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BUYING OR SELLING A BUSINESS – PART 2 OF 3:  HOW TO VALUE A BUSINESS AND DUE DILIGENCE

So, how much is this business worth, and what other costs and considerations are involved before you start signing away?  This section addresses some of the ways the value of a business can be estimated as well as discussing the extensive but important task of completing proper due diligence.

DETERMINING THE VALUE OF THE BUSINESS:

One of the biggest problems in business sales is the seller over-valuing the business. It is helpful to consider some of the most common ways prices can be determined in order to evaluate your particular situation and reach a viable estimate.

COMPARABLE SALES

One way to get a good estimate of the business’ value is to have an appraiser look for similar businesses in the same general area that have sold in the last couple of years, while making adjustments to account for inflation/deflation, location and other factors.

ASSETS & INVENTORY

When considering the value of assets and inventory, it is important to examine the replacement cost of everything you would need to purchase in order to start the business from scratch.  Once you determine replacement costs, it is fair to discount that determined value somewhat to account for the acquisition of pre-owned assets.

CASH FLOW

This type of valuation is most common in determining the worth of a business, and there are many methods that can be applied, generally beginning with examining the annual profits the business has had over the last five years.  A typical method for valuing a small business is taking the earnings before interest, taxes, depreciation and amortization (“EBITDA”) and multiplying it by a factor.  However, there are many methods used in valuation, and you should discuss with your professional team which application would be best for your particular situation.

SOME IMPORTANT CATEGORIES OF DUE DILIGENCE:

There are many facets of the business that need to be disclosed and reviewed in order to complete the sale.  Depending on the content and state of that disclosure, the buyer may be compelled to either walk away from the deal or renegotiate.  Though the following does not cover every aspect of proper due diligence, it is a relatively comprehensive list of general items that will give you a good idea of what needs to be involved.  Your professional team will advise you regarding specifics of due diligence and disclosure in order to protect your interests at every turn.

CORPORATE AND ORGANIZATIONAL

A seller should disclose copies of all organizational documents of the company, including minutes of meetings attended by stockholders and officers.  Further, among other documents, a seller should provide lists of:  names under which the company has operated, affiliates of the company, and of all officers, directors and managers of the company.

OWNERSHIP

The seller should provide the buyer with copies of all stockholder registers and stock certificates.  In addition, copies of all shareholder agreements should be shared, including any documents that limit or control the right to sell the company’s stock.  Your professional team will examine and assess the specifics of these disclosures.

FINANCIAL DOCUMENTS

A buyer should obtain copies of all currently effective loan and security agreements, indentures, short-term or long-term debt instruments, liens, financing statements, etc.  Your team of business professionals will assist in evaluating what needs to be done with each item.

CONTRACTS AND AGREEMENTS

The list of contracts and agreements that you should obtain copies of can be voluminous, and your legal team will ensure you obtain and review everything you need for a successful transaction so you don’t encounter surprises later.  Some of these documents include the following:  all standard forms of agreements used by the company, any acquisition or merger agreements, all brokers or finders agreements, joint venture or partnership agreements, any agreements with government agencies, and much more.

TAX MATTERS

Some of the important tax documents that should be obtained are as follows:  all correspondence with applicable tax authorities concerning adjustments, compliance or disputes; any tax indemnification, tax sharing or tax allocation agreements involving the company and its owners; federal income tax returns and state and local income, franchise, sales, property and excise tax returns (including audits), and more.

MANAGEMENT STRUCTURE, LABOR RELATIONS AND EMPLOYMENT

This is another section of due diligence that can be voluminous.  A few of these items that the buyer will want to review include:  agreements with employees or contractors; any arrangements with current or former employees; a description of all confidentiality, non-disclosure, non-competition, or similar agreements; bonus plans and deferred compensation programs; labor contracts; employee handbooks and/or manuals, etc.  Your team of qualified professionals will advise you as to a complete list of documents to acquire for review.

PROPERTIES, LEASES AND INSURANCE

Another important category involves property, leases and insurance matters.  A purchaser of a business should acquire copies of:  all current and former insurance policies and prior or pending claims thereon; lists of real property loaned, leased, or subleased; certificates of occupancy or other permits or licenses related to real property; all easements or rights of access granted to the company; and any leases for machinery, furniture and the like, to name a few.

OTHER ITEMS

Some other important areas of due diligence to cover the bases include intellectual property such as trademarks, patents, copyrights and trade secrets, litigation and corporate compliance activity, and environmental, health and safety-related matters, and more.

IN CONCLUSION

As you can see, there are many multi-faceted considerations in valuing a business and it is necessary to obtain and review a plethora of documents in order to facilitate a smart and smooth transition, whether you are buying or selling.  Make sure you have a good team of informed individuals in place assisting you every step of the way.  In Part 3 of this article, we will discuss options for you to consider regarding which type of business sale may be best for your particular situation.

Article Written By:
Jill-Ann Weickhardt

Business and Commercial / Real Estate

jaweickhardt@nullwaterfallattorneys.com