Where you go to buy or sell a business…..

As business owners we have become accustomed to controlling our own destiny and trusting our instincts.  When our instincts are correct we laud our decision making furthering our convictions.

Most of the time, it is impossible to see the faults in our decisions until months (maybe years) after our decisions are made.  Even then, we rarely recognize them.  We look back and say, “There is nothing I could have done differently.”  Really?  Nothing?  Then look back further!

Many times what we could have done differently is LISTEN!

It is impossible to be an expert in all things.  It is impossible to be able to see it all.  That’s why we have experts in the first place!  Experts don’t claim to know it all.  They claim to know it all within a very specific field.  There’s a difference.

Consider the example of a mother and/or father guiding their young children through life.  You will often hear the parent say, “I know what’s best for my children!”  This is no different with business owners.  As the matriarch or patriarch of our businesses, we “know what is best for our business.”

But don’t parents rely on doctors to keep their children in good health?  Don’t they rely on teachers to help educate them and coaches to teach them athletics?  Yes, they do.

A parent’s core business is parenting not coaching or healthcare.  But what is your core business?  This is not always easy to answer.  Or is it?  I define your core business as something you’re not willing to outsource to someone else.  This means, if you’re willing to open up your wallet and hire someone to do a job that job is not your core business.  The person you hired is the expert not you.  So, listen to them.

At times, their suggestions may be contrary to your instincts.  But in most cases, the expert is seeing things that you are not.  They may be trying to explain the repercussions of your instincts.  But, you’re not listening.

The attitude of, it’s my business, I know better is very common.  But, if we ignore the advice of the experts we hire, we will be forced to learn the lessons the experts already know the hard way.

People are experts for a reason. They’ve seen a large volume of cases within a niche field.  If you’ve done your due diligence before hiring them, you should trust and rely on their expertise.  After all, you’re paying for it!

If you’re a business owner at or near retirement, it is in your best interests to accelerate the sale of your business to the 2012 calendar year.

The Bush-era tax cuts enacted in 2001 and 2003 which reduced the capital gains tax rate from 20% to 15% were set to expire at December 31, 2010.  However, in the midst of tough economic times and extreme pressure from Congress, President Obama extended the capital gains tax cut until December 31, 2012.

Capital gains are set to increase back to 20% in the next 12 months!  In addition, a new tax of 3.8% will be layered on top of the 20% capital gains rate for single taxpayers with income over $200,000 and income over $250,000 for married taxpayers.  This additional 3.8% tax is the result of the Medicare tax being extended beyond wages to investment income per the National Healthcare Reform Act of 2010.

The end result is an effective capital gains rate of up to 23.8%.  The magnitude of this impact on the sale of your business can be seen in the following example:

Let’s assume you either purchased or invested $500,000 to start your business.  Annual revenues are now approximately $1.5M with cash flow of approximately $300,000.  Let’s also assume the business is valued and can be sold for $1.2M.  Subtracting the purchase price from your initial investment means you now have a total gain on the sale of $700,000 that is subject to capital gains tax and $500,000 ($700,000 – $200,000 threshold) that is subject to the additional Medicare tax.

In all likelihood some of this $700,000 gain will be allocated to asset classes taxed at ordinary income rates (rates higher than the capital gains rate)!  However, for simplicity purposes, in this example we assume that 100% of the gain is attributed to asset classes receiving capital gains treatment.  If the sale is consummated during 2012 you will pay $105,000 in capital gains tax to the federal government ($700,000 *.15).  If you wait until after 2012 to sell the business you will pay $159,000 in taxes (($700,000 * .20) + ($500,000 * .038)).  The result is an after-tax take home amount of either $1,095,000 ($700,000 – $105,000 + $500,000 basis) in 2012 or $1,041,000 ($700,000 – 159,000 + $500,000 basis) after 2012.

* Note:  The numbers above assume the taxpayer files individually and the business has no outstanding debt subject to repayment.  Debt repayments must be subtracted dollar-for-dollar from the “take-home” amounts.

In this simple example your after-tax take home decreases $54,000 by not selling before the end of 2012.  Your effective tax rate on the $700,000 gain after 2012 increases to 22.7% compared to 15% in 2012.  That’s a tax increase of 51.4%!

This is just one simple example.  As your gain on the sale of the business increases, so do the taxes!

Using the same scenario outlined above:

Assume your basis in the business is $300,000 instead of $500,000.  Your gain on the sale of the business is now $900,000 instead of $700,000.  So, you would pay $135,000 ($900,000 * .15) in tax by selling the business in 2012 and $206,600 (($900,000 *.20) + ($700,000 * .038)) if you wait and sell the business after 2012.

Your difference is take home cash is $71,600!  That’s an effective tax rate of approximately 23% on your $900,000 gain when selling after 2012 compared to a 15% effective rate in 2012.  That’s a 53% tax increase!

The math is simple.  Selling your business is not.  If you want to exit your business before the higher tax rates take effect, you need to begin the process now.  It will take about 9 – 12 months to successfully complete a sale and 2012 will be gone before you know it!

As small business owners, we are tied to our businesses, in mind, body and spirit.  We need our businesses and our businesses need us.  But, it is inevitable that a time will come when we can no longer be there for them.

Whether we accept it or not, we are mortals.  We must eventually hand over the business reigns to someone else.  Steve Jobs handed them to Tim Cook, someone he had groomed for the post since 1998.

The major differences between our businesses and Steve Job’s business are (in all likelihood) size, market share and access to capital.  But, there is no difference in the fact that for our businesses to survive after we’re gone we must consciously prepare for it.

We need our own Tim Cook.  Our businesses need to have someone groomed and prepared to take over in our absence.  Whether our absence is due to illness or a change of ownership the need is the same.

A buyer will want to know that our businesses are not contingent upon us, our personality, our relationships and our “know-how”.  The buyer will expect that we show them our businesses can operate at the same level without us as they do with us.  If the buyer suspects a decline in the company’s performance after we leave they will discount the price they are willing to pay for it.  After all, they’re paying us for what they believe the performance of the business will be going forward as of the date of sale.

The more assurance we can provide them that the business will not decline without us, the less risk they assume and the more they are willing to pay.

So, how can we provide this assurance?

• Build our brand around our products and services not around us as owners.
• Have replacement employees trained to do our jobs and let them do it!

It’s much more convincing to a buyer to see our businesses operate without us before they buy them than to merely tell them.  We must put the systems in place NOW to allow our businesses to run at full speed after we’re gone.  Steve Jobs did it.  So should we!

Most individuals that consider buying a business take what I refer to as the “shopping cart approach.”  They walk down the aisles of available listings, browse through the inventory and declare, “I’ll know what I want to buy when I see it.”

Very rarely does this approach result in the individual actually purchasing a business.  Why?  Because there is something wrong with every business.  As soon as the potential buyer learns about the flaws they put the dented can back on the shelf and continue to meander down the aisle looking for something better.

Here’s the problem.  The best business in the world could have been inside of that dented can!  But, the buyer walked away because of the surface flaws.  Had the buyer gone into the process with a shopping list, they would have known immediately if that can was worth picking up.  If it was, they would have seen past the dent because everything else about the business (or can) was the perfect fit.

Before beginning your search for a business to buy, it is critical that you clearly define your buying criteria, including:

• Geographic preference,
• Industry,
• Skills you can add to the business,
• What hours you want to work,
• How much you’re willing to travel,
• What lifestyle you want to lead after the purchase: and
• The amount of money you have available for a down payment.

Once you define your criteria, you can easily identify whether or not there are existing businesses on the market that are potential opportunities for you.  If not, your time is not wasted.  You are in an even better position.  You are ready to begin working with an intermediary that can bring you the business you desire.

Remember, the business that is the best fit for you and your family may not currently be available for purchase.  That doesn’t mean that the owner is not willing to sell it.  It just means that they have not yet taken the steps necessary to do so.  Having representation allows you to easily approach this owner, demonstrate your capabilities as a potential buyer and position yourself as their exit strategy.  This is a delicate situation that requires a difficult discussion.  But that’s why you hired representation!

This is a life changing moment.  Make sure you find the best business for you and your family and don’t go at it alone!

For more information about our buy-side services feel free to contact Scott Mashuda, Managing Director, River’s Edge Alliance Group, LLC by phone at (412) 894-3244 or (440) 915-3082.  Or, e-mail: smashuda@RiversEdgeAlliance.com.

I’ve owned my business brokerage firm for a long time.  I’ve seen a lot of others go in and out of business.  I’ve heard a lot of bad things about business brokers and read a lot of useless tips on how to pick a good one.  So, I’ve decided to compile my own list of the top 4 things to be careful of when hiring a business broker.

1)  Beware of Business Brokers that charge SUBSTANTIAL up front fees (continue reading this point!) -  Up front retainers are NOT a bad thing.  We charge one.  But it is VERY small relative to the TOTAL fees we charge for selling your business.  As most good brokers do, we put our money where our mouth is in terms of our ability to sell your business.  We take 99% of the risk that we will SELL your business.  We expect you to take the last 1% so we know that you’re serious.  Having a little “skin in the game” as the seller is a good thing.  It shows us that you’re not just shopping us for offers to gauge your market value and it shows us that selling your business a priority to you.

The problem arises when a broker requests that you pay a substantial portion of their free up-front or in up-front monthly installments.  For example, there is one business brokerage company that has crept up asking for $10,000 a month payments for each of the first six months.  Think about that this way; if their fee is $100,000 in total and you’ve guaranteed them $60,000, what is their incentive to earn the other $40,000?  They can go out and make more money buy signing up another business.  Selling your business is the harder of those two tasks and now it pays less than a new listing!  Unfortunately, the motivation of these brokers is not to sell your business.  Their motivation is to list as many businesses as possible and earn as many $60,000 fees as possible.  You will probably get a nice marketing book / presentation from them in return.  But, you won’t get your business sold.

2)  Beware of Business Brokerage Firms that are NOT local – Firms with offices in large metropolitan areas such as New York, Los Angeles, Dallas or Atlanta (but not in your local area) are not worth your time, money or effort.  If they are not in your community, you should not be their client.  Buyers for small businesses are local.  They have local accountants, local attorneys, and their families are local.  Buyers are not willing to uproot their families and move them half way across the country to buy a small to medium sized business.  There are plenty of other businesses closer to home that they can buy and accomplish their goals.  Keep in mind, it is not YOUR business that a buyer is in love with, it’s cash flow.  Cash flow is what will allow them to be their own boss, send their kids to college, make their mortgage payments and live the lifestyle they want to live.

If the buyer for your business is local, the business broker tasked with finding them needs to be local.  He/She needs to sit down with them, meet them, tour the business with them, etc.  The broker has to know the buyer’s accountant, attorney, and financial planner so that they can be introduced and a sale can be facilitated.  A “non-local” broker won’t have these community ties and won’t invest the time and effort in obtaining them (since they won’t benefit from them on their “next deal”).  Make sure the broker you hire is local and tied into the local professionals or else you’re just listing your business for sale, not selling it.

3)  Beware of Business Brokers playing the “Numbers” game –   One of the popular models that I have seen in the business brokerage community is, “list as many businesses for sale as possible and when one sells, the broker makes money.”  There are several problems with this model.  Two of the biggest are:

• Your business is less likely to sell in a “numbers game” model because the broker is more concerned with getting listings (adding to their numbers) than selling your business.  Think about it, it’s a numbers game.  More listings = more opportunities for something to fall into place and earn a fee.  To this broker quality is not important.  Quantity is their focus.  Let me be clear, a mispriced business listing will not sell.  The asking price must be properly supported by the assets and cash flow available for sale in order for the business to be sold.  Consider how much time your broker spent making sure your asking price was fully supportable and what type of analysis they compiled to substantiate that position BEFORE they tried listing your business?  Where were their priorities?  Listing the business or making sure the business was saleable and priced properly?  Listing vs. Selling.

• Let’s look at the “numbers game” broker from another angle.  This broker is not charging up front fees.  So, they must care about selling your business right?  I mean, if they don’t they won’t make any money, right?  Business brokers playing the numbers game do care about selling businesses; they just don’t care which one.  As long as they earn a fee somewhere, they don’t care which business generated that fee.  The best way to sniff out these brokers is to understand how many listings they have at any one point in time and how many of those actually sell.  The percentage of sold vs. listed is the key metric to understanding if you’re dealing with a “numbers game” player.

4)  Beware of the Other Fish in Your Pond – Business brokerage firms come in all different shapes and sizes.  Understanding how your business fits into the broker’s inventory BEFORE listing your business is critical to the broker hiring process.

• Being a small fish in a big pond is rarely good.  Most business brokers earn fees based on a percentage of the sale price.  If you’re the smallest business in a broker’s inventory, what is the likelihood that you will command the lion’s share of their time, attention and effort?  Which fees will they spend their time and energy chasing?  In all likelihood, the larger ones.  Make sure that you’re a meaningful part of the broker’s inventory.  If the sale of your company would generate $100,000 for the broker, make sure that his/her inventory is comprised of other businesses that would generate him/her $100,000 in fees.

• Being a big fish in a small pond can go either way.  The broker will be highly motivated to complete the sale of a big fish if their inventory is all relatively small fish.  It’s the opposite of the scenario above.  Now, you command the lion’s share of their time and attention.  But, will that effort result in a positive outcome?  Will the broker have access to the resources necessary to complete a successful sale?  The best way to protect yourself in this scenario is again to select a firm with a proven track record of success selling companies with deal sizes similar to yours.

If you have questions about a particular firm or broker, don’t hesitate to call or e-mail.  I’ve been in this business a long time and know a lot of the players.  I’ll either tell you what I know, or point you in a direction for more information.  Just let me know how I can help.  Scott Mashuda, Managing Director, River’s Edge Alliance Group, LLC.  Phone: (412) 894-3244 or (440) 915-3082.  E-mail: smashuda@RiversEdgeAlliance.com.