6. & 7. Passing the Baton

The following topics will be addressed in this post:

Discuss the advantages and disadvantages of buying a business as opposed to starting one from scratch. What two ways can one buy a business and which is preferable ? Why?

Is there such a concept as “good will” in reality and is it transferable? Why or why not? Give an example.

Ladies and gentlemen, step right up and get your existing business here! We have all sizes and shapes to suit! We have small ones and large ones! We have retail, wholesale, service, and more! Yes, indeed, get your existing business with positive cash flows, an established client base, oodles of goodwill, and an owner willing to assist your financing! Don’t miss this opportunity!

The preceding hawker’s cry is not entirely in jest. Not every entrepreneur needs to start from scratch. Plenty of businesses change hands daily. Buying a business can be a great way to avoid start-up hassles and get right into the business of doing business. With Greatest Generationers and and now Baby Boomers retiring daily, acquiring an existing business might become the normal transfer model during the next couple of decades.

Before we go buy a business, let’s discuss the advantages and disadvantages of acquiring a business as opposed to starting one from scratch. The following list comes from across the pond in the U.K. (Businesslink.gov.uk):

Advantages

  • Continuing clients provide revenues and cash flows
  • Business processes are already established and employees are experienced
  • Acquiring financing may be easier

Disadvantages

  • Finding an appropriate business can be difficult
  • Accurately valuing an existing business can be tough
  • Upfront capital outlays may be high
  • Existing personnel may not like the change
  • Business reputation with clients and business associates may be difficult to change
  • Equipment may be old or the entire business model may be in secular decline

After weighing the factors, an existing business still seems the correct choice, so how does one acquire an existing business? One may inherit a business, and many families build and transfer wealth through their businesses. The other ways are more transactional in nature. In the corporate world, people buy and sell business ownership daily through public exchanges of stock, but these transactions rarely involve controlling stakes, even among institutional investors. In the small business world, one usually seeks a controlling stake or complete ownership.

One can purchase a business in a variety of structured transactions, but they distill into a buy-in or a buyout. Buy-ins do not result in complete transfers because, by definition, the previous owner or owners retain some portion of the business. With a buy-in, sole proprietorships become partnerships but all other business forms can remain the same. Buy-ins require less capital than buyouts and they help retain talented personnel, but the situation can become complicated if the previous owners or retained employees resist the new business practices. On the other hand, buyouts transfer complete ownership.

Technically, a sole proprietorship or partnership cannot transfer through a buyout so a key resource acquisition or bulk asset sale is used. A specialized form of buyout is the employee stock option plan (ESOP) wherein owners sell a majority stake to the employees, usually over the course of years. Boyouts are more straightforward than buy-in and are usually preferable. Sometimes a buyout can be complicated if the business has liabilities like outstanding litigation, but performing due diligence prior to the transaction should minimize this risk (Katz and Green).

As noted previously, one of the primary advantages to acquiring an existing business is the continuing client base and positive relationships with business associates. The business jargon is “goodwill,” which can be defined as “that part of business value over and above the value of identifiable business assets” (ValuAdder.com). Goodwill is an intangible asset, but sometimes is given a valuation when businesses construct their balance sheets, especially during mergers (About.com).

In the small business world, goodwill is the positive feeling and trust that customers and business associates transfer to the new owners, and consequently how much they are inclined to continue business with the new owners. Goodwill definitely exists because humans are emotional beings. Goodwill is most likely to transfer when the ownership transition has been smooth and protracted as customers become familiar with the new management. When my grandparents sold their store, it was thriving. When the new owners assumed control some key personnel remained and people continued to patronize the store because they had shopped there for years. Unfortunately, the new management did not listen to or treat the customers in a similar manner to my grandparents. Over time, the goodwill evaporated and the store eventually closed. Nonetheless, to this day over twenty years later, people in town reminisce gleefully with my grandmother about their remembrances of shopping in that store.

Some resources for buying a business:

local Chambers of Commerce

Trade journals

Service Corps of Retired Executives

Sources:

About.com. http://beginnersinvest.about.com/od/analyzingabalancesheet/a/goodwill-on-the-balance-sheet.htm

Businesslink.gov. http://www.businesslink.gov.uk/bdotg/action/detail?type=RESOURCES&itemId=1074410852

Katz, J.A. and Green, R.P. (2009) Entrepreneurial small business, Second edition. McGraw-Hill: New York.

ValuAdder. http://www.valuadder.com/glossary/business-goodwill.html

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One Response to 6. & 7. Passing the Baton

  1. First, I love the titles of your posts. Very creative and makes me want to read more.

    Secondly, in regards to your posts about buying a business, I appreciate your explanation on the multiple ways to buy the business, specifically if it is an employee owned business. I forgot to cover that area in my own blog.

    Lastly, thanks for the links and references. Very valuable.

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