If you are able to determine the exact reason or reasons why the current owner wants to divest himself of the company it will or should allow you to negotiate the acquisition of the business at the best possible price under the best possible terms.
- For instance, if the current owner has some debt that needs to be repaid then the Letter of Intent must contain enough cash at closing to allow that debt to be repaid. An offer that has a much higher total financial consideration but with less cash at closing will not satisfy the sellers needs and will most likely not be accepted.
As an example, the current owner has a debt burden $500K and has decided to sell this business in order to obtain enough cash to eliminate that debt. The Business Broker informs you that he has already rejected a Letter of Intent to purchase his business of $1M. Your initial reaction to that statement by the Business Broker may be that you would have to offer much more than $1M in order to consummate the transaction and acquire the business. But that may not be the correct interpretation of what the actual situation is. What if the original Letter of Intent to purchase for $1M was based on an initial $300K cash at closing with the seller taking back a $700K 10 yr note with interest and principal payments made quarterly in arrears. The seller may have decided to reject the offer not because of the total price consideration offered, but because of the payment terms. The seller may, under these circumstances, be more than willing to sell the business for $750K providing that you pay a minimum of $500K cash at closing. In this case an offer to purchase his business at $1.5M, if it only provided $400K on closing may not be accepted.
- It is possible that you would have your offer rejected by the seller if one of the stipulations is that he stays involved in the business for a minimum of a three-year period and he is suffering from poor health.
- A business that is being sold due to the demise of the owner can usually be purchased at a bargain. However, you have to make sure that the business has not deteriorated over the period of time from the owner’s demise to the time that you acquire it. As well you must take into account that there is not going to be any transfer of knowledge pertaining to the prior success or operation of the business.
- In some cases a seller may be much better off financially if he does not get the total selling price of the business in one lump sum payment. A payment plan may help the seller avoid or if nothing else spread out the taxes on the profits he is about to make on the sale of the business.
Depending on the resources of the seller, it may help you to structure your offer to purchase if you have your accountant explain the tax consequences that the seller will face under different payment scenarios.
A seller will usually list their business for sale at price higher then the price that they are actually prepared to accept. As well, the seller will usually request that the total purchase price be paid in cash at closing. In most cases the seller does not get the price that the business is listed for nor does he get 100% cash at closing. But it is the starting point for negotiations.
Remember that if there is a Business Broker or other intermediary involved that they will get their fee based on a percentage of what you pay for the business. Hence, it is in their best interests to have you pay as much as absolutely possible.
Earn-out Agreements:
In a lot of cases the current owner will set his selling price on what he believes is the growth potential or the future profitability of his company.
As an example, let’s assume that you are considering the acquisition of a manufacturing company that has made an average of $250K profit per year for the last four years and over that four year period it had invested heavily in new product development and that those products are just beginning to gain acceptance in the market place. The current owner now wants to sell his company for two primary reasons. The first is that the company needs additional capital for production equipment in order to meet the expected market demands for the new products. Secondarily his personal interests lie in developing products and the thought of running a “large” company does not intrigue him in the least. Based on his sales and profit forecasts for the next three years, he sets the goodwill portion of the selling price at $5M well above any industry standard of three to five times the last years earnings.
If in fact his future sales and profit forecasts are correct, you feel that the $5M that he is requesting in goodwill is quite fair. But forecasts, especially where new products are concerned are at best educated guesses and no one can actually predict the future.