The Matt Mittan Show

(Biz Law) Mastering Business Acquisitions: From Valuation to Employee Retention

• Michael Palermo / Matt Mittan

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What if you could confidently navigate the complexities of buying a business, ensuring no stone is left unturned? That's exactly what you'll gain from our latest episode. From dissecting revenue streams and evaluating equipment to understanding operational costs and the often-overlooked aspect of goodwill, we've got you covered. We underscore the importance of accurate business valuation and the critical role of nondisclosure agreements (NDAs) in protecting sensitive information during negotiations. This episode is your ultimate guide to making well-informed decisions, whether you're a seasoned entrepreneur or stepping into business acquisition for the first time.

Transitioning to a crucial yet often tricky aspect, we tackle the challenge of retaining key employees during business transitions. Learn how to secure their commitment with effective strategies like contracts and equity options, tailored to meet their preferences—be it ownership stakes or competitive salaries. We stress the importance of structuring these agreements upfront to avoid future complications. To round off, I'll share my contact details, emphasizing email as the best way to reach me, and direct you to my website for more in-depth services. This episode is an essential listen for anyone aiming to master the intricacies of business acquisitions and employee retention.

Visit https://palermolaw.com/blog-2/ for Michael's blog on Biz Law topics!

Be sure to visit BizRadio.US to discover hundreds more engaging conversations, local events and more.

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Speaker 1:

Good day everybody, and welcome to another episode in the series of Biz Law with business lawyer Michael Palermo. And so I said it in a previous episode. I want to say it again Congratulations. Just recently found out your popularity award. There is a top 20 business program in the state of Illinois, and it'd be nice if other states were letting us know how you rank in those states too. But we'll take some of your old stomping grounds in Illinois, so that's really cool.

Speaker 1:

Well, our topic oh go ahead Number 11 with a bullet. Yeah, there we go. We got to aim for that top 10, crack the top 10 next. All right, so here we go. The next topic in the series. Here we're going to talk about buying an existing business. So there's a lot to cover under that heading, so I'm looking forward to getting into it. But one of the things that, as a serial entrepreneur myself, I'm always looking at if I'm going to go ahead and create something from scratch, or if I'm going to buy into an existing situation whether it's a startup company that is looking to sell, or if it's a franchise agreement or something what am I getting? What am I paying for? Talk about buying an existing business.

Speaker 2:

Well, you're right, it's a complex topic and today I think we're going to talk about what are you really paying for and how to value it. I've done blog posts and I think we've done podcasts on what the agreements look like and how to negotiate the agreements and things like that. But you're right, I've got clients that are serial business starters and I've got clients that just like to buy businesses that are already going. So, to answer the first question, what are you really paying for with an existing business? Start out with a revenue stream. That's the first thing most people look at. Is just business making money and if so, how much money is coming in and then how much can be peeled away for profits? Next up on the list is equipment. If you're buying a construction business, I got a client now that's buying a coffee shop here in town and along with that is the equipment Construction businesses, bulldozers, dump trucks, cranes, whatever construction company you're buying Coffee shop has.

Speaker 2:

They've got all the baking equipment because they do lunches. They've got the coffee machines, all that sort of thing. So those are kind of the two main things, and then the third one is an operating system. Anyone who has ever started a business from scratch, knows that they need to put systems in place to efficiently operate the business, whether it's scheduling, billing, customer acquisition, project management. An existing business a good existing business will have those systems already in place, and not just generically but tuned specifically to that business. So those are kind of the three main things that you're buying. And then the last thing is goodwill, and that's sort of an intangible that we could talk about in a minute.

Speaker 1:

Yeah. So going back to the revenue stream, one of the things if you watch different programs, whether it's talking about venture capitalists, angel investors, or if you watch something like Shark Tank revenue stream actually has some subcategories under it as well. Where you're talking about okay, well, there's the revenue stream. What's the debt service, what's the outlay for your operation? Those kind of things. When you're going to buy, this is going to seem like a sidebar, but I've just seen it come up a couple of times in the last couple of months. But going to talk to somebody about their business and not being well, they don't want to tell you anything unless you sign an NDA. What kind of what's your thoughts on that as a prospective buyer, when someone doesn't want to talk at all, is that a reasonable request? Or you know, how do you feel on that when you're going to look at an existing business to purchase?

Speaker 2:

It's case by case. I know just from talking to a lot of business owners and hanging out with business owners. One of the very first things that business owners will talk about is what's your revenue? How much money is coming in the door. That's what revenue means. Is it a million dollars? Is it $500,000? Is it $40,000? Someone who's selling a business might not want that information broadcast for a variety of reasons. Maybe they don't want their competitor to know how good they're doing or how bad they're doing, maybe they just don't. A lot of people just don't like their private information being disclosed. Maybe they don't want the employees to know how well they're doing or how bad they're doing. So I don't think a nondisclosure to get financial information is unreasonable. In fact, I know business brokers a lot will. That's just par for the course. Let's get a nondisclosure on file so that the potential purchaser doesn't turn around and use that information in a way that's detrimental to the seller.

Speaker 1:

Yeah, because I've seen a number of people. You know, especially if they started a business themselves, they've grown it to a point where they sell it. You know they're just operating on goodwill and like, oh, somebody's interested, yeah, I'll talk to them. But you know it's okay to get those. You know, get with your business lawyer, get that stuff crafted in advance and ask for it before you have that conversation.

Speaker 2:

Put it in place In 30 years I've never had a problem with somebody disclosing the information regarding revenue stream, or it could be employee salaries, it could be operating costs. A potential purchaser isn't there to disclose that information to somebody else. They're there because they want to evaluate the business, so that just it may be a layer, sort of a comfort for the seller, because money's personal to a lot of people and they've worked hard to get to that point. Or they're embarrassed where they are, or they just don't want their competitors knowing. So it's not an unreasonable request.

Speaker 1:

Yep, all right, let's talk about the goodwill you mentioned. You know there's some areas into that we can get into. Let's go ahead and dive a little bit deeper on Goodwill. If you're looking to buy a business and you say, well, I'm buying it because there's Goodwill that will come from it, talk about that a little bit. The first thing I thought when you said it was like when Budweiser bought Wicked Weed. Wicked Weed was a local homegrown thing in Asheville, north Carolina. It gets really popular. Budweiser comes in, buys it. You know there's some street cred, you know kind of thing. But talk about that a little bit more.

Speaker 2:

So it's a little more technical than how you're perceived in the community, which was more of the Budweiser wicked weed situation. And I mean it took me a long time to sort of understand the concept of goodwill, because I'm sort of a technical guy and and goodwill is a made-up number. Goodwill is defined, generally speaking, as that amount that a buyer is willing to pay for a business. That's over and above just the assets of the business and that's just sort of a seat-of-the-pants definition. So what are you willing to pay to have this business? And that's sort of the legal, technical definition of goodwill rather than just how you're perceived in the community.

Speaker 1:

Oh, that's interesting yeah.

Speaker 2:

Yeah, so there is a value put on goodwill and that value is just sort of this Think of it as the seller's premium because we're talking about buying an existing business premium because we're talking about buying an existing business, well, you know, I can buy a sandwich shop. That's been ongoing for years, people know it, people come to it, and that's sort of social goodwill. But what am I willing to pay for? The fact that this business has a solid customer base, a good revenue stream, the equipment in place, the operation systems that we talked about? What am I willing to pay for that part of it that it's already in place and that's the business goodwill, and I can see how that can flip the other way too.

Speaker 1:

I'm aware of a business that has a very, very strong name recognition and looking to sell. But one of the conditions of buying is you cannot use the imaging, the style, the naming or anything like that of that business once you buy it. So you know it's. Basically you're looking at what's the equipment, what's the operation systems. You know things like that, because the other things, the revenue stream you can't count on that if you can't use the goodwill and the name recognition, the advertising that was already established.

Speaker 2:

Right and and, like I said, it sort of encompasses social goodwill. However you perceived in the community, and if your favorite sandwich shop showed up with a new name and a new facade over the weekend, maybe you'll give it a try, maybe you won't. So selling a business without sort of the cladding that comes with an existing successful business, the goodwill is not as valuable.

Speaker 1:

Yeah, let's talk about value. Let's talk about valuation. It's something that we bring up a lot in these series episodes In the context of this conversation buying an existing business how do you value it?

Speaker 2:

So, first of all, I don't do the valuation. There's people who study valuations and do a good job of it. But one thing I will say is there are multiple valuation methods and it depends on the type of business. And then there's part sort of voodoo, witchcraft, angel dust, whatever you want to call it, which is it's sort of a craft and an art, more than it is just dollars and cents. And I'll just give a couple here. There's one that I like which is discount, cash flow or earnings. There's liquidation value, there's book value, and then, of course, we talked about goodwill a minute ago.

Speaker 1:

Talk about book value a little bit. What is involved in book value?

Speaker 2:

Book value. That's the only one. That's sort of a literal math calculation. Somebody looks at the assets of the businesses, the business, and they subtract the liabilities and there may be intangibles that are involved. But book value is you literally look at the books of the business, books of the business, and tally up the assets how many, how many trucks do you own, how many sandwich shops, how many? How many storage facilities do you own and then put a value on those and then you look at what are the liabilities and then you just subtract them and it's assets minus liabilities gives you book value.

Speaker 1:

And to call back to a previous episode, where, in this process, do you look at what the shareholder situation is, on how many owners there are of equity in the business?

Speaker 2:

So if there's a purchaser, you always want to know who's got their hand in the business. So if there's a purchaser, you always want to know who's got their hand in the till. And that means shareholders as well as employees. Because if you want to buy the whole business, or if you have a consortium of three or four people that want to buy the business, they want to start from scratch. Not start the business from scratch, but just start operating it from scratch. So if there's a bunch of smaller shareholders on board, they want to get rid of them. So any type of buyout of an existing business generally includes all the shareholders being bought out.

Speaker 1:

And you talked about some intangibles. One of the things that made me think of is like key personnel retention. One of the things that made me think of is like key personnel retention. Is that one of the things that you would be considered an intangible when looking at evaluation of a business?

Speaker 2:

Yeah, in fact I worked on a big case back in Chicago years ago where it wasn't a buy sell but it was. It was a key employee type case where my client had bid on an underground construction project, building tunnels under the city. It was up in Evanston for all my Illinois listeners and it was a $9 million project. But they had to have a key employee on board who knew how to manage a project of this size, because you need a tunnel boring machine, you need dump trucks, you need paving equipment. It's a very complex project In the context of somebody buying an existing business with a key employee like that. It may be a key salesman, it may be a million-dollar-a-year salesman, it may be the guy that knows how to run the tunnel boring machine. You want to lock that person in as part of the deal, so the deal is always contingent on that person sticking around and that often involves an agreement with the selling owners, but also with the key employee, to get a one-year contract or three-year contract or whatever it may be. Is that something?

Speaker 1:

where equity would be. That would be like an equity option for the key employee. I've seen that happen a couple of times, where people say, look, want to retain you, we're going to give you this percentage of shares in the company that's.

Speaker 2:

That's definitely one option. Um, a lot of employees are just happy being employees, making their salary and going to work in the morning. They don't want the the headaches of ownership. So it's just just like any any business deal. Um, it can be structured however it needs to be structured, or you want to structure it. But, yeah, offering equity to a key employee is a good way to keep them in, because now they own shares in the business, so they've got a stake in the success of the business.

Speaker 1:

All right and, speaking of structure, highly recommend people do that on the front end instead of dealing with it on the back end. What's the best way for people to communicate with you?

Speaker 2:

Email is the best way. Palermo at palermolawcom that's also my website, palermolawcom, and people can go there and just get a sample of the type of work I do. But if it's not on there, give me a holler anyway, because I do more than just on my website.

Speaker 1:

All right, very good, Thank you, Michael.