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Steve Windhaus Ask the Small Biz Adviser

Dealing with changing business-sale terms

Dear Small Biz Adviser:
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?
Joe

Dear Joe:
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.

Asset purchase
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.

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Stock purchase
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 to buy.

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 the U.S. 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 offer.

I wish you well.

-- Posted: July 11, 2002

Read more Small Biz Adviser columns
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See Also
Business Basics: Buying a business
How not to sell a business
Buying a business requires organization

9 worst mistakes when buying a business

Small-business glossary
More Small Biz stories
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