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Buying a business - Physical execution, not the usual what its worth

Mcgyver

Diamond
Joined
Aug 5, 2005
Location
Toronto
I get what you're saying, but then again, anything you listed should be written down somewhere. If not, then it's the typical half-ass business, of which you probably don't want to buy.

If it is written down and formalized, it would be a crime for the current owners to not divulge all.

If the current owner(s) have verbal contracts--meaning it's not written down, signed, or formalized in any way besides verbal, then it's 100% on them.l.

Its never that black and white. Doesn't have to even be something the current owner knows about. I've done this professionally, others hired me to negotiate, figure out the deal structure, documentation, strategy, financing, due diligence etc. There are a million ways to get whacked with the stupid stick.

A crime? Its not a crime for the vendor to not divulge everything that ever happened. Its the opposite - most will downplay, obfuscate, or either conveniently or legitimately forget to mention things that negatively affect value. If you had the right reps and warranties you might have a civil case, depending, but do you know how expensive commercial litigation is? and how dicey? Plus you have no money at that point - you've either put everything in to stem the bleeding or are sitting there broke because of some stupid thing you didn't know about, and you're going to call the cops? (that's who you call for a crime). "Hello Officer, I'm calling because the previous owner didn't tell me about _______ and that's not right". They'd laugh. Even if it was a crime, slapping the cuffs on doesn't get your business back or cover your losses.

You buy the shares, you step into the previous shareholders shoes and every skeleton in the closet becomes yours. You may or may not have recourse toward the vendor (a big unsecured vtb can really help in that regard lol) and suing may or many not make sense....buts that's an after thought.....meanwhile...YOU own the problem/skeleton and will have to deal with it..

Its not impossible, lots of share deals close - maybe even more than asset deals. It just takes a lot more due diligence, a lot more sophistication as its a lot more complicated, generates a much larger legal bill and will always have a higher risk than an asset deal. Also, few of us here are going to be buying $100 million divisions of some public company; in my experience, the smaller the business, generally the more cowboy'ish they are, and the riskier a share deal becomes.
 
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cnctoolcat

Titanium
Joined
Sep 18, 2006
Location
Abingdon, VA
Its the opposite - most will downplay, obfuscate, or either conveniently or legitimately forget to mention things that negatively affect value.

If a person does this in the process of selling shares in a publicly registered and licensed corporation, LLC, and other legal forms of a business, I would imagine..., uh, yeah, I think it is considered illegal, and thus a crime.

ToolCat
 

Mcgyver

Diamond
Joined
Aug 5, 2005
Location
Toronto
If a person does this in the process of selling shares in a publicly registered and licensed corporation, LLC, and other legal forms of a business, I would imagine..., uh, yeah, I think it is considered illegal, and thus a crime.

Illegal means its against some law. Crime means its against criminal law. The two are NOT the same. Robbery is illegal and is a crime. Building your deck to close the property line might be illegal but is not a crime. Ergo, just because something is illegal you cannot say thus its crime.

Don't know why you would think failure to disclose was illegal let alone a crime. Just because its a corporation? So what? That doesn't impose on the seller of the shares some legal obligation to tell you anything or everything. The obligation for disclosure is what you contract for and your recourse is civil and only then if you have strong reps and warranties (which they will try to soften, and its hard to stop it from happening, with a "to the best of my knowledge" etc). You give a list of what you want document wise; there's no "tell me everything I need to know". i.e. the onus is on the buyer to ask not the vendor to volunteer. If you did have a strong civil case because of a failure to disclose, it does you little good when you're sitting there broke and have just been served on same huge claim no one saw coming.

Out and out misrepresenting something of might be fraud (criminal) buts is rare, and not what we're talking about. Intentionally lying is not the same as not disclosing or not even being aware of a risk (i.e. law suit around the corner that becomes your problem once you own the shares) etc. In any case it doesn't change anything in the discussion: It furthers my point on the higher risk of a share deal and the need for more expensive DD, more lawyer time, more risk and doesn't change what happens to you
 
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vmipacman

Cast Iron
Joined
Nov 21, 2014
Location
Virginia, USA
Sellers expect a premium or multiple for the cash flow stream. The multiple is low (1 to 2.5) for very small businesses that are low margin, dependent on the owner’s skills or dependent on a few customers. The number is about 3.5 for a business with a couple million in sales with respectable margins and some degree of redundancy in people, products and customers. For diversified companies over 5 million, the multiple is typically somewhere between 4 and 7. The multiple can go very high for rich companies with high margins and technical advantages.

I wish this was common knowledge for the sellers. Seems all their CPA's tell them "5 to 10". WHAT?! The older gents who I've talked to about retiring are completely off base. When you get wrong information it just makes the recalibration process much harder.

Guy has 750K in sales from a small job shop and takes home 200K, while while his two sons make up the majority of the competant labor, and he thinks his business is worth 1M+250K in assets? Haha year right!! (But since they won't get that they would rather it just peter out and fades away then not sell it for that)
I'm convinced most new businesses in the US just backfill for the ones that die because of unwillingness to allow succession.

Good luck with your endeavor. Be sure to get a REALLY accurate valuation! I have found small-local Banks good judges of valuation too. If you can't pay it back in 5 years, (i.e. they won't lend on it) its not not worth buying at that price. And Banks are smarter than I used to give them credit for. If they can't get their money back in 5 years, it's not a good investment for you either.
 

Mcgyver

Diamond
Joined
Aug 5, 2005
Location
Toronto
valuation of private business is a real challenge. The reason is they are not recorded anywhere, so unless you did the deal its about impossible to develop a good set of comparable sales - which is fundamental to arguing what multiple to use. Even if you do hear the purchase price, so what? You can't calculate the multiple without knowing the normalized EBITDA. The parties to the transaction might not even agree on that and there is no way to find out for a private business. Lastly, there's an old line, "its not what you pay, its how you pay". Cash is going to drive a lower price than a 95% zero interest non secured VTB.

If you have ever read through a "professional" valuation, its 50 pages of BS (analysis of business etc) then at the end they pick a value determining multiple using the WAG method (WAG - wild ass guess). And you pay $10,000 for it. Complete BS, but judges etc accept them because there is no better way. I remember one example where a judge needed three valuations and lowest (all done by certified valuation people) was 1/3 of the highest.

So at best you have rules of thumb. the bench mark has traditionally been 4x. That would be for a business that you could argue had sustainable earnings. A job shop where every customer is a buddy of the owner is not very sustainable. Thats bigger business ofter trade at high multiples - easier to say its not all riding on the owner. Businesses like a say a smallish general contractor might get valued the liquidation value of the tangible assets less liabilities plus the NPV of any existing contracts. I suppose you could argue the multiple should be higher now with low interest rates. And sometimes small businesses go at premium just because they are affordable and there's a bunch of accountants and lawyers without a clue (about running the business and valuation) who have some dough, are convinced because of their brilliance it will shine in their hands and have grown to hate professional services. (the irrational buyer)

Another approach is to look at public PE's and discount for size of business and lack of liquidity. Its still kind of BS as those discounts are guesses, however it does show the different multiples you'd see in different types of businesses.

The above posters example of someone wanting a multiple, then adding the value of assets is just so fundamentally stupid that there is no hope of getting reasonable deal with them. People who assume knowledge where they have none hurt themselves of course and there's little we can do about it.

The bright young people stuck at their desks in investment banks until the wee hours everyday are basically running discounted cash flows. They project profit and discount it into today's dollars, add it up and that's the value. Stated in English the value of a business the present value of future profits. Of course its got is own BS issues as who determines the growth on the projections? Still its the best and only real way to value things. Multiples of whatever are kind of shortcuts to the same answer...with multiples the Q is what earnings and what multiple and with DCF's its what projections and to a lesser degree what discount rate (although there is some sensible methodology for that).
 








 
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