Laws of the Business of Buying and Selling

Jim Blasingame

According to a survey conducted by the Kauffman Center for Entrepreneurial Leadership, one in 12 Americans are actively thinking of starting a small business. If you are one of the "one-in-twelve," good for you. It's an exciting process to envision your new business and then set about creating it.

But wait! Maybe someone has already created it? After all, when you need a new suit you don't build a suit factory do you? If you want your own business, why not see what you can get "off the rack"?

But before you jump into the deep end of the ownership pool, let's look at some things you need to know. I'm going to call on a friend of mine, Russell Brown, to help. In his book, Strategies For Successfully Buying Or Selling A Business, Russ lists what he calls the "Laws Of The Business Buying and Selling Jungle." Here are the first seven of Russ's fifteen Laws, followed by my thoughts on each.

Lawyers Are Deal Killers
I'm not going to go as far as Dick, the butcher, in Shakespeare's King Henry VI, who said, "First thing we do is kill all the lawyers." Truth is you're going to need a lawyer to put your business acquisition together.

But if you, or the other party, introduce the lawyers into the negotiation process too soon, the chance of having a deal that won't get done is greatly increased.

Notice that I said, "introduced into the negotiation." My rule of thumb is tell your attorney the minute you begin thinking about buying a business, keep him or her up-to-date on every step taken and all progress made, enlist and employ the legal advice and documentation they provide, but don't let them near the negotiation process until virtually the very end. And never let them negotiate with the other party on your behalf.

Lawyers are like medication: They can save your life, but can also be detrimental when improperly administered.

Caveat Businessus Emptor
In the securities industry full disclosure is the operating standard. But in the greater marketplace, caveat emptor -- let the buyer beware -- is the fair warning standard for all participants. And nowhere is this standard more in evidence than when buying a business.

If a seller commits fraud at a buyer's expense, legal redress may be available. But unhappy buyers are born more from improper business buying practices than from malfeasance by a seller. Ignorance, impetuousness, and/or stupidity by the buyer are not actionable.

Forewarned is forearmed. Let the buyer beware.

A Business Is Worth What Someone Will Pay
There are no foolproof methods of valuing anything for sale in the marketplace, let alone something as complicated as a business. Nevertheless, there are many acceptable formulas and methods that are used to divine the value of a business.

Some methods are quick and easy, and some are long and sophisticated. But for every calculation that delivers a value perspective there are any number of reasons why a buyer will buy that aren't directly tied to the numbers.

If you're looking at a business to buy, it's understandable that you will attribute some value to how this business fits your professional plans. Perhaps you'll even pay an extra couple of bucks for the business because it fits your idiom. But before you let your ego write a check your ability can't cash, be sure to consider Russ Brown's next Business Buying Law Of The Jungle.

You're Buying a Stream of Earnings
With a few exceptions, like buying a business, or its assets, for a strategic purpose, your interest in buying a business should be based on its ability to generate earnings -- net profits. If the business you're thinking about buying isn't creating earnings at a level that provides an acceptable return on investment, and if you aren't sure you know how to make that happen in spite of past history, don't buy the business.

Just as many a bride has wrongly believed she could change her new husband, too many new owners have foolishly purchased a business for the wrong reasons and with expectations they weren't qualified to deliver.

Ignore Claims of Unreported Cash
Okay, let's get the disclaimer out of the way. Imagine I'm holding your head between my hands as I say the following very slowly: "It's against the law to fail to report business income. The IRS will come and take you away."

The cash Russ is talking about is from the business income that a prospective seller might tell you about in order to justify the asking price. Russ says ignore such claims. But I'm sure he wouldn't argue with my advice. I say, "Run away."

I'm not naïve about how some businesses underreport income. But I have two problems with buying a business from someone who tries to justify the purchase price by telling you about how much he does it.

1. You're probably not going to be able to complete a comprehensive acquisition with such an unsophisticated owner, so don't waste your time.

2. Do you really want to buy a business from someone so stupid as to actually tell you they break the law as a natural course of business, and then tries to trade on those ill-gotten gains?

Most Sellers Are Liars
This law has a two-part explanation. The first one is the seller's fault, and the second one is your fault.

1. When something untrue comes out of the mouth of a seller, to them it's at best what politicians would call "spin," and at worst, what many sellers consider obligatory hyperbole.

But to you, it's at best an owner bragging about his baby, the way a parent embellishes the talent of a child, and at worst, it's invalid information that can delay or derail your deal.

2. Never ask a seller a question that should be found during the fact-finding tasks of the due diligence process. If you do, you will likely get some of the hyperbole mentioned above. And when the due diligence facts become evident, you've got the potential to have an embarrassed seller and perhaps a deal that goes south.

If you conduct effective due diligence, you don't have to ask for information. Instead, you ask where to find the information, and once found, ask the seller to help you understand what you've found. There will be less "embellishing" when the facts and figures are laid bare on the table.

You Probably Shouldn't Buy from a Seller Who Needs to Sell
With a few exceptions, such as illness or disability, when an owner has an urgent need to sell it's probably due to a defect in the business operation. Sometimes this can convert into opportunity for a savvy buyer, but more often than not, the defect has created a financial problem that manifests in a sale price that can't be justified by the performance of the company. Translation: The seller needs someone to take him out to solve his financial problems, and his price is based on the extent of the problem and not on the true value of the business.

Like the owner who tells you about unreported cash, you're probably not going to be able to complete a deal with this kind of seller unless you pay his price. So if you proceed anyway, do so knowing that the odds are against successfully completing a deal based on terms that are equitable for both parties.

Write this on a rock... Buying a business is likely the most important transaction you will ever make. Do it for the right reasons, be patient, resist urgency of others, conduct proper due diligence, and negotiate the best deal for you.

Jim Blasingame
Small Business Expert and host of The Small Business Advocate Show
©2008 All Rights Reserved

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