Chap. 7 Buying an Existing Business

Lean

a creditors claim against an asset

Due-on-sale clause

a loan contract provision that prohibits a seller from assigning a loan arrangement to the buyer, instead the buyer is required to finance the remaining loan balance at prevailing interest rates

Covenant not to compete (restrictive covenant or noncompete agreement)

an agreement between a buyer and a seller in which the seller agrees not to compete with the buyer within a specific time and geographic area

Earn-out

an exit strategy in which an entrepreneur can increase his or her pay out by staying on and making sure that the company hits specific performance targets

Adjusted balance sheet technique

a method of valuing a business on the basis of the market value of the companies net worth (net worth = total assets - total liabilities)

Balance sheet technique

a method of valuing a business on the basis of the value of the company's network (net worth = total assets - total liabilities)

Earnings approach

a method of valuing a business that recognizes that the buyer is purchasing the future income (earnings) potential of a business

Market approach

a method of valuing a business that uses the price/earnings (P\E) ratio of similar, publicly held companies to determine value

Employee stock ownership plan (ESOP)

an employee benefit plan in which a trust created for employees purchases stock in their employers company

Evaluating an existing business

(five critical areas) motivation, asset valuation, market potential, legal issues, financial condition

Product liability lawsuits

lawsuits that claim that a company is liable for damages and injuries caused by the products it makes or sells

Legal issues (the biggest legal traps include)

liens, contract assignments, covenants not to compete, and ongoing legal liabilities

Hidden market

low-profile companies that might be for sale but are not advertised as such

Capitalized earnings approach

method of valuing a business that divides estimated earnings by the rate of return the buyer could turn similar risk investment

Discounted future earnings approach

method of valuing a business the forecast the company's earnings several years into the future then discounts them back to their present value

Advantages of buying an existing business

successful existing businesses often continue to be successful, superior location, employees and suppliers are in place, installed equipment with known production capacity, inventory in place, trade credit is established, the previous owners experience, easier access to financing, high-value

Skimming

taking money from sales without reporting it as income

Opportunity cost

the cost of the next best alternative choice; the cost of giving up one alternative to get another

Goodwill

the difference in the value of an established business and one that has not yet built a solid reputation

Due diligence

the process of reviewing, investigating, and analyzing the relevant details about the top acquisition candidates to determine which one best meets a buyer's purchase criteria

Disadvantages of buying an existing business

Cash requirements, the business is losing money, paying for ill will, employees inherited maybe unsuitable, unsatisfactory location, obsolete or inefficient equipment, difficult management change, obsolete inventory, worthless accounts receivable, business maybe overpriced