BUYING A BUSINESS

Submitted by:
1

Jasmine Bal Nilanshu Agarwal Kriti Verma Ashish tyagi Deepanshu

IMPORTANCE OF BUSINESS VALUATION

1)

2)
3)

4)
5) 6)

7)
8)

Buying or selling a business, division, or major assets. Establishing an employee stock option plan (ESOP) or profit-sharing plan for employees. Raising growth capital through stock warrants or convertible loans. Determining inheritance tax liability (potential estate tax liability) Giving a gift of stock to family members. Structuring a buy/sell agreement with stockholders. Attempting to buy out a partner. Going public with the company or privately placing the stock.

ACQUISITION
1) Personal Preferences 2) Examination of Opportunities Business Brokers Newspapers ads Trade sources Professional Sources 3) Evaluation of the Selected Venture The Business Environment Profit, Sales, and Operating Ratios The Business Assets

CONT.
4) Due Diligence: A through analysis of every facet of the existing business. Why is the business being sold? What is the physical condition of the business? How many key personnel will remain? What is the degree of competition? What are the conditions of the lease? Do any liens against the business exist? Will the owner sign a covenant not to compete? Are any special licenses required? What are the future trends of the business?

UNDERLYING ISSUES
Three issues underlie the acquisition of a business:
1)

Goals of the Buyer and seller: both major parties i.e. the buyer and the seller, will assign different values to the enterprise because of their basic objective. Emotional Bias: Whenever someone starts a venture, nurtures it through early growth, and makes it a profitable business, the person tends to believe the enterprise is worth a great deal more than outsiders believe it is worth.

2)

CONT
3)

Reasons for the Acquisition: The third issue in valuing a business is the reason an entrepreneurs business is being acquired. Developing more growth-phase products by acquiring a firm that has developed new products in the companys industry. Increasing the number of customers by acquiring a firm whose current customers will broaden substantially the company's customer base. Increasing market share by acquiring a firm in the companys industry. Improving or changing distribution channels by acquiring a firm with recognized superiority in the companys current distribution channel.

CONT

Expanding the product line by acquiring a firm whose products complement and complete the companys product line. Developing or improving customer service operations by acquiring a firm with an established service operation, as well as a customer service network that includes the company's products. Reducing operating leverage and increasing absorption of fixed costs by acquiring a firm that has a lower degree of operating leverage and can absorb the companys fixed costs. Using idle or excess plant capacity by acquiring a firm that can operate in the company's current plant facilities.
7

CONT
Integrating vertically, either backward or forward, by acquiring a firm that is a supplier or distributor. Reducing inventory levels by acquiring a firm that is a customer(but not an end user) and adjusting the companys inventory levels to match the acquired firms orders. Reducing indirect operating costs by acquiring a firm that will allow elimination of duplicate operating costs (eg. Warehousing, distribution) Reducing fixed costs by acquiring a firm that will permit elimination of duplicate fixed costs (eg. Corporate and staff functional groups)

ANALYZING THE BUSINESS

In analyzing small, closely held businesses, entrepreneurs should not make comparisons with larger corporations. Many factors distinguish these types of corporations , and valuation factors that have no effect on large firms may be significantly important to smaller enterprises. For example, many closely held ventures have the following shortcoming: Lack of management depth Undercapitalization Insufficient Controls Divergent Goals These weaknesses indicate the need for careful analysis of the small business.

CHECKLIST FOR ANALYZING A BUSINESS

History of the business Market and Competition Sales and Distribution Manufacturing Employees Physical Facilities Ownership Financial Management

10

BUYING A BUSINESS: DOING IT RIGHT

One reason entrepreneurs need to know how to valuate a business is that they may want to buy one someday. When this is the case, they should keep in mind a number of factors. There are five most imp. factors: 1) Get a lawyer involved from the beginning. The purchase of assets often involves tax questions, unknown risks and, in some cases, the assumption of liabilities. A lawyer can help the entrepreneur be aware of these issues before they become problems. 2) Be aware of hidden risks that may not surface for 12 to 18 months. For example, a customer who was injured by a company made product before the firm was sold may end up suing the new entrepreneur.

11

CONT
3)

4)

5)

Have the old owner sign a non-compete clause whereby the individual promises not to reenter the business for a certain number of years (at least not in the local area). Be sure this clause is reasonable in terms of what is being promised; otherwise, the courts may set it aside. Have a certified public accountant or an outside financial expert confirm all income and expenses as well as assets account. In this way, the entrepreneur knows what he or she is buying. Before closing the deal, check out the seller. Why is the individual selling? Additionally, is the individual honest in business dealings? If not, the person may end up trying to walk away from the deal before the purchase has been finalized.

12

METHOD FOR VENTURE VALUATION

13

Method

Description OR explanation
Two or more owners set initial
value Based on what owners think business is worth. Uses figures from any one or combination of methods. Common for buy/sell agreements. 1. 2. Tangible Book Value: Set by the businesss balance sheet Reflects net worth of the firm. Total assets less total liabilities (adjusted for intangible assets) Adjusted tangible book value: Uses book value approach Reflects fair market value for certain assets Upward / downward adjustments in plant and equipment, inventory, and bad debt reserves.

Notes or key points

Inaccuracies exist due to personal estimates. Should allow periodic update.

1) Fixed Price

2) Book Value (known as balance sheet Method)

Some assets also appreciate or depreciate substantially; thus, not an accurate valuation. Adjustments in assets eliminate some of the in accuracies and reflect a fair market value of each asset.
14

Tangible Adjusted tangible

Method

Description OR explanation

Notes or key points

3) Return on Investment

Net profit divided by investment. Will not establish a value for Provides an earning ratio. the business. Need to calculate probabilities of future earnings. Does not provide projected Combination of return ratio, present future earnings. value tables, and weighted probabilities. Based on value of each asset if it had to be replaced at current cost. Firms worth calculated as if building from scratch. Inflation and annual depreciation of assets are considered in raising the value above reported book value. Does not reflect earning power or intangible assets. Useful for selling a company thats seeking to break into a new line of business. Fails to consider earnings potential. Does not include intangible 15 assets ( goodwill, patents, and so on )

4)Replacement Value

Method

Description OR explanation

Notes or key points

5) Discounted future earnings (discounted cash flow)

Attempts to establish future earning Based on premise that cash power in current dollars. flow is most important factor. Projects future earnings (5 years), Effective method (1) business calculates present value using a then being valued needs to generate discounted rate. a return greater than Based on projected timing of investment and (2) only cash future income receipts can provide the money for reinvesting in growth. Needs a known price paid for a similar business. Difficult to find recent comparisons. Methods of sale may differ- installment versus cash. Should be used only as a reference point.

6) Market Value

Valuable only as a reference point .

Difficult to find recent, 16 similar firms that have been sold.

OTHERS FACTORS TO CONSIDER

Avoiding Start-up Costs Accuracy of Projections Control Factor

17

THE LEVERAGED BUYOUT

18

THANK YOU
19