Once the business to be purchased has been identified and evaluated, the next step is to negotiate and close the deal. Figure 6.4 below provides an overview of this process.
Figure 6.4: The process of closing the deal
6.4
SELF-CHECK 6.2
1. When estimating the value of a business, what are the factors that must be given due consideration before making the decision to buy the business?
2. What are the basic steps in evaluating a business? How do you think we can improve these steps to make better decision?
The negotiation process kicks off with preliminary discussions between the buyer and seller. It is advisable to seek the professional expertise of advocates and financial advisors when negotiating the deal. There is no rule of thumb to go by when negotiating for the price of the business. The buyer must have a fixed range of price that they are willing to pay to guide their negotiation process. This price is based on the value determined in the earlier stages. In all situations, they must take a firm stand and not to allow the seller to pressure them into purchasing the business.
Once the preliminary sales price is agreed upon, the next step is to negotiate a letter of intent. The purpose of this letter is to ensure both parties are serious and committed to the preliminary deal. However, this letter of intent is usually non binding unless stated so.
With the preliminary deal in place, the buyer would usually want to scrutinise the internal works of the business before finalising the deal. This process is known as the due diligence process. Before allowing access to such confidential information, a confidentiality agreement will have to been signed to prevent the buyer from divulging any information about the business to anyone other than their advisors.
If the buyer is satisfied with the internal workings of the business, the formal agreement will be drafted with the expert guidance of advocates. A typical agreement should include essential information such as purchase price, date of settlement, complete record of all assets and liabilities to be bought, operating conditions of the equipments and machineries, the overall payment package inclusive of down payment amount and amount financed through debt, and conditions for final sale. The agreement should also be all-inclusive and should permit the buyer to withdraw from the deal in case they find at any time that the owner deliberately misrepresented any information regarding the business. In addition, a no compete clause should be included in the agreement to guarantee the seller will not open a competing business. When both parties are pleased with the agreement content, the contract is signed. Figure 6.4 summarises the process to close the deal.
SELF-CHECK 6.3
1. Discuss the process involved in closing a deal to purchase a business?
2. In your opinion, what are the common mistakes buyers may make when negotiating the deal?
• Buying an existing business provides a fast entry into running a business.
• Buying an existing business has advantages such as the business having a track record, the business is all set up and running, and the level of risk shouldered by the new owner is reduced.
• The disadvantages of buying an existing business are: the new owner has to solve problems that led to the sale of the business, continue and take responsibility from where the previous owner left off, make additional investment to improve the business, and manage change.
• Before buying any business, it is important for the entrepreneur to determine the right type of business to purchase. The business must match his/her skills, knowledge, motives, commitment level, and passion.
1. Imran has asked you whether he should purchase the cyber cafe up for sale near his housing area. What would you advise him?
2. Sakina is planning to buy over a book shop. The bookshop is located near two schools, one university and several private colleges. There is only one other bookshop located close to this shop. The business has accumulated assets worth RM150000.
The bookshop is well known in the residential area where it is located and the owner estimated that the intangible value of goodwill is worth RM20,000. The liabilities of the business is set at RM50,000. Last year the business earned RM30000. Its current earnings level is at RM30,000 and it is assumed that the annual earnings will continue throughout. The current discount rate is at 15%. Calculate the value of this business.
(Note: Justify the setting of the ratings for the business and the weights assigned)
3. When negotiating and closing a business purchase deal, what are the issues that must be addressed by both parties to protect themselves?
ACTIVITY 6.2
• When the entrepreneur knows what type of business to buy, the next step is to find the right business to purchase.
• Entrepreneurs must evaluate several options and select the business that fits them.
• Entrepreneurs interested in purchasing that business must ensure that the business is worth the price being charged.
• The value of a business can be determined using different methods. A basic method includes four steps:
− Determining the companyÊs net worth;
− Calculating companyÊs past earnings;
− Determining the companyÊs discounted future earnings; and
− Assigning weights to these three values, multiply them with those weights and sum them to obtain the market value.
• Evaluating the companyÊs net worth requires the liabilities to be deducted from tangible and intangible assets (e.g. goodwill).
• The companyÊs past earnings is obtained by multiplying the business annual earning (past year) by a rating of the business performance based on the overall business health.
• The future earnings of the business is calculated by multiplying the current annual earning by the discount factor.
• The negotiation process to close the deal involves preliminary negotiation, letter of intent, due diligence and finally, the signing of the formal contract.
Asset valuation Business net worth Buying a business
Discounted future earning Due diligence
Evaluating a business
Formal agreement Letter of intent Market value Past earnings Preliminary deal