||Ask the Small Biz Adviser
changing business-sale terms
Dear Small Biz
We are trying to buy a business. We thought we were buying it as
an asset purchase, but now the sellers want to sell as a stock purchase.
What are the differences? Would it be wise to buy it, or should
we back out?
From your inquiry, I am assuming that the sellers definitely wanted
to conduct an asset purchase, but changed their minds and now want
to negotiate the stock purchase. As a consultant and your advocate,
I raise red flags immediately.
Let us first consider the distinction between a purchase
based on assets and one based on stock.
In the purest definition, an asset purchase is based on the present
value of all assets, current and long-term. Current assets, including
cash on hand, accounts receivable and inventory, are strictly defined.
Cash is cash, accounts receivable represent the outstanding accounts
to be collected and inventory is based on the company's cost to
purchase those items, not the selling price.
Fixed or long-term assets that are tangible have an
accumulated depreciation that is subtracted from the original cost
to the company, resulting in an adjusted value.
Intangible and intellectual assets, such as trademarks,
copyrights and patents, are based on cost, marketing or income-generating
potential. A good example of valuing such assets is demonstrated
in a September 2001 workshop
presented by Don Drinkwater of Standard & Poor's.
The stock-purchase approach, in the simplest of terms for a privately
held company, divides the net worth, including retained earnings,
by the total number of outstanding shares of stock.
The process is different for a publicly traded company,
which is subject to the speculative ups and downs connected with
being listed on the stock market. In such a case, I strongly suggest
you get professional advice. Stock analysts make a living of evaluating
the worth of publicly traded companies.
I presume that the business you want to buy is privately
held. Thus, without a stock analyst to provide evaluation assistance,
you must consider alternative sources of information to determine
the company's value.
Digging out the data
First, find out precisely why the current owners are selling the
company. While you always want to hear what the sellers have to
say, don't be content with their reply. Weigh that response in comparison
with your own investigations.
Examine the last three years of financial statements,
looking closely at year-to-year performance of sales, gross margins,
expenses, net profit, cash flow, additional injections of capital,
retained earnings and net worth. It is a perfectly legitimate request
to examine those financial statements.
Furthermore, when lenders finance buyouts they want
to see company Internal Revenue Service returns for the last three
years and the financial statements for the last six consecutive
months. The sellers should not object to providing that information
to you. If they do, then I may begin looking for another business
Don't overlook conducting an independent analysis
of the respective industry of which the company you want to buy
is a part. Many sources can help you take the pulse of any industry.
Excellent starting points for your investigation include trade journals
and magazines such as The
Wall Street Journal, especially its online, paid version; BizMiner,
an online proprietary research firm; and the economic data from
Bureau of the Census.
Seek independent input from a consultant regarding
the company and the industry. You may want a consultant who specializes
in market research or who specializes in that specific industry.
Attempt to secure a Dun
& Bradstreet report on the company's credit rating.
Finally, review these four business-valuation
models summarized by American Express' small-business site.
Here you will get additional insight into the various factors involved
in the process.
This research will give you a better idea as to the
value of the company and the fairness of the seller's stock-purchase
I wish you well.
-- Posted: July 11, 2002