The difference between Business Brokers and Real Estate Brokers

Those involved with the selling of businesses in California are required to have a real estate license issued by the state.  This is the same license that is required to sell a home, a commercial property, or to be involved with property management. What does selling a house and selling a business have in common?  Other than sharing the same license, very little!

Real estate brokers deal with zoning, housing types, mortgage rates, flood zones, physical inspections, and the personalities involved with emotional buyers and sellers.  Business Brokers deal with financial statements, leases, covenants not to compete, and work with the other professionals involved with the transaction, such as Attorneys, CPAs, Wealth Managers, etc.

Residential Brokers list and sell houses. According to the National Association of Realtors, the average house sold had been on the market for 3 weeks.  Business Brokers list and sell businesses. According to Business Brokerage Press, the average time on the market for a business is a little over 7 months.

Real Estate Brokers typically advertise their property on a Multiple Listing Service (MLS) where brokers all over the state can see what is available.  Business Brokers, because the information about the business is more sensitive and confidential, must “make the market” for the business, rather than rely upon an MLS.  This can include advertising on websites, print media, direct solicitations to likely buyers, exposure to Private Equity Groups, etc.

The skillset and knowledge base necessary is vastly different between the two. So, if you are selling a home seek out those who are Realtors.  If you are selling a stand-alone commercial property without a business, then look for a commercial broker. And if you are selling a business, find a Certified Business Broker or Certified Business Intermediary.

Earn Outs In The Sale Of A Business–A Bridge To A Deal

It won’t surprise anyone to know that the seller of a business almost always thinks that the business is worth more than the buyer is offering, just as it won’t surprise anyone to know that the buyer almost always thinks the seller is asking too much.  One way to close the deal gap to the satisfaction of both parties can be an earnout.

Internet-based Investopedia says an earnout is “…a contractual provision stating that the seller of a business is to obtain additional future compensation based on the business achieving certain future goals.”  It goes on to say that “…the future earnings are usually stated as a percentage of gross sales or earnings.”

Let’s take a look at our view of how an earnout might work in the real world.

The owner of San Diego Widgets wants to sell.  During last year’s recession, sales slipped to $8M from the previous year’s $10M, but the owner is convinced that the business is rebounding.  The buyer is skeptical.  For a number of reasons – not the least of which are the looming tax burdens on business sales due to take effect on January 1, 2011 – the seller thinks making a deal this year is in his best interest.  He wants $2M, but the buyer is only willing to pay $1.7M.  How can an earnout close the $300k gap?

The simplest way would be an earnout based upon a percentage of gross sales.  The buyer might agree to pay the seller 5% of gross sales over $8M each year for the three years following the closing.  If the company rebounds to $10M and remains at the $10M mark for the three years, the seller would receive 5% of $2M each year for three years.  This is an amount equal to the $300k deal difference.

Why does this work for both parties?  For the buyer, it protects the “downside.”  If the buyer is right, and the business does not rebound, the buyer is protected and has not “over-paid” for the business.

The seller, on the other hand, gets full value if he’s right and the business does rebound.  And to provide the seller with an incentive to take less now in exchange for the possibility of more later, the buyer has agreed to pay the seller an additional 2.5% on sales up to $12M.  That means that the seller could earn an additional $150k if the business jumps to $12M and stays there.  The buyer figures that the extra incentive will keep the seller interested in the success of the business and encourage him to help it grow.

So, an earnout can be a bridge to a deal.  But there are two important things to consider in structuring earnouts that will make the bridge dependable and easily crossed.

First and foremost, the parties should insist that the earnout be based upon an objective and readily ascertainable criterion or benchmark, such as gross revenues.  If the parties choose to use some other criterion, then the method whereby the less-objective criterion will be determined, and by whom it will be determined, should be specified.  For example, if “net income” is the criterion, it will be affected by discretionary decisions regarding capitalization, deferral of revenue, allocation of overhead expense, and salary levels applicable to senior managers.  Buyers and Sellers of small businesses should be cautioned that language such as “… in accordance with Generally Accepted Accounting Principles (GAAP)…” by itself is not sufficient and small businesses almost never have statements prepared according to GAAP.

Second, the sale agreement should specify what types of financial reports will be created, where will the records be maintained, who will maintain them, when will they be distributed to the seller, and on what schedule they will be made available.  The Seller shall have full and complete access to all financial records, including source documents and accountant’s work papers, and the agreement should also prescribe that the Seller may inquire directly of Buyer’s in-house and outside accountants and may obtain documents directly from them upon request.

There are, of course, other considerations, and an earnout is best structured with careful consideration and with the input of an attorney experienced in business transactions.

Private Equity: Sell Now, Keep Your Job, Retire Later

A lot of people know that Harvard University’s $23B endowment fund is famous for consistently out-performing the marketplace, but far fewer know that one key to the fund’s success is its astounding 15% investment in private equity.  Similarly, while many people know big-name private equity firms (“PEGs”) like Kohlberg, Kravis & Roberts (KKR)  made famous by the book and movie “Barbarians at the Gate,” a considerably smaller number know that there are today thousands of small- and medium-sized PEGs focused on buyouts of small- to mid-sized privately held companies.

 

It’s been estimated that collectively these funds represent well in excess of one billion dollars in capital available for the acquisition of these privately held businesses.  This is great news for the business owner whose firm is too large for the typical private investor, but too small to attract the KKR’s of the world.  Until the emergence of this new and growing private equity marketplace, the owners of these firms were typically limited to selling to their employees and/or family members or selling to a competitor.  Neither of these is an ideal option.

 

Selling to the kids or employees typically means an ESOP – Employee Stock Ownership Plan.  Since it’s extremely rare that children or employees have sufficient capital to purchase the business outright, the owner is typically left with substantial debt.  This means spending the next several years worrying about whether or not the company will flourish and meet its obligations.  Unfortunately, all too often, the company flounders and it does not.

 

Selling to competitors is equally unattractive.  Just alerting the competition that a company is for sale has serious potential for repercussions.  Competitors can be quick to use the company’s uncertain status to go aftermarket share and key employees, often with devastating results.  And even if they decide to buy the company itself, they almost never pay full value.

 

That’s what makes private equity so attractive: the opportunity to sell the company without assuming significant debt or alerting competitors.  And contrary to popular belief, the prices paid by private equity are more than competitive with the prices paid by strategic buyers.  In fact, the competition between private equity firms for acquisitions often pushes the dollar amounts to the very top of the scale.

 

So, what’s the hitch?  Why doesn’t everybody sell to a PEG?

 

The answer is simply this: PEGs aren’t interested in running companies; PEGs are interested in investing in companies.  That means that the company must have a management team in place or the owner must be willing to remain for a period of time while a management team is groomed and put into place.  Sometimes, that time period can be protracted:  PEGs know that the individual who got the company to the place that attracted their interest is often the best individual to ensure the company’s continued growth and success.  It’s only natural that they want that individual to hang around for a while to hedge their bet in its future.

 

So, what does this mean to the owner of a business that could be targeted by the PEGs?

 

For an owner thinking about retiring in three to five years, now is the time to sell.  By making a deal today, the business owner can have the best of both worlds: cash in the bank and a job until retirement that often comes with significant monetary incentives for growth.

 

 

 

 

 

 

 

 

 

 

 

 

 

Seller Discretionary Earnings-Calculating Your Earnings Correctly

What’s the first question the Buyer asks about your business? Usually, it’s “how much can I make if I own this business?”  For main street businesses, those transactions under $1,000,000 in transaction value, usually the Buyer is looking for “Sellers Discretionary Earnings.”

Seller’s Discretionary Earnings (SDE) is usually calculated as follows:

Net profit of the business, plus

Officer or Owner Salary, plus

Owner Perks such as country club memberships, etc., plus

Interest, depreciation, and amortization, plus

One- time extraordinary expenses

 

But the devil is in the details. So, make sure you don’t make the following mistakes:

  1. The owner’s salary can only be included if the Owner paid themselves through the business and expensed it on the income statement or tax return. Owner draw CANNOT be counted.
  2. Only ONE owner’s salary can be included. If there is more than one owner, or family members working in the business, a fair market wage must be included in the expenses.
  3. Only those Perks that do not impact the business can be adjusted. For example, if your customers rely upon the owner taking them out to dinners or sporting events, and without those perks, you could lose the business, then those must stay with the business. Same with the owner’s automobile expenses if they go to see clients, pick up things at Costco, make deliveries, etc.
  4. Usually, most interest can be “added back”, but not interest that will stay with the business after the sale. For example, interest costs on vehicle loans not being paid off at closing, flooring interest for businesses with large amounts of inventory, etc. cannot be adjusted out.
  5. Depreciation costs are usually an adjustment, but consideration must be given to those businesses with assets that depreciate quickly and are costly to replace. For example, a business with a fleet of 10 trucks and on average, a truck will last 10 years, you need to consider leaving in enough depreciation to cover the cost for one truck being replaced each year.
  6. One-time expenses are just that—ONE TIME. These can be items like the cost to design a new company logo which may never be done again. Or to rebuild a storage shed after a fire that was a once in a lifetime occurrence. It is NOT the cost to replace the carpet in a restaurant that traditionally is replaced every three years. (you could amortize that cost over the useful life instead of it impacting one year in particular)

Every business is different, so buyers and sellers really need to use common sense and fairness in computing SDE. And buyers need to remember, this is the SELLER’s Discretionary income, not Buyers! SDE is a snapshot of the Sellers operation, and how the buyer operates the business will determine THEIR SDE.

What You Need to Know About Foreign Buyers

There is a potentially lucrative group of buyers that many sellers don’t initially think about.  We are talking about foreign buyers.  While there are some hurdles to working with these types of buyers, it is important to note that there are many huge advantages as well.  Let’s take a closer look.

How Are Foreign Buyers Different? 

At the top of the list of ways in which foreign buyers are different is that they are often seeking a visa.  Another commonality among foreign buyers, one that will surprise many, is that they may want access to the U.S. educational system. 

It is common for foreign buyers to want to buy a business so that they can get their children into a particular U.S. school district or college.  Sometimes the desire to be eligible for state tuition also plays a role in the selection of a business and the decision-making process.  In this sense, business location takes on a level of importance that it might not have for domestic buyers. 

It is important to keep in mind that there are cultural and business differences that play a role with foreign buyers.  Everything from a different use of business terminology to expectations can play a role.  This could impact negotiations. 

What About Visas and Immigration?

One of the most important things to remember is that foreign buyers are often navigating the complex world of visas and immigration.  Whether or not a visa is issued can dramatically impact whether or not a deal ultimately takes place.  This fact is often built into agreements.  For example, a purchase condition may be conditional upon visa approval.  Nonrefundable deposits may also play a role in the process.

What Do Foreign Buyers Really Want? 

Foreign buyers have been impacted by the pandemic too.  Yet, some factors remain unchanged.  Not too surprisingly, they will want to see that a business is profitable.  In this regard, you should be able to showcase profitability in a clear fashion.  You can expect foreign buyers to want to see tax returns and all the typical documentation that you’d need to provide to any buyer.

A second factor that foreign buyers are interested in is longevity.  If your business has successfully operated for decades, this will be a major advantage.  

Ultimately, most of what domestic buyers are looking for in a business will translate over to what foreign buyers are seeking as well.  With that stated, however, there are factors that are often unique to foreign buyers.  As mentioned above, navigating the often-complex visa process can add a wrinkle to the entire process.

Copyright: Business Brokerage Press, Inc.

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Essential Meeting Tips for Buyers & Sellers

The buyer-seller meeting is quite often a “make or break” meeting.  Your business broker or M&A Advisor will do everything possible to ensure that this meeting goes as well as possible. 

It is vitally important to realize that rarely is there an offer before buyers and sellers actually meet.  The all-important offer usually comes directly after this all-important meeting.  As a result, you want to ensure that meetings are as positive and productive as possible.

Buyers need to understand how the process of selling a business works and what is expected of them from the process.  Buyers also need to understand that following their broker’s advice will increase the chances of a successful outcome. 

Sellers should be ready to be honest and forthcoming during the meeting.  They also want to be sure to not say or do anything that could come across as a strong-armed sales tactic. 

Asking the Right Questions

If you are a buyer preparing to meet a business owner for the first time, you’ll want to make sure any questions you ask are appropriate and logical.  It is important for buyers to place themselves in the shoes of the other party. 

Buyers also shouldn’t show up to the buyer-seller meeting without having done their homework.  So be sure to do a little planning ahead so that you are ready to go with good questions that show you understand the business. 

Building a Positive Relationship

Buyers should, of course, plan to be polite and respectful.  They should also be prepared to avoid discussing politics and religion, which often can be flashpoints for confrontation.  When sellers don’t like prospective buyers, then the odds are good that they will also not place trust in them.  

For most sellers, their business is a legacy.  It quite often represents years, or even decades, of hard work.  Needless to say, sellers value their businesses.  Many will feel as though it reflects them personally, at least in some fashion.  Buyers should keep these facts in mind when dealing with sellers.  A failure to follow these guidelines could lead to ill will between buyers and sellers and negatively impact the chances of success.

Sellers Should Be Truthful

Sellers also have a significant role in the process.  While it is true that sellers are trying to sell their business, they don’t want to come across as a salesperson.  Instead, sellers should try to be as real and honest as possible.

Every business has some level of competition.  With this in mind, sellers should not pretend that there is zero competition.  A savvy buyer will be more than a little skeptical.

The key to a successful outcome is for business brokers and M&A Advisors to work with their buyers and sellers well in advance and make sure that they understand what is expected and how best to approach the buyer-seller meeting.  With the right preparation, the odds of success will skyrocket.

Copyright: Business Brokerage Press, Inc.

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The Main Street Lending Program

There is no doubt that the COVID-19 situation seems to change with each and every day.  The disruption and chaos that the pandemic has injected into both daily life and business is obvious.  Just as it is often difficult to keep track of the ebbs and flows of the pandemic, the same can be stated for keeping up to speed on the government’s response and what options exist to assist companies of all sizes. 

 In this article, we’ll turn our attention to an overlooked area of the government’s pandemic response and how businesses can use a whole new lending platform to navigate the choppy waters. 

As the pandemic continues, you will want to be aware of the main street lending program, which is a whole new lending platform.  It was designed for businesses that were financially sound prior to the pandemic.  Authorized under the CARE Act, the main street lending program is quite attractive for an array of reasons.  Let’s take a closer look at what makes this program almost too good to be true.

This lender delivered program is a commercial loan.  Unlike the PPP, there is no forgivable component.  However, the main street lending program does have one remarkable feature that will certainly grab the attention of all kinds of businesses.  It can be used to refinance existing debt at a rate of around 3%.  With that stated, it is also important to note that businesses cannot refinance existing debt with the current lender.  Instead, a new lender must be found.  Generally, loans are a minimum of a quarter million dollars and have a five-year term.  In another piece of good news, there is a two-year payment deferment period.

The main street lending program can be used in a variety of ways.  In short, the program is not simply for refinancing existing debt.  Additionally, there is no penalty for prepayment.  The way the program works is that lenders make the loans and then sell 95% of the loan value to the Fed.  This of course means that the lender is only required to retain 5% of the loan on their balance sheet.  The end result is that lenders can dramatically expand the amount of loans they can make.

Whether it is the PPP or a program like the main street lending program, there are solid options available to help you.  Businesses looking to restructure debt or put an infusion of cash to good use may find that the main street lending program offers a very flexible loan with great interest rates.

Copyright: Business Brokerage Press, Inc.

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Seller Financing: It Makes Dollars and Sense

When contemplating the sale of a business, an important option to consider is seller financing.  Many potential buyers don’t have the necessary capital or lender resources to pay cash.  Even if they do, they are often reluctant to put such a hefty sum of cash into what, for them, is a new and untried venture.

Why the hesitation?  The typical buyer feels that, if the business is really all that it’s “advertised” to be, it should pay for itself.  Buyers often interpret the seller’s insistence on all cash as a lack of confidence–in the business, in the buyer’s chances to succeed, or both.

The buyer’s interpretation has some basis in fact.  The primary reason sellers shy away from offering terms is their fear that the buyer will be unsuccessful.  If the buyer should cease payments–for any reason–the seller would be forced either to take back the business or forfeit the balance of the note.

The seller who operates under the influence of this fear should take a hard look at the upside of seller financing.  Statistics show that sellers receive a significantly higher purchase price if they decide to accept terms.  On average, a seller who sells for all cash receives approximately 70 percent of the asking price.  This adds up to approximately 16 percent difference on a business listed for $150,000, meaning that the seller who is willing to accept terms will receive approximately $24,000 more than the seller who is asking for all cash.

Even with these compelling reasons to accept terms, sellers may still be reluctant.  Selling a business can be perceived as a once-in-a-lifetime opportunity to hit the cash jackpot.  Therefore, it is important to note that seller financing has advantages that, in many instances, far outweigh the immediate satisfaction of cash-in-hand.

  •  Seller financing greatly increases the chances that the business will sell.
  • The seller offering terms will command a much higher price.
  • The interest on a seller-financed deal will add significantly to the actual selling price. (For example, a seller carry-back note at eight percent carried over nine years will double the amount carried.  Over a nine-year period, $100,000 at eight percent will result in the seller receiving $200,000.)
  • With interest rates currently the lowest in years, sellers can get a much higher rate from a buyer than they can get from any financial institution.
  • The tax consequences of accepting terms can be much more advantageous than those of an all-cash sale.
  • Financing the sale helps assure the success of both the sale and the business, since the buyer will perceive the offer of terms as a vote of confidence.

Obviously, there are no guarantees that the buyer will be successful in operating the business.  However, it is well to note that, in most transactions, buyers are putting a substantial amount of personal cash on the line–in many cases, their entire capital.  Although this investment doesn’t insure success, it does mean that the buyer will work hard to support such a commitment.

There are many ways to structure the seller-financed sale that make sense for both buyer and seller. Creative financing is an area where your business broker professional can be of help. He or she can recommend a variety of payment plans that, in many cases, can mean the difference between a successful transaction and one that is not. Serious sellers owe it to themselves to consider financing the sale. By lending a helping hand to buyers, they will, in most cases, be helping themselves as well.

Copyright: Business Brokerage Press, Inc.

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Negotiating the Price Gap Between Buyers and Sellers

Sellers generally desire all-cash transactions; however, oftentimes partial seller financing is necessary in typical middle market company transactions.  Furthermore, sellers who demand all-cash deals typically receive a lower purchase price than they would have if the deal were structured differently.

Although buyers may be able to pay all-cash at closing, they often want to structure a deal where the seller has left some portion of the price on the table, either in the form of a note or an earnout.  Deferring some of the owner’s remuneration from the transaction will provide leverage in the event that the owner has misrepresented the business.  An earnout is a mechanism to provide payment based on future performance.  Acquirers like to suggest that, if the business is as it is represented, there should be no problem with this type of payout.  The owner’s retort is that he or she knows the business is sound under his or her management but does not know whether the buyer will be as successful in operating the business.

Moreover, the owner has taken the business risk while owning the business; why would he or she continue to be at risk with someone else at the helm?  Nevertheless, there are circumstances in which an earnout can be quite useful in recognizing full value and consummating a transaction.  For example, suppose that a company had spent three years and vast sums developing a new product and had just launched the product at the time of a sale.  A certain value could be arrived at for the current business, and an earnout could be structured to compensate the owner for the effort and expense of developing the new product if and when the sales of the new product materialize.  Under this scenario, everyone wins.

The terms of the deal are extremely important to both parties involved in the transaction.  Many times the buyers and sellers, and their advisors, are in agreement with all the terms of the transaction, except for the price.  Although the variance on price may seem to be a “deal killer,” the price gap can often be resolved so that both parties can move forward to complete the transaction.

Listed below are some suggestions on how to bridge the price gap:

  • If the real estate was originally included in the deal, the seller may choose to rent the premise to the acquirer rather than sell it outright.  This will decrease the price of the transaction by the value of the real estate.  The buyer might also choose to pay higher rent in order to decrease the “goodwill” portion of the sale.  The seller may choose to retain the title to certain machinery and equipment and lease it back to the buyer.
  • The purchaser can acquire less than 100% of the company initially and have the option to buy the remaining interest in the future.  For example, a buyer could purchase 70% of the seller’s stock with an option to acquire an additional 10% a year for three years based on a predetermined formula.  The seller will enjoy 30% of the profits plus a multiple of the earnings at the end of the period.  The buyer will be able to complete the transaction in a two-step process, making the purchase easier to accomplish.  The seller may also have a “put” which will force the buyer to purchase the remaining 30% at some future date.
  • A subsidiary can be created for the fastest growing portion of the business being acquired.  The buyer and seller can then share 50/50 in the part of the business that was “spun-off” until the original transaction is paid off.
  • A royalty can be structured based on revenue, gross margins, EBIT, or EBITDA.  This is usually easier to structure than an earnout.
  • Certain assets, such as automobiles or non-business-related real estate, can be carved out of the sale to reduce the actual purchase price.

Although the above suggestions will not solve all of the pricing gap problems, they may lead the participants in the necessary direction to resolve them.  The ability to structure successful transactions that satisfy both buyer and seller requires an immense amount of time, skill, experience, and most of all – imagination.

Copyright: Business Brokerage Press, Inc.

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Getting Back to Business After the COVID-19 Pandemic

Historians have long known the historical relevance and impact of epidemics and pandemics.  Despite our various technological advances and the complexity of our society, disease can instantly change the course of history.  Not having a robust global system for dealing with disease and pandemics comes with a hefty price tag.  In the case of the COVID-19 economic crisis, the price tag will no doubt be in the trillions. 

You can’t control what has happened, but you can focus on what to do when the pandemic is over and life begins to slowly return to normal.  In his recent article, “How to Hit the Ground Running After the Pandemic,” author Geoffrey James explores what businesses need to do to jumpstart their operations once the pandemic is in the history books.

James wants his readers to understand that the pandemic will end and that business owners need to be ready to charge back in when the pandemic is over and the economy rebounds.  As James points out, if history is any indicator, the economy will eventually rebound. 

Almost everything about this economic downturn is unique.  Take, for example, the fact that the U.S. has just seen its largest-ever economic expansion.  The gears and wheels of the economy were spinning along quite quickly before the pandemic hit.  This could help restart the economy faster than in past severe economic downturns.  In short, many experts feel that this particular economic downturn could be short, but of course, this is speculation.  There is no way to know for sure until COVID-19 is in the rearview mirror.

James correctly asserts that businesses need to put together a plan for how they will get up and running as soon as the pandemic is over.  His recommendation is to divide your plan and thinking into four distinct categories: Facilities, Personnel, Manufacturing, and Marketing.

Each of these categories has three key questions that business owners should be asking themselves so that their businesses are ready to hit the ground running when COVID-19 is over.  Below are a few of the key questions James recommends asking.

  1. How can we create the most sanitary and disease-free workplace possible?
  2. Which employees will continue to work from home?
  3. When there’s a spike in demand, how will we ramp-up?
  4. What will be our “We’re Back!” marketing message?

The pandemic caught everyone except the experts off guard.  Moving forward, business leaders, think tanks, and politicians alike need to work to develop and implement robust plans to minimize the damage caused by pandemics.  Humanity, and business, has been “lucky” several times in recent years, as we dodged bullets ranging from Ebola to SARS. 

As James points out in his article, “Failing to plan is planning to fail.”  Businesses need to plan for the recovery and they need to plan for another pandemic because another one is quite possible especially if better planning and decision making are not firmly entrenched in place.

Copyright: Business Brokerage Press, Inc.

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