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If you're looking to buy a business,
make sure you have all the paperwork in order before signing on
the dotted line.
Dear Small Biz Adviser
I would like some information on how to purchase my boss's company.
It's a small Corian countertops shop. The company has proven contracts
with very big construction companies worth $200,000 in the
next six months. He is asking around $150,000. I really need
some help getting the ball rolling. Thank you,
Frank
Dear Frank:
Buying a business involves an organized process. To be successful,
it requires the cooperation of the seller and potential buyer. Your
inquiry does not indicate if you will need to secure a loan, but
I will assume it does.
Success in buying a business demands a detailed
inspection and analysis of the company's financial documents, a
legitimate dollar value for the purchase of the venture, agreement
on the terms of sale between buyer and seller, and successfully
fulfilling the requirements of the lender financing the purchase.
Some of the most common documents a buyer needs
to adequately value the sale price include:
- Company IRS returns for the past three years.
- Annual financial statements (balance sheets,
income and cash flow statements) for the last three years.
- Certified financial statements of the company
for the last six months.
- A list of all fixed assets, including original
purchase value, depreciation formula implemented, any improvements,
accumulated depreciation and present adjusted value of each item.
- A list and supporting documents of all notes
payable for which the company is liable.
- A monetary listing of inventory, including
raw goods, work in progress and finished products.
- Documentation of days payable and receivable.
- Listing of all accounts payable and receivable,
including balances due.
The set of documents you will need to add to
this list, for consideration of a loan, will likely include:
- A personal financial statement -- the equivalent
of a company's balance sheet.
- Lender approval to secure your credit report.
- A business plan.
- Loan application.
The SBA Web site provides a list of documents
you need to take to the lender. Though it's designed for people
taking out SBA-guaranteed loans, any commercial lender is likely
to ask for the same documents.
Regarding loan approval, the SBA has a unique
six-part evaluation process that relates to all loan applications.
It is called the Financial
Six Cs: character, capacity to pay, capital, collateral, conditions
and confidence.
Prior to submitting all documents for lender
consideration, you and the seller must agree on a selling price.
This process involves evaluating several elements in two general
formats -- price/building and ROI (return on investment). The price/building
format implements the basic approach of determining present market
value of the following:
- Real estate (you have not indicated whether
real estate is involved).
- Leasehold improvements previously made to
the company facility, at present market rates of construction
cost.
- Any equipment and fixtures.
- Inventory and supplies.
Remember, your ability to value the equipment
and fixtures depends on the detail of depreciation bookkeeping the
seller has maintained over the years. You may need to secure the
input of a building contractor for the present market value of any
leasehold improvements.
The ROI process is not as easy to determine.
You begin with the company's financial statements. What is the net
worth of the company on the most recent balance sheet? Remember
that financial statements are structured to reduce tax liabilities.
For example, fixed assets may be valued, due to depreciation, at
a level lower than their present market value. That would be more
evident if accelerated depreciation formulas have been implemented
over the years. What is the annual net profit on the income statements
over the years? Do you see ways it could be increased by trimming
expenses or other means? How often goods been bought, but used for
something other than the enterprise? That may be difficult, if not
impossible to determine.
Finally, do remember that you are engaged in
the art of negotiation. The level of homework you do on valuing
the company, the better prepared you will be to document the legitimacy
of the selling price.
I wish you well.
Bankrate.com writers base their answers on our
editorial content and advice of financial professionals. We make
no claims or representations about the accuracy, timeliness or completeness
of such content, advice or the answers provided to you. Our content,
advice and answers are intended only to assist you with your financial
decisions. However, by its nature such information is broad in scope.
Your financial situation is unique, and our content, advice and
answers may not be appropriate for your situation. Accordingly,
we recommend that you get different opinions and seek the advice
of your accountant and other financial advisers before making any
final decisions or implementing any financial or investment strategy.
-- Posted: Oct. 3, 2000
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