Personal Goodwill: Who Owns It?
Personal Goodwill has always been a fascinating subject, impacting the sale of many small to medium-sized businesses – and possibly even larger companies. How is personal goodwill developed? An individual starts a business and, during the process, builds one or more of the following:
• A positive personal reputation
• A personal relationship with many of the largest customers and/or suppliers
• Company products, publications, etc., as the sole author, designer, or inventor
The creation of personal goodwill occurs far beyond just customers and suppliers. Over the years, personal goodwill has been established through relationships with tax advisors, doctors, dentists, attorneys, and other personal service providers. While these relationships are wonderful benefits, they are, unfortunately, non-transferable. There is an old saying: In businesses built around personal goodwill, the goodwill goes home at night.
It can be difficult to sell a business, regardless of size, where personal goodwill plays an integral role in the business’ success. The larger the business, the less likely that one person holds the key to its profitability. In small to medium-sized businesses, personal goodwill can be a crucial ingredient. A buyer certainly has to consider it when considering whether to buy such a business.
In the case of the sale of a medical, accounting, or legal practice, existing clients/patients may visit a new owner of the same practice; they are used to coming to that location, they have an immediate problem, or they have some other practical reason for staying with the same practice. However, if existing clients or patients don’t like the new owner, or they don’t feel that their needs were handled the way the old owner cared for them, they may look for a new provider. The new owner might be as competent as, or more competent than, his predecessor, but chemistry, or the lack of it, can supersede competency in the eyes of a customer.
Businesses centered on the goodwill of the owner can certainly be sold, but usually the buyer will want some protection in case business is lost with the departure of the seller. One simple method requires the seller to stay for a sufficient period after the sale to allow him or her to work with the new owner and slowly transfer the goodwill. No doubt, some goodwill will be lost, but that expectation should be built into the price.
Another approach uses some form of “earnout.” At the end of the year, the lost business that can be attributed to the goodwill of the seller is tallied. A percentage is then subtracted from monies owed to the seller, or funds from the down payment are placed in escrow, and adjustments are made from that source.
In some cases, the sale of goodwill may offer some favorable tax benefits for the seller. If the seller of the business is also the owner of the personal goodwill, the sale can essentially be two taxable events. The tax courts have ruled that the business doesn’t own the goodwill, the owner of the business does. The seller thus sells the business and then also sells his or her personal goodwill. The seller’s tax professional will be able to give further advice on this matter.
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Copyright:Business Brokerage Press, Inc.
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The Three Ways to Negotiate
Basically, there are three major negotiation methods.
1. Take it or leave it. A buyer makes an offer or a seller makes a counter-offer – both sides can let the “chips fall where they may.”
2. Split the difference. The buyer and seller, one or the other, or both, decide to split the difference between what the buyer is willing to offer and what the seller is willing to accept. A real oversimplification, but often used.
3. This for that. Both buyer and seller have to find out what is important to each. So many of these important areas are non-monetary and involve personal things such as allowing the owner’s son to continue employment with the firm. The buyer may want to move the business.
There is an old adage that advises, “Never negotiate your own deal!”
The first thing both sides have to decide on is who will represent them. Will they have their attorney, their intermediary or will they go it alone? Intermediaries are a good choice for a seller. They have done it before, are good advocates for their side and they understand the company and the seller.
How do the parties get together in a win-win negotiation? The first step is for both sides to work with their advisors to settle on the price and deal structure positions. Both sides should be able to present their side of these issues. Which is more important – price or terms, or non-monetary items?
Information is vital to a buyer. Buyers should keep in mind that the seller knows more about the business than he or she does. Both buyer and seller need to anticipate what is important to the other and keep that in mind when discussing the deal. Buyer and seller should do due diligence on each other. Both buyer and seller must be able to walk away from a deal that is just not going to work.
Bob Woolf, the famous sports agent said in his book, Friendly Persuasion: My Life as a Negotiator, “I never think of negotiating against anyone. I work with people to come to an agreement. Deals are put together.”
Copyright: Business Brokerage Press, Inc.
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Due Diligence — Do It Now!
The Importance of Due Diligence in Business Acquisitions
When it comes to buying a business, due diligence is not just a formality – it’s a crucial step that can make or break your investment. Proper due diligence helps you uncover potential risks, validate the seller’s claims, and ensure you’re making an informed decision. In this comprehensive guide, we’ll explore the essential aspects of business due diligence and provide you with actionable strategies to protect your interests.
What is Business Due Diligence?
Business due diligence is the process of thoroughly investigating and evaluating a company before making a purchase decision. It involves a detailed examination of various aspects of the business, including:
- Financial records and performance
- Legal and regulatory compliance
- Operational efficiency
- Market position and competition
- Human resources and organizational structure
- Intellectual property and assets
By conducting thorough due diligence, you can identify potential red flags, assess the true value of the business, and negotiate better terms for the acquisition.
Key Steps in the Due Diligence Process
1. Financial Analysis
One of the most critical aspects of due diligence is a comprehensive financial analysis. This includes:
- Reviewing financial statements (balance sheets, income statements, cash flow statements)
- Analyzing tax returns and audit reports
- Examining accounts receivable and payable
- Assessing the company’s debt structure and obligations
Pro tip: Look for inconsistencies or unusual patterns in the financial data that may indicate hidden issues or misrepresentation.
2. Legal and Regulatory Review
Ensure the business is compliant with all relevant laws and regulations:
- Review contracts with customers, suppliers, and partners
- Examine licenses, permits, and certifications
- Investigate any pending or potential litigation
- Verify compliance with industry-specific regulations
3. Operational Assessment
Evaluate the company’s operational efficiency and processes:
- Analyze the supply chain and inventory management
- Review production processes and quality control measures
- Assess the condition and value of equipment and facilities
- Examine the company’s IT infrastructure and systems
4. Market and Competitive Analysis
Understand the business’s position in the market:
- Research industry trends and growth potential
- Analyze the competitive landscape
- Evaluate the company’s customer base and market share
- Assess the effectiveness of marketing and sales strategies
5. Human Resources and Organizational Structure
Examine the company’s workforce and management:
- Review employee contracts and compensation structures
- Assess the skills and experience of key personnel
- Evaluate company culture and employee satisfaction
- Identify potential retention issues or skill gaps
6. Intellectual Property and Assets
Verify the ownership and value of the company’s intangible assets:
- Review patents, trademarks, and copyrights
- Assess the strength of the company’s brand
- Evaluate proprietary technologies or processes
- Examine licensing agreements and royalties
Best Practices for Effective Due Diligence
To ensure a thorough and effective due diligence process, consider the following best practices:
- Assemble a skilled team: Include experts in finance, law, and industry-specific areas to cover all aspects of the business.
- Develop a comprehensive checklist: Create a detailed list of items to review, tailored to the specific business and industry.
- Set realistic timelines: Allow sufficient time for a thorough investigation, but be mindful of deal momentum.
- Maintain open communication: Foster a collaborative relationship with the seller to facilitate information sharing.
- Document everything: Keep detailed records of all findings, communications, and decisions made during the process.
- Verify information independently: Don’t rely solely on the seller’s representations; seek third-party verification when possible.
- Consider cultural fit: Assess whether the target company’s culture aligns with your own organization’s values and goals.
- Evaluate synergies and integration challenges: Identify potential areas for value creation and anticipate integration hurdles.
Common Pitfalls to Avoid
While conducting due diligence, be aware of these common mistakes:
- Rushing the process to close the deal quickly
- Overlooking red flags or inconsistencies in the data
- Failing to investigate customer relationships and satisfaction
- Neglecting to assess the quality of earnings and sustainability of revenue streams
- Underestimating the importance of cultural fit and employee retention
The Role of Professional Advisors
Engaging professional advisors can significantly enhance the quality and effectiveness of your due diligence process. Consider working with:
- Experienced M&A attorneys
- Certified public accountants
- Industry-specific consultants
- Valuation experts
- Environmental specialists (if applicable)
These professionals can provide valuable insights, identify potential issues, and help you navigate complex aspects of the transaction.
Conclusion: Protecting Your Investment Through Diligence
Business due diligence is a critical step in the acquisition process that can protect you from costly mistakes and help you make informed decisions. By thoroughly investigating all aspects of the target company, you can:
- Validate the seller’s claims and representations
- Identify potential risks and liabilities
- Assess the true value of the business
- Negotiate better terms and conditions
- Develop a more effective integration plan
Remember, the time and resources invested in due diligence can pay significant dividends in the long run by helping you avoid bad deals and maximize the value of your investment.
Call to Action
Are you considering buying a business? Don’t navigate the complex world of due diligence alone. Contact Indiana Equity Brokers today for expert guidance and support throughout the acquisition process. Our experienced team can help you conduct thorough due diligence, identify potential risks, and make informed decisions to protect your investment. Schedule a consultation now to learn how we can assist you in your business acquisition journey.
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Considerations When Selling…Or Buying
Important questions to ask when looking at a business…or preparing to have your business looked at by prospective buyers.
• What’s for sale? What’s not for sale? Does it include real estate? Are some of the machines leased instead of owned?
• What assets are not earning money? Perhaps these assets should be sold off.
• What is proprietary? Formulations, patents, software, etc.?
• What is their competitive advantage? A certain niche, superior marketing or better manufacturing.
• What is the barrier of entry? Capital, low labor, tight relationships.
• What about employment agreements/non-competes? Has the seller failed to secure these agreements from key employees?
• How does one grow the business? Maybe it can’t be grown.
• How much working capital does one need to run the business?
• What is the depth of management and how dependent is the business on the owner/manager?
• How is the financial reporting undertaken and recorded and how does management adjust the business accordingly?
Keys to a Successful Closing
The closing is the formal transfer of a business. It usually also represents the successful culmination of many months of hard work, extensive negotiations, lots of give and take, and ultimately a satisfactory meeting of the minds. The document governing the closing is the Purchase and Sale Agreement. It generally covers the following:
• A description of the transaction – Is it a stock or asset sale?
• Terms of the agreement – This covers the price and terms and how it is to be paid. It should also include the status of any management that will remain with the business.
• Representations and Warranties – These are usually negotiated after the Letter of Intent is agreed upon. Both buyer and seller want protection from any misrepresentations. The warranties provide assurances that everything is as represented.
• Conditions and Covenants – These include non-competes and agreements to do or not to do certain things.
There are four key steps that must be undertaken before the sale of a business can close:
1. The seller must show satisfactory evidence that he or she has the legal right to act on behalf of the selling company and the legal authority to sell the business.
2. The buyer’s representatives must have completed the due diligence process, and claims and representations made by the seller must have been substantiated.
3. The necessary financing must have been secured, and the proper paperwork and appropriate liens must be in place so funds can be released.
4. All representations and warranties must be in place, with remedies made available to the buyer in case of seller’s breech.
There are two major elements of the closing that take place simultaneously:
• Corporate Closing: The actual transfer of the corporate stock or assets based on the provisions of the Purchase and Sale Agreement. Stockholder approvals are in, litigation and environmental issues satisfied, representations and warranties signed, leases transferred, employee and board member resignations, etc. completed, and necessary covenants and conditions performed. In other words, all of the paperwork outlined in the Purchase and Sale Agreement has been completed.
• Financial Closing: The paperwork and legal documentation necessary to provide funding has been executed. Once all of the conditions of funding have been met, titles and assets are transferred to the purchaser, and the funds delivered to the seller.
It is best if a pre-closing is held a week or so prior to the actual closing. Documents can be reviewed and agreed upon, loose ends tied up, and any open matters closed. By doing a pre-closing, the actual closing becomes a mere formality, rather than requiring more negotiation and discussion.
The closing is not a time to cut costs – or corners. Since mistakes can be very expensive, both sides require expert advice. Hopefully, both sides are in complete agreement and any disagreements were resolved at the pre-closing meeting. A closing should be a time for celebration!
