In this interview, Walter Blijleven discusses how you can avoid a faulty sale through due diligence, how you can protect yourself from paying too much for a business, whether you need to have your business and real estate appraised separately, how to secure funding for a purchase, the proper ways to exit your business, and the importance of a buy-sell agreement. Mr. Blijleven is a highly experienced finance professional, a Dutch CPA and a US business valuator.
Tina: I am a buyer, how do I know if I am paying too little or too much for a business? How can I protect myself from paying too much?
Walter: Well, too little is hard to imagine. In my opinion, there is no such thing as too little when it comes to buying a business. I can only think of a seller who is not in the right capacity (mentally or physically for instance) to make appropriate decisions about selling his or her business. In such a situation, as a buyer, you should consider if it is ethical to buy a company for a price so low it is not realistic. This could backfire down the road.
You know you are paying too much when the price will prevent you from reaching the goals you set in advance with regard to the specific transaction.
When you are a financial buyer, one who is primarily interested in the stand-alone proceeds from the target company, you will have to formulate your expectations with regard to cash flow and capital gains in advance. This is a prerequisite to assess if the forecasted return from that business will be meeting your targets. You will have to assess the specific risks of the business as well as the industry in the business is a part of.
If you are a strategic buyer, one who wants to consolidate existing businesses with the target business or one who wants to take out a competing business, you should estimate what the impact will be of buying the target company. This will need to be done both stand-alone and after integrating the target business in your existing group of businesses, which are called “synergies.”
In general, to protect yourself from paying too much, you should invest in a comprehensive business valuation before you make an offer and in a thorough buyer’s due diligence after the offer has been accepted. In other words, your offer should be subject to a satisfactory due diligence.
Tina: If I also own the real estate, is it necessary to have my business and real estate appraised separately?
Walter: In general, I would answer this question with a yes. As a valuator, I usually appraise the business and the real estate separately.
When appraising the business, you will have to ‘normalize’ the income statements of that business, inserting an at arms length lease amount that would have been paid in case the business was not the owner of the real estate as a business expense.
When appraising the real estate, you usually consult a real estate appraiser. However, when appraising a real estate company, one that is primarily leasing office space or apartments, you will appraise the business yourself as well. For instance by analyzing the market rental value of the lease agreements that the real estate company has in place.
When real estate is involved, always pay sufficient attention to the tax implications on the valuation and possible transaction.
I believe there is also a trend in the market now which questions whether a business should own the real estate it uses as its place of business. That is another benefit of having your real estate valued separately, it could give you a better view of whether it complements or actually weakens your business (valuation).
Tina: What methods do you use to appraise a high potential startup with no revenue? For example, an online company with $500,000 invested in web development with positive revenue, no profitability but high growth ahead.
Walter: Since this startup will not have a proven track record, your effort will be primarily in the thorough review of the forecasts of the business and the underlying assumptions leading to these forecasts. Since startups could be highly risky, with a significant possibility it will fail all together, understanding and assessing the risks is imperative.
Since less quantitative information is available, you will focus more on qualitative information. For instance, the track records of the owners and key staff, the growth potential of the business and the industry or market it is targeting, the funding of the business etc.
In your valuation report, you will be using more and more extensive disclaimers and your value ranges would be broader than usual.
It [business valuation] will provide you with a strong baseline on the current value of your company and can help you to improve the value of your company in the remaining years before the exit.
Tina: In many lower middle-market businesses, investment bankers do not recommend an appraisal. Do you feel a business appraisal is necessary for companies looking to sell in the lower middle market ($5-50 Million in Annual Revenue)?
Walter: In my opinion, a business valuation is always a good investment for a seller. An experienced professional will explain to you the value of the company and the strong and weak points he has discovered and which form the basis for the resulting valuation amount.
As a seller, you will be better prepared for the price negotiations.
It would be even better to invest in a business valuation at least two or three years before your desired exit date. It will provide you with a strong baseline on the current value of your company and can help you to improve the value of your company in the remaining years before the exit.
Tina: I am looking to buy a business. How can I secure funding for the purchase? Do I have to go through a bank?
Walter: No, you don’t have to go through a bank. A bank could provide you with part of the funding, but normally a bank will never fund a transaction for the full 100 percent. In my experience and in the markets where we are active, a bank will require at least 30 percent or 40 percent equity to fund the transaction amount.
There are other sources of funds available, like private investors, family members, private equity funds etc. It primarily depends on your own reputation and track record, your net worth, the quality of your network of funders, the “bankability” of the business you intend to buy, etc.
The better you prepare yourself, the more you will improve your odds to get financing from third parties. For instance, by doing a thorough industry analysis, by getting a professional business valuation and in-depth due diligence.
Going to the bank is the most common source of funding for entrepreneurs looking to buy a business. It determines the feasibility of a valuation. You could have a great valuation report prepared and a willing buyer lined up to execute the transfer of company at an agreed price, but if the bank is not willing to finance it, the deal could fall through. It is a good thing to think about your funding source early in the process of buying a business and speaking to some bankers to get a sense of their appetite to fund your acquisition before you invest in a business valuation or a due diligence process.
Tina: If I am thinking about exiting my business, what are my options and when should I start planning for this?
Walter: Exiting your business needs careful preparation. A well-prepared exit could take as many as three to five years. Some successful business owners even claim you should already know your exit strategy before you start your business!
In general, the value of your business will be higher when you prepare your exit well, which should result in a higher selling price.
Our company, The Curacao Financial Group, assists business owners who want to make an exit through our Value Improvement programs. We do this in cooperation with The Sellability Score and The Value Builder organization.
It is better to know your weaknesses and solve them in advance.
Tina: What is due diligence and how will this affect the sale of my business?
Walter: When you as a seller or a potential buyer of your company wants to execute due diligence on your business, it means thorough investigation to all material aspects of your business will be necessary. This is not restricted to the financial records of your company, but it will also include all important commercial, legal, human resource, IT, and environmental matters that affect your business. Essentially all aspects of your business and the environment you operate in which could lead to potential gains and losses in the future.
As a seller you could also demand due diligence on the prospective buyer of your business, in which his reputation, his ability to pay the transaction price, etc., could be investigated.
I always advise a seller to engage his own seller’s due diligence before the start of negotiations with prospective buyers. It is better to know your weaknesses and solve them in advance. This will help you gain a stronger position during the negotiations, and generally results in a higher transaction price.
Tina: When does a business need a buy-sell agreement? Is this a common issue you encounter? If so, what advice do you have for business owners?
Walter: A buy-sell agreement, which is defined by Wikipedia as “a legally binding agreement between co-owners of a business that governs the situation if a co-owner dies or is otherwise forced to leave the business, or chooses to leave the business,” is especially important when a closely held business is owned by a limited number of owners, normally two or three, with equal amounts of shares and voting rights. In such a situation, I generally advise to have a buy-sell agreement in place. It stipulates in details how the shareholders (or the heirs in case of a deceased owner) will have to act if one of the owners (or heir) wants or needs to sell and the remaining owner(s) want to buy the shares. If such an agreement is drafted in a situation of stability and peace, there is less risk of anxiety and problems in case of instability. For instance when the owners have a serious dispute among themselves or in case of death of one of the owners.
Tina: I am located in the United States and I am selling my online business. I have a few international clients and employees. One of my international employees is interested in buying the business. We both plan to have the business appraised. Will there be a significant difference in the appraisal?
Walter: If both engage their own appraiser, this could happen. It depends on the standards being used, the appraisers being engaged, the information both appraisers have available, the quality of the industry analysis they do, etc. This risk could be minimized if both appraisers have the same information available and if parties agree about the standards to be used in the valuations. Parties could also consider to c0-engage an independent appraiser who advises both seller and prospective buyer about the value of the company. Based on that valuation, parties could derive the eventual transaction price. The question you should ask yourself is at what price you would be content in selling your business. Later you could benchmark the independent valuation against your initial expectations.
Tina: What are some issues that may come up when selling my business to an international buyer?
Walter: In general, an international transaction is more complicated, since there are more and different legal, tax and cultural issues to be dealt with. Sometimes language differences could result in additional complications as well.
However, in past decades, more and more cross-border transactions have taken place. Hiring the right advisers who have experience in executing international transactions, could significantly help to avoid and reduce these differences and resulting risks.
Tina: Do you have any other tips or advice for anyone buying, selling or appraising a business?
Walter: Always do your homework seriously and understand the implications of the transaction at stake. Take your time to study and analyze the economy, the industry and the business itself. Hire the best advisers like business appraisers, lawyers, due diligence and tax advisers etc. The transaction costs incurred will be earned back easily by: