There are six rules of engagement when negotiating as a buyer or pre-planning as a seller
In part one we'll cover the first three of six rules in depth
There are some basic rules that any prospective buyer of a business must remember during the negotiations. Similarly, there is some pre-planning that a seller must do to ready his business and herself for the best price. This article will attempt to cover the major rules of engagement, from each sides perspective .
Rule 1: Take Emotion Out of the Equation
Over 40 years of seeing deals done, we have observed that a seller’s estimation of value of her company often increases disproportionately and illogically based upon the seller’s proximity to retirement, or when the seller has excessive debts to pay. Neither of these motivational factors are related to the true value of the small business enterprise ( SBE).
Therefore, sellers need an advisor on their side to help the seller understand the real value of the business, and to encourage a seller to deal with realities. However, even if the seller does not have an advisor, the lack of interest in the deal from qualified buyers will ultimately tell the seller she is over-pricing the deal, and that economics will prevent a deal from being made. This occurs many times because funding sources like banks, economic development agencies and the Small Business Administration will send clear signals that a deal is not bankable .
Similarly, buyers sometimes ”fall in love with the deal”. We have seen situations where a buyer felt so determined to buy a company, that he would “do it at any cost”.
If an SBE has signs of distress (overly burdened with debt, decreasing pattern of sales over time, shrinking profit margins) or does not have sufficient cash-flow to cover all operating expenses, pay the new owner fair and reasonable compensation, and pay the new monthly bank loans, based on the deal you would make, it may be a bad deal. In order to force the deal, sometimes buyers will stretch their personal economic assets by cashing in their retirement plans, tapping out high interest credit cards or borrowing “grandma’s last nickel”.
A deal needs to fund itself through reasonable market-rate bank financing. Just like the seller, a buyer needs an advisor. While most buyers go to see their attorney (and attorneys are an important part of the entrepreneur’s advisory team) the buyer should either seek out a certified public accountant experienced in business acquisitions and business valuations, or the buyer can make contact with your state’s Small Business Development Center (SBDC) . To contact the local SBDC, simply do an internet search , and your closest SBDC should be found easily .
So, let the buyer beware, and remember Rule #1: No Deal is Better Than a Bad Deal.
Rule 2: Be Honest With All
A buyer needs to first be honest with himself.
Take inventory of what your skills and talents are, what ability you have to obtain sufficient financing, and evaluating where you are in life. If you have never owned a business before, that does not disqualify the buyer. But if you expect “learning on the job” is your plan, that is a dangerous first step. Instead, take appropriate business classes (primers) at your local community college or high school, or check with the local SBDC for available training. Make sure you understand the product or service your proposed SBE offers, if you plan to be the company’s primary sales person. Determine what are your economic resources .
If you are nearing retirement age (59 or more) and must cash out your pension to make the deal happen, you may be making a serious mistake because you won’t have enough time to recover if the deal flops. Finally evaluate the state of your physical and mental health. Small business owners do not work an 8-hour day, and often face tremendous stress associated with owning an SBE. Know yourself.
The seller has to demonstrate integrity. While the seller may “hype” (exaggerate) the positives of the business he is selling, any buyer should be leery of a seller who shows you his tax returns and financial statements, and then tells you something like “ Well, there is actually more money that does not hit the books”. When a seller suggests something like that, it is evidence that he either lied on his tax returns when he filed them, or that he is lying now to you. Either way, this means the owner lacks integrity. Such verbiage does not mean a buyer should immediately walk from the deal.
Our approach is typically to value the income streams of what the business actually shows or can prove, and make an offer based on what can be proven. Some small business owners will at least attempt to record all of their sales a year or two before the owner wants to sell off, as a means of showing what the company actually generates in profit. While this is good news for both the buyer and seller, it may produce an untrue appearance of company growth, because the most recent years are inflated compared to earlier years when the owner was “skimming” cash.
Either way, Rule 2 is simple. As the buyer or the seller, be honest with yourself, so that a good transaction occurs with all the facts known.
Next- Rule 3: Due Diligence Is Required for All Deals, Big and Small
About the author
Raymond M Nowicki CPA is managing partner of Nowicki and Company, LLP, a firm with its headquarters in Buffalo, NY with a satellite in Manhattan. Nowicki is a nationally recognized speaker and trainer of CPAs on pension plan auditing, and quality improvement for CPA practices. His firm also audits 401K plans. Ray has helped Nowicki and Company, LLP grow to be one of the top 30 firms in Western New York. In recognition for service to small businesses, New York Governor George Pataki awarded him the Small Business Advocate of the Year Award in 2005. He serves most of the firm clients, especially in a number of specialized areas including estate planning and trusteeship, structuring new business ventures, strategic planning and workouts, and litigation support.Website