buying or selling a business: a checklist for successfully negotiating ...

BUYING OR SELLING A BUSINESS:A CHECKLIST FOR SUCCESSFULLYNEGOTIATING PRICE© Phil Thompson · Business Lawyer, Corporate Counsel – www.thompsonlaw.caA COMMON GOAL AND COMMON UNDERSTANDINGSAgreed: Our common goal is to make the best possible deal for both parties based upon afair assessment of the business opportunity in question.Agreed: you do not buy or sell a business, you buy or sell a business opportunity.Agreed: the seller’s reasons for selling and the buyer’s reasons for buying probably havenothing to do with each other.Agreed: fair market value and a fair price are not the same thing.Agreed: It does not matter how you get to the same price, as long as you get there.Agreed: the best deal for both parties rarely means either party gets their best deal onprice.Agreed: There is no “right price” for a business, only a range of reasonable prices.Agreed: We will disclose our calculations and the reasons behind our assumptions, butwill not emotionally debate those assumptions again and again.Agreed: There is more to a good deal than price.Agreed: Price depends on structure.Disclosed: the seller’s reasons for selling.Disclosed: the buyer’s reasons for buying.RECASTING THE COMPANY BALANCE SHEET – ADJUSTED BOOK VALUE andREDUNDANT ASSETSReceivablesInventory1

Capital assetsIntercompany receivables or other which the seller does not wish to sell or the buyer doesnot wish to buy with the companyRedundant assets or assets which are not important to company operationsRemoving any goodwill figures (which will be negotiated separately – see below)Liabilities which have been under or over statedLiabilities which the buyer does not want to assumeUnusual items related to the seller’s tax planningIdentified, quantified and discussed: controversial items from recast balance sheet itemsIdentified, quantified and discussed: controversial items from redundant asset discussionIdentified, quantified and resolved: non-controversial items from redundant assetdiscussion.RECASTING THE INCOME STATEMENT: NORMALIZED SUSTAINABLEEARNINGS (aka EBITDA)after tax profits from financial statementsplus taxes, interest expense, depreciation and amortization, all owner compensation(salaries, bonuses, cars, spouses, management fees, etc.), all owner perqs (clubmemberships, toys), charitable donations, and non-recurring or unusual one-timeexpensesless the cost of hiring independent management to perform the owner’s functions in thebusinessless capital expenditures required to maintain normal earnings, and non-recurring orunusual one-time revenuesand other adjustments as required (e.g. to normalize rents or other costs related tocommon ownership real estate or other assets) (could be plus or minus).Identified, quantified and discussed: controversial items from historical earnings.2

Identified and discussed: controversial items with respect to projected earnings.ASSESSING THE BUYER’S RISK: MULTIPLES AND CAPITALIZATION RATESDiscussed, and quantified and agreed to where possible: key risk factors in businessopportunity.Identified and discussed, and quantified where possible: controversial items with respectto buyer’s perception of key risk factors in business opportunityHigher Risk/Lower Multiple/HigherCapitalization Rate/Lower Pricenew business or short time frame upon whichto base normalized sustainable future earningsweak balance sheetquestionable growth trendweak position in weak industryfew barriers to entry for competitioncompany competes heavily on price, orprovides commodity product or servicecustomer loyalty, sales, companymanagement strongly tied to personalgoodwill of departing ownershare purchasedeal structure means absence of healthy futuredepreciation and amortization opportunity toshelter cash flowno vendor take back financingLower Risk/Higher Multiple/LowerCapitalization Rate/Higher Priceestablished business and reliable, historicalbasis for normalized sustainable futureearningshealthy balance sheetgood growth trendstrong position in strong industrysignificant barriers to entry for competitioncompany sales not price dependantcompany performance not tied to personalgoodwill of departing ownerasset purchasedeal structure favours healthy futuredepreciation and amortization opportunity toshelter cash flowvendor take back financing with good termspurchase price not tied to post-closingperformance, no “earn-out”vendor providing excellent management butnot staying onpurchase price tied to post-closingperformance, and vendor sharing in postclosingrisksvendor providing excellent management andstaying on for extended period of time3

Higher Risk/Lower Multiple/HigherCapitalization Rate/Lower Pricelack of proprietary assets or sustainablecompetitive advantagebusiness poorly managed or poorlypositioned, buyer providing the“sustainability”significant personal goodwill with seller; riskof loss of key customers, suppliers andemployeesminimal synergy for buyernegative trends in marginsquestionable or negative trends re: keysuppliers or raw materialsquestionable or volatile labour trends in nearfuture, including increasing costs, labourstrife, shortage of supply, lack ofpredictability, layoffs requiredsignificant currency risksbuyer inexperienced in the industryeconomy or industry in or headed into adownturnno, questionable, poor or uncertain prospectsor contracts for future salesbuyer does not “need” to do a dealvendor “needs” to do a dealbuyer not afraid of competitor making theacquisitionLower Risk/Higher Multiple/LowerCapitalization Rate/Higher Pricelots of valuable intellectual property andsustainable competitive advantagewell managed and well positioned business,seller providing “sustainability”minimal personal goodwill with seller; lots ofcorporate goodwill with customers, suppliersand employeeslots of synergy with buyer’s other enterprisesgood margin trendsstrong bargaining position on supply side,including favourable contracts for futuresupplysolid trends in reasonably priced labourminimal currency risksbuyer well established and familiar with theindustryeconomy or industry coming out of downturn,or appears to be on track for strong future inthe foreseeable futuregood prospects or contracts in place for futuresalesbuyer “needs” to do a dealvendor does not “need” to do a dealbuyer wants to eliminate or acquire acompetitor, or to deny a competitor theopportunity to acquire the business4

Higher Risk/Lower Multiple/HigherCapitalization Rate/Lower Pricetax situation favours seller at buyer’s expense(e.g. none of purchase price allocated to postclosingmanagement fees or depreciableassets)acquisition or business hard to finance at lowratesassets over valued on balance sheetNo opportunity for post-closing breakup ofbusiness assetsSignificant capital investment required in nearfutureBuyer accepted normalized sustainableearnings at the high end of the rangeLower Risk/Higher Multiple/LowerCapitalization Rate/Higher Pricetax situation favours buyer at seller’s expense(e.g. lots of purchase price allocated tomanagement fees or other taxable income toseller)good opportunity for buyer to financebusiness or acquisition at very competitiveratesassets undervalued on balance sheetgood opportunity for post-closing breakupvalueno significant capital investment needed innear futureseller accepted normalized sustainableearnings at the low end of the rangeRECASTING COMPANY PERFORMANCE RATIOSDiscussed, and agreed to where possible: key company performance ratios.Discussed, and calculated where possible: controversial items with respect to buyer’sperception of adjusted key performance factors.Annual Break Even = Fixed Expenses (Gross Profit Net Sales)Annual Break Even (Months) = Fixed Expenses (Gross Profit Net Sales) Net Sales X 12Margin of Safety (As Percentage) = (Net Sales – Annual Break Even) Net Sales X 100Operating Leverage = (Net Sales – Variable Costs) Pre-Tax ProfitsOperating Leverage X % Change in Sales = % Change in ProfitsWorking Capital = Current Assets – Current LiabilitiesCurrent Ratio = Current Assets Current LiabilitiesAge of Inventory = Closing Inventory (Cost of Goods Sold # of Months)Age of Accounts Receivable = Accounts Receivable (Net Sales # of Months)Age of Accounts Payable = Accounts Payable (Credit Based Purchases # of Months)Debt to Equity Ratio = Total Debt Total EquityDebt Service Coverage = (Pre-tax profits + Depreciation + Interest Expense) (All AnnualCurrent Loan Payment Requirements for Principal and Interest)Interest Coverage = (Pre-Tax Profits + Interest Expense) Interest ExpenseReturn on Assets = Pre-Tax Profits Operating Assets5

Return on Shareholders’ Equity = Pre-Tax ProfitsLoans).(Adjusted Book Value + Shareholders’USE OF COMPARABLESList of useful comparable sales identified, compared and sharedRelevance of comparables discussedBRIDGING THE GAP: SHARING THE RISK - PRICE ADJUSTMENT FORMULAS,EARNOUTS, VTB FINANCINGDiscussed, and quantified where possible: potential for price adjustment mechanisms.Discussed, and quantified where possible: potential for earnout or seller risk participation.Discussed, and quantified where possible: potential for price deferral through escrowfunds, VTB security, etc.BRIDGING THE GAP: SHARING THE BURDENSeller contributing to certain buyer expensesBuyer contributing to certain seller expensesPaying part of the purchase price by consulting fees or non-competition payments or otherways which are more favourable to the buyer from a tax perspective than to the sellerSeller providing financial support by deferring payments, holding a VTB with no or lowinterest rates, holding on to key assets and leasing them back to the buyerSeller keeping certain assets for itself, reducing the price to the buyer but leaving the sellerwith the opportunity to liquidate those assets at a later date to the benefit of the sellerBRIDGING THE GAP: SHARING THE TAX SHIELDDiscussed, and quantified where possible: tax shield to buyer based on buyer’s preferredprice range and deal structure.Discussed, and quantified where possible: tax shield to seller based on seller’s preferredprice range and deal structure.Discussed, and quantified where possible: potential to bridge the price gap throughsharing the tax shield.6

BRIDGING THE GAP: INTANGIBLESDiscussed: intangible reasons for bridging the gap, including:• how badly each party “needs” to do the deal• how badly each party “wants” to do the deal• how badly the parties want to do business with each other• what synergies the buyer thinks it can bring to the table to drive normalizedsustainable future earnings to higher levels, thereby effectively reducing the buyer’smultiple• how the buyer is financing the deal, and whether that financing package ultimatelyreduces his risk to an acceptable level• how the deal is structured, including vendor take back financing, price adjustmentclauses, post-closing support, etc.• how the deal is structured for after tax cash flow to each party.7