor in regard to the amount of working capital required and having a sound cash flow projection.

Keep A Sharp Eye On The Value Of Your Stock back to top

Stock is the lifeblood of a business, but it can cause all sorts of problems when a company changes hands, mainly to the detriment of the buyer. Obviously some types of businesses, such as garden services, do not have any stock and therefore don’t have these problems. The rule is always that stock is an extra amount to be counted and paid for on the days of takeover of the business. Therefore the selling price is X plus the value of stock after a stock take has been completed. The stock value is at cost and the seller should provide invoices reflecting its purchase cost. Be wary if he states his mark-up is 100%. The stock value should be 50% of the selling price.

You will probably find that he has inflated the selling price to give himself a better stock value. In a recent sale of a health shop, the buyer complained that the stock value seemed very high and all the price labels were new. Sure enough, the seller had increased the prices the night before the take over. This is where a consultant who is experienced in that particular type of business will be able to advise you, especially as to whether the stock is old or obsolete. You do not want to pay for something 'unsaleable'. Other points which need to be considered:

Are their suppliers stable? Do they carry sufficient stock and will you receive the same terms and conditions as the seller? Is the business under or overstocked? Can the stock be reduced without affecting the business so less capital is outlaid?

Is any of the stock on consignment or items on lay-by? You don’t want to discover that you have sold something you had no right to sell. On one occasion, we sold a video outlet and although the videos being hired out were not stock in the true sense, the point is still the same. The buyer took over the business and paid the seller out for the 4 000 video titles after stocktaking on the day of takeover. Everything appeared perfectly normal until the buyer phoned us a few days later to complain that there seemed to be a lack of the most recent movies in the store. We found that though there were 4 000 video titles, as required in terms of the sale agreement, the most recent titles were missing. The seller has another video outlet and had gone back into the business after the stock take and takeover and exchanged the most recent movies for older ones!

Avoid Purchase Pitfalls back to top

In most transactions the buyer and the seller see staff as part of the business without giving much thought to their importance. Firstly they are not bought and sold in the purchase price. They have to agree to accept the new owner. If their working conditions are going to be no different than at present, there should be no problem. But, if not, watch out Mr. Seller. The seller could find that they want to leave and you could become liable to pay them, not only for leave and sick pay, but also a severance pay of one week’s wages for every year they have worked for the business.

You could have the same problem in having taken the business over as a going concern with all the staff on the same terms and then find in a few months time that the business in overstaffed and some need to be retrenched. You would then be responsible for any severance pay, not only for the short period you have had the business, but for the whole period they have worked in the business. My advice is chat to a labour lawyer or consultant.

Ensure that right at the start, you receive a complete break down, not just the number but, job function, pay and length of service in the business. Establish whether they are unionised and if they are paid the recommended rate.

Many small to medium sized businesses are paying higher rates than laid down, but some are exploiting their staff, especially where the business does not fall under any particular union category. As the buyer, you could be purchasing a load of trouble. Another important point is whether key staff receive any special perks.

Some time ago we had a hardware store for sale, which did a few home deliveries, but nothing of any importance. The seller wanted to take the bakkie in the business with him and the buyer could see no problem with this, as he would just do the small amount of deliveries in his own bakkie. What was not disclosed, was that the employee who ran the paint section and did all the mixing and matching of paints, used the bakkie to go to and from work and over the weekends.

In sale negotiations, staff are the last to know the business is for sale. Naturally, if they knew, they would be anxious and could leave, with repercussions for the business. However, whether staff know or not, immediately the sale has been finalised, the seller and buyer should put them in the picture and reassure them of their job security.

Evaluating Business Assets back to top

It is ideal to have a breakdown of the overall value of fittings and fixtures when buying a business. But what value does one use? Is it the depreciated book value, the present replacement value, or an estimated forced sale price? In fact, it is somewhere in between, call it the going concern value, an educated guess. On one hand, we have high replacement value and on the other the forced sale situation. Let’s say a four door filling cabinet would cost about R500 new. A good second hand one at an auction would cost about R150, so the in the business would be set at around R250. This can be negotiated in the selling price, but this is a reasonable estimate.

You now need to learn from the seller whether there are items not on the inventory which he intends removing from the business, meaning that they will not form part of the sale.

A while ago, we had a factory making metal components for sale. It was exceptionally well equipped and making good profits. The seller, who was moving overseas, had provided the buyer with a full inventory list. On the day of the take over, the buyer burned up the telephone wires because the seller had removed an essential item for making jigs with which components were produced. The seller pointed out that it was not on the inventory and that he intended taking the machine overseas to set up a similar operation. In the end, he had to return it, but it would have been disastrous to his old firm if he hadn’t.

It is also important to verify that all items are paid for and not subject to any leases or HP agreements. If you take over any leases / HP’s, the value of these items should be reflected as the difference between the going concerns value and the settlement value.

If you are not familiar with plant and machinery, have a qualified person give it the once over, older equipment may go on for ever, but it may also be obsolete and unviable for further expansions.

Licences are normally only required if the business falls in the accommodation, food, entertainment or liquor categories. The rest have only to be registered with your joint services board. But, be wise, phone your licensing department and check. With food businesses, speak to the local health inspector to see if there are any problems and in all cases, make sure the business activities are covered by the licence.

Banks Seem Very Wary of Financing a Business Buyer back to top

One of the most frustrating aspects of buying and selling a business is trying to raise finance from a bank. Time and time again, serious buyers rush to their bank managers hoping to raise finance on the strength of their assets and those of the business they hope to acquire, only to be turned down. The truth is, banks are nothing more than glorified pawn brokers. The banks are generally not geared up to finance purchase of a business.

The ones which claim to be, usually have set criteria as follows: * A sound business plan * Have the necessary expertise to run the business * Have 20 – 30% of the price in cash * Have security, preferably property, to cover the loan, rand for rand * Able to prove profitability of the business.

Take a borrowing requirement of R120 000. If you have R30 000 in cash and the balance to be secured by a bond over your property, you may succeed. But without the security of equity and property, you’ll be out of luck. A business manager with a major bank says the problem lies with bank managers without the business skills to provide creative financing. But all the security in the world and a history of 22 years with the bank, are no guarantee you’ll get a loan. We had a solid home improvement business for sale once. A working director was staying on and the buyer was technically qualified, in addition to having a bond over his house and a portfolio of blue chip shares to cede to the lender. Three banks turned him away. In the end, a switched on Amanzimtoti bank manager stumped up the loan, backed up a second bond on the house and cession of the business debtors and shares. And he paid two visits to the company to assess viability, something most loan managers seldom do. Banks attribute their traditional backwardness to the experience of burned fingers in business finance. I believe most of their losses have been with start up businesses, not sound going concerns. The only way to succeed is to shop around until you find a switched on bank / loans manager that will work with you to achieve your dream.

Alternatively - 'Khula' Guarantee Scheme There is hope however, under the "Khula" Guarantee Scheme – through the Department of Trade and Industries. The basics are that the government will guarantee 80% of what a bank is prepared to lend thereby reducing the banks risk. In theory, subject to certain criteria, one could buy a business with a 10% to 20% deposit. Unfortunately most banks are not promoting the scheme. We have had a lot of success with Absa and Standard Banks' Commercial Divisions - don't be surprised if your local branch has never heard of the scheme.. Bear in mind - this scheme is for empowerment not enrichment, so if you have substantial financial resources you will not qualify.

The general requirements are: * deposit 10 / 20% * necessary expertise to run the business * full business plan * curriculum vitae * cashflow forecasts * use all his/her collateral * cannot have 2nd business * minimum loan R70,000 and maximum R480,000. The delay for bank and Khula approval and for funds to be paid out is 6/8 weeks from receipt of all documentation. NB. This is an excellent scheme for helping to finance a business.

Price Myths To Avoid

There are four traps buyers and sellers fall into in assembling the value of a business. As a result, they end up paying more than they should, or expecting too much if they are selling. The "comparison game" is first. This assumes that because someone paid a certain price for a particular type of business, that all similar businesses with the same profits will fetch that price.

If a hardware store with net profits of R10 000 a month was sold for R250,000, every other similar venture with that sort of profitability should sell for R250,000. Nonsense. Appreciate that each business operates within its own economic environment and although profit levels might be the same, that could be all that is. The first may have been going for five years, the other five months. One works long hours, 7 days a week, the other a 5 day week.

Another variable is the turnover multiplier, particularly pertinent in food businesses, like supermarkets or tea rooms. The myth is that price is calculated at three or four times monthly turnover. So a store doing R100,000 sales would have a price tag of R300,000 or R400,000 plus stock. Service stations also go wrong here. Value here is often put at monthly literage multiplied by R1,50 or R2. That would mean a station pumping 200,000 litres a month would go for between R300,000 and R600,000 plus stock. The flaw is that the concentration is on the wrong end. Just because the sales volumes of two supermarkets or garages are the same, does not mean their profits are identical. One could have a much higher rental than the other or a large amount to pay off on leases or installment purchase agreements.

Hours and wages bills may vary substantially and hence bottom line. Another myth is that you’ve got a good buy if you knock the seller down 10% or 15%. But, most sellers inflate their price anyway hoping to catch a sucker. So, you end up paying what it’s worth anyway.

The time to knock the price down, is once the seller has been forced to bring it back to earth because the business won’t sell. One important myth is the "tangible asset" myth, which says if you pay the asset value for a going concern you’ve done well. Remember, a business needs profits before assets represent any value.

You could sell off the machinery, you argue. Bear in mind in a forced sale, you never get your price for equipment and surely the reason for buying a business is to make a profit every month, not just a one off sale profit.

Setting A Value back to top

Ask 20 experts to value a business and you get 20 different answers over an amazing range. You have the sellers accountant telling him he has a fabulous business with a fortune in goodwill and the value of stock and equipment. At the other extreme is the buyer’s accountant. He says it looks like a good business, but with little goodwill and inflated asset values. Value in a business is nothing more than what you as a buyer or seller perceive it is worth to you. Property traders can use the comparative property analysis, which records actual sale prices. These tend to be roughly similar for similar properties in similar locations. With businesses, the variable are too great to make this type of comparison reliable. People buy and sell businesses for many different reasons. There are roughly 27 different ways to reach a value. Over the past 12 years, Aldes has used the following three basic formulae very successfully and they are recommended by the Institute of Realtors for small to medium size businesses.

Payback Method Sometimes referred to as the Magic Multiplier, establishes value by multiplying the net profit by the period over which a purchaser would expect to recoup his investment.

Return On Investment method This method sets the value by dividing the net profit, after allowing for a owners salary, by an acceptable return on investment percentage.

Extra Earning Potential / Super Profits Method Sets the value based on the value of assets, plus a goodwill figure calculated after deducting the owners salary, plus interest from the net profit of the business.

Although the result of each method may differ greatly, the average of the 3 methods is viewed as a realistic market value for the business.

How Different Valuation Methods Affect The Price Of Two Businesses back to top

Let’s look at how valuation methods introduced affect the price of two businesses. One is a garden service business, the other a gift shop. Both have been established for two years and have profits of R20,000 per month. The garden service runs from the owners garage, has assets of approximately R60,000 including an old bakkie and various lawn mowers and hedge cutters. It has 50 monthly contracts of which a large part have been running for more than a year. It operates a five day week. Its clientele is derived from advertising in local pamphlets. The gift shop has assets of R250,000, comprising stock at cost of approximately R200,000 and fixtures and fittings of R50,000. It has a good position in a busy mall and is open five and a half days a week with its sales coming from passing trade.

Payback Period As a guide, an older, more established business with a high asset base, say 50%, would need 18 to 24 months to recoup the investment. A younger business with a low asset base and particularly businesses perceived to be higher risk because they are easier to start from scratch, would need 12 to 15 months. The gift shop would be calculated at 24 months, times the net profit of R20,000 and the garden service at 15 months times net profit.

Why the difference With the garden service, being home based, it could be easier to start from scratch and have less valuable goodwill. Also the contracts can be cancelled on a months notice and the customers may not take too kindly to a change of ownership. With the gift shop the business stems from its good position in the mall, which is not easy to duplicate and most landlords will not allow businesses selling the same merchandise in their malls. As long as the same stock mix is maintained it won’t matter who is behind the counter.

Return On Investment Assess an acceptable percentage return before tax and how much one would pay a manager to run the business. The norm is 35% before tax for small to medium sized businesses with a managers salary of say R5,000 a month, particularly as both ventures do not require highly skilled people to run them. One could accept that the gift shop has a lower business risk and the expected return would then be 35% and the garden service with a high risk 40%. As can be seen, both the above methods look purely at the net profit of the business and don't take assets into account and this is why in assessing a market value for a business we bring in another method, The Extra Earning Potential or Super Profits. This takes the assets into account and therefore an average of all three gives a more realistic value. The Extra Earning Potential In this method, if you took the asset value of the business (fixtures & fittings, equipment) and stock at cost, and invested the total amount in a safe investment, say a fixed deposit you would earn ± 12% before tax. If you then worked in the firm as a manager you would earn a salary of R x. Add the two together would give a total. The question is how much more is this business generating in profits and this is the EEP/Super Profits method. The EEP amount multiplied by the payback period for the for the Garden Service / Gift Shop would give the Goodwill amount which is which is added to the asset value giving the total EEP value.

The three methods would work out as follows:-

Method Garden Service Gift Shop Payback Period R300 000 R480 000 ROI Method R450 000 R514 286 EEP R276 000 R550 000 The Average Market Value for each business would be R342 000 R514 762

Super Profits Method Of Business Valuing back to top

The last method of valuing a business is the extra earning potential, or super profits method. To do this, calculate the income that would be earned from investing an amount equivalent to the asset worth of the company, its fixtures, fittings, machinery and stock, in the bank. Add to it an annual salary for managing the business, then deduct it from the net profit of the business over 12 months. This is called the extra earning / super profit of the business. Multiply by the same factor used in "payback period" method, to determine the goodwill and add the result to the asset value and you get a value for the business.

Example: Extra Earning potential / Super Profits Garden Service With assets of R60 000, the equivalent percentage amount on fixed deposit at 11% would earn R6,600 a year. Add a R36,000 annual salary = R42,600. Deduct R42,600 from the annual net profit of R72,000 to give an extra earning potential of R29,400 a year. Using the one year period of the payback method detailed previously gives a goodwill value of R29,400 ( R29,400 x 1 ). Add this to the R60,000 asset value to give a price valuation for the garden service business of R89,400.

Gift Shop Asset value = R140,000. Earning 11% pa = R15,400 return + salary of R36,000 pa = R51,400. Deduct R51,400 from the annual net profit of R72,000 to give an extra earning potential of R20,600 a year. Multiplied by 1,5 years = R30,900 plus assets of R140,000 = a price of valuation of R170,900. This method puts a higher price on a business with a higher asset base. This may not always be justified. Market Value To balance out anomalies, take an average of results of the three methods I have detailed. For the garden service, that works out at R72,000 + R90,000 + R89,400 for an average of R83,800 For the gift shop, R108,000 + R120,000 + R170,900 = R132,966 average. The R49,166 variation between two businesses with the same net profit is justified by the differences in risk profile and asset base.

Although the price of the gift shop is only its stock value, remember assets are only as good as the profits they generate and also each business with similar profits is in competition for the same buyers. But why should you pay a premium of R49,000 plus to achieve a very similar profit level? Simple. Not everyone wants a garden service business some and would rather pay the extra for a venture with less risk, fewer labour problems, a bigger asset base and maybe most importantly one they can empathise with.

Price and Value Compared back to top

It is one thing to have practical methods for putting a market related value on a business you want to buy, but will theoretical prices be realised in the market place?

We have looked at three methods of assessing the value of two businesses with the same net profit but different asset bases. Both had net profits of R20,000 a month, but the garden service business achieved it with assets of R60,000, while the gift shop required assets worth R250,000.

We put an average price tag on the garden business of R342,000 and on the gift shop one of R514,762. There often is a difference between value and price. It can be based solely on horse trading between parties.

But there are many other factors influencing price, a violent robbery, for example. Unfortunately, over the past few years this had been a real concern with buyers. A seller whose wife passes away may want to get out of the business at virtually any price. He is not overly interested in the value of his business. Partners who are at each others throats and are keen to sell tend to accept any reasonable offer, even less than the valuation. A seller with cash flow problems will be forced to accept a lot less than the value.

A seller who is not prepared to provide any financial information about the business will receive low offers. But there are things which help the seller to get value. Offering good terms to a buyer is one way. Having sound records and provable profits, VAT returns etc. creates buyer confidence, resulting in a better price.

Buyers often find they lose golden opportunities by adhering religiously to third party advice on not paying more than a certain amount. They spend months trying to find a similar operation, eating up their capital and berating themselves for not offering a little more the first time.

Summing Up back to top

That’s it, then. If you can’t yet buy or sell your business, you haven’t been reading carefully enough for the last 21 articles. To end off, here is a summary.

Mr / Mrs Buyer; are you ready to invest sweat equity? Buying a going concern means not having to spend 18 months getting to a profit situation with a new business.

Identify acquisition prospects with a broker or by scanning "business for sale" ads or advertising in "businesses wanted". Get advice from the right people.

Mr / Mrs Seller; making it widely known that your business is for sale sends the wrong message to suppliers and your bank. Tart up the firm to improve price prospects by being liberal with information to a qualified buyer.

Buyer, shortlist good buys and check these aspects: * Lease on the premises. * Turnover. * Gross profit. * Net profit, bearing in mind these include all owners perks. * Stock check. * Staffing and * List of fixtures, fittings, plant and equipment.

A myth in setting a price for a business is that profit is the major determinant. You can’t put the same price on two businesses with identical profits if they are otherwise quite different.

The methods I recommended involve the payback period, return on investment and extra earning capital.

Remember, 80% of businesses are purchased on emotion, not logic. So be careful and do your homework

PLEASE BE AWARE that all business brokers have to be registered with The Estate Agents Affairs Board (EAAB) and hold a current Fidelity Fund Certificate (FFC).
It is in both the sellers and the purchasers interests to insist on seeing the Brokers card for the EAAB, authenticating their membership. Terms & Conditions.