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How to Acquire a Company

Eyeing a potential acquisition? From vetting your target's assets to signing on the dotted line to seamlessly continuing your new operation's output, a lot goes into buying a company.

Assemble a Team

Before you can even dig into all the due diligence required, you'll need to put together an acquisition team, normally consisting of your banker, accountant and attorney. Whether these are existing employees or professional contacts, or whether you're looking for brand new assistance (see this guide to finding a small business attorney), you'll want to make sure your team is experienced in acquisitions.

Preliminary Analysis

First, answer some very basic questions. What is this business' reputation? Why is it for sale? How has it changed over time? Talk to existing customers; reach out to the Better Business Bureau, industry associations and credit reporting agencies to make sure things look positive at the most basic level.

Data Collection

Before you can even begin to make the all-important valuation, it's time to dig deep into your potential acquisition's assets and prospects for the future. The following checklist contains some of the key areas to evaluate:

  • Inventory: What's on-hand that’s new? What was on-hand at the end of the last fiscal year? Is the inventory old? New? In good condition? You should be able to assign a hard dollar value to this stock.
  • Facilities and Equipment: Like the inventory, what condition is the office furniture in? What about the office building itself? And what is the state of the lease?
  • 5 Years of Tax Returns: Make sure you and your accountant are differentiating actual business purchases from personal purchases made by the previous owner in the name of their business.
  • 5 Years of Financial Statements: Open the books and make sure they match up to the numbers you've viewed in the tax returns. Sales and operating ratios should be compared against industries norms, which you can find in these annual reports.
  • All accounts receivable and accounts payable: List out the top ten accounts, and check their credit worthiness in an attempt to evaluate the company's cash flow.
  • Merchandise Returns: Is there a high return rate? If so, why?
  • Marketing and Advertising: How much is the company spending on these efforts? And to whom are the efforts being directed?
  • Seller-Customer Ties: What percentage of the business is accounted for by personal ties to customers that will leave with the current owner/operators? Will the customers continue to work with the business once they're gone?
  • Organizational Chart: What are the experience and skill levels of the employees you'll be overseeing? Who reports to whom? And what is their compensation (salary, stock, bonuses, health benefits, etc.)
  • Organizational Chart: What are the experience and skill levels of the employees you'll be overseeing? Who reports to whom? And what is their compensation (salary, stock, bonuses, health benefits, etc.)
  • Insurance: What type of insurance do they have, and who is the underwriter? An underinsured business could present a huge potential risk for you.

Valuation

While there's no single gold standard, you should consider using the following methods to help pin down a workable and justifiable price for your acquisition:

  • Multipliers: Generally, this involves a weighted multiplier of one of several different metrics, including monthly gross sales, monthly gross sales plus inventory or after-tax profits. While using multipliers is quick and easy, the method lacks the nuance to account for true value, so use them only for a quick estimate.
  • Book Values: The net value is the difference between total assets minus liabilities. Assets can include unsold inventory, real estate and accounts receivable, while liabilities generally include any unpaid debts, liens, bad investments, judgments or unpaid taxes.
  • Capitalized Earnings: This is the product of your projected earnings multiplied by the capitalization rate. But what is "capitalization rate?" It represents the risk of investing in this business in comparison to other investments (e.g. government bonds or stock in other companies). Anywhere between 20 and 40 percent is a solid capitalization rate for a buyout.

Structuring the Deal

Once you've arrived at a valuation, it's time to begin negotiations and ultimately make a deal. First, you'll have to decide between:

  • Asset Acquisition, in which you purchase only those assets you're interested in, which means you're not risking unwanted legal liabilities.
  • Stock Acquisition, which means you're purchasing all of the business assets, but is generally simpler and less expensive than an asset-by-asset negotiation.

You should expect to pay between 30 and 50 percent of the acquisition in cash, but in case you're short, consider financing by:

  • Leasing with an option to buy, just like you might with an expensive new car. Make a payment, become a minority stakeholder and operate the business as you would with a full acquisition.
  • Leverage the seller's assets by listing them out and showing them to banks and financiers.
Starting a Business?
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