Buying and Selling a Business (Part 1)
Keith Wasserstrom
November 08, 2005

Buying and Selling a Business (Part 1)

By Keith Wasserstrom

When buying a business, there are certain things that should be considered by the purchaser.

The most important, and most obvious, is the purchase price. What is the business worth? There are many ways to determine the value of a business. First, you can look at recent sales of similar businesses, just like you would do when purchasing a home. There are other methods, including a multiple of revenues, sales or earnings. For instance, a doctor's office may sell for 2 times earnings, or 1 times revenues. Whatever formula is used, you need to make sure that the components of the formula are agreed to in advance. The doctor may be taking a salary of $250,000, a portion of which would need to be added back to the calculation of earnings. Typically, you would "add back" that amount that is above and beyond what a normal doctor would be making. In our example, assume that doctors in the community in this specialty make $200,000 a year in salary. Then, you would add back the additional $50,000 that this particular doctor was making to the earnings that will be used to set the purchase price.

Additional thought has to go to the structure of the purchase price. Will it be an all cash purchase, will debt be used, as in a home mortgage, or will equity be exchanged? As a purchaser, the preference should be to pay as little cash down as possible. Conversely, sellers want as much cash as possible. The purchaser wants to defer paying cash because there are risks associated with purchasing a new business. One of those risks is that the business does not

perform as well as the seller suggested. This could be due to the seller's better ability in running the business, including his reputation and experience, or it could be due to the seller's misrepresentations as to the performance of the business. For the latter problem, it is best to seek indemnification from the seller. That means that you ask the seller to compensate you for the loss you incurred due to the misrepresentation. For instance, if you agreed on a purchase price that was 2 times earnings and the seller exaggerated the revenues of the business, the purchase price should be reduced by 2 times the difference in the true earnings from those misrepresented by the seller. Often there will be purchase price adjustments drafted into the documents that handle this very situation. Other times, the purchaser would have to seek reimbursement from the seller, who may no longer be easy to find. For that reason, it is best to have some of the purchase price set aside in escrow, or in the form of a deferred payment or promissory note so that the purchaser could set-off from such moneys the amount owed by the seller. The seller, on the other hand, wants as much cash at closing as possible because the seller can avoid the risk that the purchaser does not pay the purchase price, and the seller can avoid the risk that the purchaser makes claims against the money owed for alleged breaches or misrepresentations by the seller.

About the Author:

Keith Wasserstrom is a founding partner of Wasserstrom, Weinreb, & Wealcatch in Hollywood., e-mail keith@corporatecounsel.com or visit the firm's Web site at www.HollywoodCounsel.com.