BUYING A BUSINESS

The motivations for buying a business are many. A common reason these days is that the person has been retrenched. He or she may be over the age of 40 and the chances of obtaining further employment are slim. He or she will often have received substantial severance pay. To put it bluntly, the person is "buying" a job. Another reason is that the person may be a married woman whose children have grown up and she wants to return to the work-force. Because of a lack of skills, the only employment avenues open to her may be menial jobs like cleaner etc. Running one's own shop looks a much more attractive proposition. Another group will comprise those who cannot stand having a boss and who want independence and who want to able to do their own thing.

How do you start? First of all, you must find what skills or aptitudes you have. It is a sad fact that 80% of all small businesses fail in the first five years. Lack of management ability plays a big part in these failures. What have you worked at in the past five years? If you worked in a shop or store, then buying a retail shop might be appropriate. If you worked in an office, then your choices are more limited. You could start or buy a secretarial agency. What are your hobbies? If you like gardening, perhaps buying a plant nursery might be appropriate. If you have worked at home for the past 20 years, you may think that you have no skills. But how about a child-minding business? Or a cleaning business? You can also acquire the necessary skills by attending night-classes.

A developing trend over the past 30 years has been for a person to buy a franchise. A good franchisor will show you the ropes and train you. The proportion of failures in franchising is much lower than with ordinary businesses. Many franchisors are now household names such as MacDonalds, Kentucky Fried Chicken, Pizza Hut, H & R Block, Ultratune, The Body Shop etc. But you should be aware that some franchise schemes are nothing more than "con" jobs. You pay your $10,000 or whatever for the franchise. You are then given the right to trade under some franchise name, carrying out some ordinary activity. That will be the last you will hear from your franchisor. You may find that trading under the name adds little or nothing to your business prospects. So beware!

Where do you look for businesses for sale? The first place to look is in the classified advertisements in the local paper. Also, consult your local estate agents. Inspect as many businesses as possible. Do not be stampeded into a purchase without adequate investigation.

When looking at a business, there are a number of things you should concern yourself with. Why is the person selling? Often, these days the reason for selling is that the business is doing poorly i.e. it is either running at a loss or it is not making sufficient profit. Another common reason for selling is that the business is currently profitable but the seller has identified a cloud on the horizon. The "cloud" may be another competitor about to start up nearby. Or it may be that the market is slowly declining for some reason. Or it may be there is development planned for the locality such as re-routeing a road. To state it broadly, in some way the business environment is about to change for the worse. It is amazing how often the reason given for a sale is "health reasons" of the proprietor.

When you see a business which you like, the first thing that you must do is obtain the records of the business for the past five years. You must ask the seller to allow you or your accountant to inspect 1) the Tax Returns for the past five years, 2) the Financial Statements including Profit & Loss and Balance Sheet for the past five years, 3) the Cash Book for the past five years, 4) the bank statements for the past five years. In particular, examine the Financial Statements for trends. Is the turnover and Net Profit increasing or decreasing? Remember to take inflation into account. A turnover which is static in actual fact will nevertheless show increases each year due to inflation.

If the business has been reasonably profitable in the past, the next thing you must decide is 'Will it continue trading profitably in the future?' You must look at all factors that could have a bearing on this. Is competition starting up nearby? What developments are planned for the area? Is the industry in decline? For example, what effect will the Federal Government's abolition of tariffs have? Will many customers leave because they have a personal attachment to the present owner? Will key employees continue in your employ? Is unemployment on the increase in the area? From all the information garnered, you or your accountant should do a projection of profit for the next three years. If you are satisfied that the business has been profitable and, most importantly, that it will continue being profitable under your ownership, then you think about buying it.

How much should you pay? Many people think there is a formula, based on turnover, to calculate this. This is not true. The answer really is fairly simple. Let us take an example. Suppose you have $100,000 to invest. If you put this money in a bank at present, you will get approximately 6% interest i.e. $6,000 per year. If you were to invest it in buying a business, you would expect at least a similar return i.e. a Net Profit of $6,0000 per year. The Net Profit of $6,000 would be, of course, after paying wages to yourself for working in the business. However, interest rates are expected to rise and long-term interest rates are quoted at about 10% at present. So, you would expect at least 10% interest. But there is a greater risk attached to money invested in a business compared to money in a bank. Because of the greater risk, you would expect at least 15% interest. Let us suppose that the business you have in mind makes a Net Profit of $70,000 per year before taking out any wages for the owner. What is the value of the business? Let's say the wages of a manager (yourself) would be $30,000. As we said above, you would expect a return of 15% p.a. on the investment.

Net profit 70,000
less owner's wages 30,000
TRUE NET PROFIT  $ 40,000

Expected return on investment is 15% p.a.

Value of business is 40,000/15 X 100 = $266,667.

This means that if I invest $266,667 at 15% pa, I will get $40,000.

Now, assume that the business comprises the following assets. Plant and equipment, $100,000. Stock, $50,000. What is the value of Goodwill? It is the balance of the purchase price.

Plant and equipment 100,000
Stock   50,000
Balance i.e. goodwill     116,667
VALUE OF BUSINESS  $ 266,667

You find that the asking price of the seller is close to this mark, so you decide to go ahead with the purchase.

Most often, the buyer will not have the cash to pay the full purchase price. He or she will need finance. You should not overlook obtaining finance from the seller. Often they will give you finance at a much lower rate than a bank or finance company. Your accountant can prepare a schedule of monthly repayment terms once you have agreed on 1) the amount to be borrowed, 2) the number of years for the loan and 3) the interest rate. You must be able to give adequate security i.e. a charge over the business, a mortgage on your private house, a guarantee by your spouse etc. Banks invariably give cheaper loans than a finance company. Both will want full details when considering granting a loan. Invariably, they will want a Cash Projection prepared by your accountant. This is a document estimating your Gross Income for the next 12 months, your expenses for the next 12 months, your own wages required for the next 12 months and the cost of purchase of equipment for the next 12 months. It will show cash coming in each month and cash going out each month and the estimated balance at the end of each month. Obviously, the bank will not advance you a loan unless your forecast shows that you will be able to meet the monthly loan repayments.

Once you have arranged finance, you must consider the actual purchase procedure. There are generally three options open to you and the seller. The first is termed WIWO - "walk-in-walk-out". With this option, there is no written agreement. You present yourself at the business on an agreed day. You pay over a bank cheque to the seller. The seller hands you the keys and walks out. This type of agreement is common in the purchase of small businesses such as a retail shop in a shopping centre. The next option is as follows. You agree on terms. Then one of you writes down the terms in black and white. You both sign the document and each keeps a copy. This may be better than WIWO but it is fraught with legal ramifications. You are taking a calculated risk. The third option is to go to a solicitor and have a written agreement drawn up by him. This is the more expensive option. In Victoria, New South Wales and South Australia, the seller must give you certain details in a prescribed statement.

Whatever procedure you adopt, you should consider the following matters.

Plant and equipment.

The seller must prepare a list of plant and equipment included in the sale. He must also state the values attaching to each amount. These are often what are called the tax written-down-values. It is important that you both agree as to the items handed over and their values. Otherwise, you could have tax problems. You should also make sure that no outstanding Bills of Sale or Hire Purchase agreements attach to any plant and equipment. If there are any outstanding Bills of Sale, the finance company can repossess the equipment if you do not keep up the payments. You can do a search of the Bills of Sale Register at your local Land Registry. Also, make sure that the plant and equipment is owned by the seller and not just leased by him.

Lease.

The most desirable course is to obtain a new lease in your name from the landlord. Examine the lease for the following provisions. Does the lease state that you have an option to renew it? Does the lease state that you can sublet? Does the lease state that you can assign it without the consent of the landlord? How will the rent be fixed? Is it based on turnover? When finalised, you should register the lease at your local Land Registry.

Stock.

Normally, the quantity of stock fluctuates from day to day. You cannot fix the price to be paid for the stock until the day comes to take possession of the business. The normal agreement, therefore, provides that the stock will be valued jointly by seller and buyer at date of entering into possession. It will be valued at cost price. Obsolete, damaged stock etc will be written down.

Business Name.

Make sure the seller signs a transfer form at date of sale. You must carry out the new registration at your Business Affairs Office.

Fixtures and Fittings.

Often these are included in the list of assets to be sold with the business. But often in these cases, the seller does not actually own the fixtures and fittings. It is the law that fixtures belong to the landlord and not to the tenant. So beware.

Employees.

Decide which employees you will keep on. Look into questions of their existing Long Service Leave entitlements, holidays due, Occupations Superannuation entitlements.

Tuition.

Agree whether the existing owner will provide tuition to you. Often, the existing owner will stay on for a few weeks at agreed wages to train you.

Seller starting up similar business.

You might be put out if the seller immediately starts up a similar business next door to you after the sale. You might wish to include in the written sale agreement a provision that the seller, for example, will not trade in a similar capacity for three years within two kilometres of your shop. Do not stipulate for too onerous conditions binding the seller. They will not be legally valid. For example, a stipulation that the seller must never own a similar shop again would not be legally binding.

Utilities.

Make sure the phone, electricity, garbage collection, Post Office box number, fax number, rates, are transferred into your name. Once you have started up in business, do not forget about the tax-man. Normally, no PAYE tax will be taken out of your drawings each week. You will have to pay all of your tax in one king-hit on the 1st April each year. Ask your accountant to estimate your Net Profit for the year and then to estimate the tax that you will have to pay based on that Net Profit. Then save up for it. Open a savings deposit account at the bank. Put a sufficient amount into it each week. When the time comes to pay the tax-man, hopefully, you will have enough in the account to pay him.

You should be aware that any profit received on sale of Goodwill is now taxable as a capital gain. However, there is a concession by the Tax Office inasmuch as only 50% of the profit on sale will be subject to Capital Gains tax.

DISCLAIMER: See disclaimer on home page.

Copyright 1994



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