Business Sale: Tangible vs Intangible Assets a Quick Analysis

Business Sale: Tangible vs Intangible Assets a Quick Analysis

Business Sale: Tangible vs Intangible Assets a Quick Analysis

A mysterious part of buying a business is the intangible asset sale. We find a wide variety of views and preconceived notions about business value from individuals as they review a business sale. Most the time, the discussion turns quickly to the business assets. That inevitably leads to a discussion of Tangible and Intangible Assets.

Investors involved in a business sale generally have a reasonable understanding of tangible assets but usually a less than good understanding of an intangible asset. They have a tendency to use disparaging terms like “Blue Sky” or “air ball” when they don’t understand the true value of intangible assets.

First let’s try to reach common ground on some basic definitions that are commonly used but not always understood.

Tangible Assets

Tangible assets are really based on banking and lending definitions. A general definition is an asset that has a physical form. For instance a truck is a tangible asset. You can touch it, feel it and more importantly sell it. While a truck is a tangible asset that may be salable, there are other tangible assets that might have different characteristics. Suppose you own a widget shop and you have a special machine you invented that bends the widget a special way. You love the machine but it’s of no use to anyone but you. That is still a tangible asset but it has relatively low value to the outside world. The truck you can likely sell pretty easily but finding a buyer for the widget machine might be a whole different problem.

Intangible Assets

These are assets that don’t have a physical form. For instance the trademarked Nike swoosh is a very high value intangible asset. One way to think about tangible vs intangible assets is tangible assets are used to make or deliver the product or service and intangible assets are what are used to generate the demand for the product or service or create the system to produce the product or service efficiently.

A very well known intangible asset is the secret formula for Coca-Cola. That formula has no tangible form, it’s basically words written down somewhere (likely different parts of the formula in different places). But that intangible asset is worth much more than the cost of the machines (tangible assets) used to produce Coke.

Now that we have a basic idea of the assets, let’s talk about why we have assets at all and how they effect a business sale.

Assets in a business have only one purpose (or one purpose that makes sense), to generate profits.

So what value can be created in a transaction? A Tangible Asset Sale or an Intangible Asset Sale?

I’ll give you 2 simple but real life situations.

1) Let’s say you can buy a machine for $100 that will generate $25 more per year in profits. You decide that’s a good investment, so you invest the $100 and you’ll get your $25 per year profits for as long as the machine works. So now you have a $100 tangible asset (the machine) and a $25 cash flow from it.

2) Now let’s say you add an email capture tool to your website, it captures visitors’ email addresses which you can use to automatically send out specials and mailers. The email tool costs $100 and generates $25 in cash flow.

In this case you created 2 intangible assets:

a) the email tool on your website and b) the list of emails of people interested in your products.

The intangible asset sale with the highest value is the list of emails for people interested in your products. Anybody can buy the email tool for $100 but you have the specific list of people’s email addresses that represent potential sales, this list is an intangible asset.

Think of it this way. Two businesses are exactly the same except one has the email addresses for these customers and one business doesn’t, which business is worth more?

The moral of this story is that when investigating a business sale and determining the value of the business for purchase, the assets that have real value are the assets responsible for generating the business profit, regardless of if they are tangible or intangible asset sale. A smart buyer knows how to identify those assets and isn’t blinded by the tangible asset mantra preached by the bankers.

Selling a Business in the NEXT Energy Boom

Selling a Business in the NEXT Energy Boom

Those of us who work regularly in and around the oil & gas energy industry recognize the difficulties presented by the current depressed energy prices and it’s effect on energy services, production and exploration companies. We view the world through the process of Mergers & Acquisitions as we work with business owners to sell their companies. Many Texas businesses are heavily impacted by the swings in energy prices. We see machine shops, water disposal, inspections, welding, tank, vessels, trucking, temporary housing and many other energy related businesses that suffer the financial pain when energy prices and production declines. We also see these same companies reap the benefits of rising energy prices and production cycles. Unfortunately too many business owners have short memories.
“When the energy business is good many business owners think it will last forever. It won’t.” Dan Elliott
Like you, we have seen this play out before in different cycles and many energy companies (and related businesses) always seem to recover. Selling a business for the highest value is often driven by timing. Will you be ready when the market is?
If your goal is to sell your business in the next energy boom here are 3 things you can focus on now to make sure your business achieves its highest value in the next energy recovery cycle.

  1. Get your financial reporting up to standards that will one day survive a buyer’s due diligence.
    Excellent financial records increase the value of your business because it reduces the buyer’s perceived risk that poorly maintained financials mean more financial room for error. Make sure your accounting is done consistently from year to year and make sure your current tax structure (C, S, LLC, etc) is what will create the highest value transaction. Look at your financials as a buyer would or better yet give us a call and we can review your information and give you a report that identifies the areas for improvement. Tip: To most buyers Reviewed financial statements are almost as good as audited financials and a lot less expensive. If you have audited great, but if you just have compiled statements find a good business accountant to do reviewed statements.
  2. Work hard on Customer Concentration Issues
    A buyer often perceives risks if 1 or 2 customers dominate the revenue of your business. Ideally your largest customer should be less than 20% of your annual revenue (unless you have long term contracts which assure buyer purchases). Shifting customer concentration is often a long process, start now. Tip: Look at your commission plans for your sales people. Are you rewarding sales people who diversify their customer base?
  3. Review your insurance to be sure you are adequately covered for your business risks
    An under-insured claim is a nightmare for a business owner and can interfere with the sale of the business for many, many years. Do you have enough coverage? Do you have the right coverage? The “right coverage” question is even more important than how much coverage. We had a client get hit with a $2 million claim that he thought he had insurance coverage for. He didn’t. The deal to sell his business that we had on the table for millions of dollars was delayed until he found out he wasn’t covered, then that deal disappeared altogether. Talk to more than one agent and certainly more than just your regular insurance agent who may think they know your business but really don’t. Many commercial insurance agents will be more than happy to give you a review. Tip: Talk to an insurance agent who specializes in your industry. Your trade association knows who they are.
  4. Here’s an article on West Texas Oil industry as oil production continues full bore.

Far too many business owners don’t plan ahead for an opportunity that could arise without much notice. Selling a business for the highest value and best terms is never an accident. The value goes to the prepared.

Buying a Business in Texas – Define Earnings and Profits First

Buying a Business in Texas – Define Earnings and Profits First

When looking at buying a business in Texas and other parts of the U.S. there are many different terms used and the same term can be defined differently depending on who is using the term.

In this post I’ll try to define some of the terms commonly used to represent the “earnings” or “profit” the business generates.

The terms below are attempting to describe the operating profit available to the new business owner when the selling business owner, and all of the selling business owner’s non-business expenses, leave the business. Keep in mind that the vast majority of small business owners do their accounting with a single intent, minimizing taxes owed.

Here are some common terms you will see when looking at businesses for sale:

Cash Flow (CF or C/F) – This is a commonly used term for representing the “earnings” of the business and is definitely not the same definition of cash flow that a CPA would use. A CPA would include changes in accounts receivables, accounts payable, capital expenditures and a number of other items when calculating the true “cash flow” of a business. When you see the term “cash flow” used on Business for Sale sites what they likely mean is the “Earnings Before Interest Taxes Depreciation and Amortization” (EBITDA) plus Owner’s Compensation. Once you understand EBITDA and Owner’s Compensation you’ll have the code for the other definitions.

Net Income – Net income is a fuzzy one because lots of people include and exclude items that others might not find appropriate. You’ll have to have the person claiming the net income number explain EXACTLY what the source of the information is and what is included and excluded.

EBITDOC – This is a term I have created that I’m hoping the industry adopts. This was explained above when you piece together EBITDA and Owner’s Compensation. It’s the business earnings before interest, taxes, depreciation/amortization and owner’s compensation. With this definition it allows you to focus on the most critical of the elements which is proving the claims of the Owner’s Compensation, in all it’s forms. Many small business owners are very creative with their accounting. Make certain you understand the source and veracity of the numbers before you make any decisions.

EBITDA – This is a common measure of earnings in larger businesses but is less useful when buying a business in Texas. This earnings definition assumes that the “owner” or CEO of the company is receiving fair compensation for the job being performed and therefore no adjustments need to be made. This is rarely the case in small businesses for sale and therefore EBITDA, without Owner Compensation adjustment, is generally useless in evaluating the small businesses earnings. You will however see some representations of ebitda that make total sense as a stand alone number if embedded in that EBITDA number is an reconciliation for owners compensation. This number is often called Adjusted EBITDA.

Pre-Tax Income – This term is generally useless when evaluating the earnings of a small business. The problem is all of the non-cash entries and the owner compensation entries that happen before the pre-tax number is established. Often times this pre-tax number is manipulated so that the business owner reduces his taxable income.

The takeaway for this is that when evaluating buying a business in Texas or other places in the U.S. you need to take the time to understand how the advertised earnings were established and understand the items included. Don’t assume one business broker’s earnings is calculated the same way as another business broker, do your homework.

The Value Goes to the Prepared.

earnings of a small business.

Sunbelt Completes Sale of Medical Products Companies

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We are pleased to announce the sale of two related companies. One is a 40 year old manufacturer of medical lotions, the other is a research company focused on medical lotions and compounds.

The products are manufactured in an FDA regulated facility in Houston, Texas.

The company is in it’s 3rd generation of family management but the time had come to bring in outside investment. The current leader, the grandson of the founder, will remain in an executive position with the new ownership.

These deal was complex due to the regulatory requirements of the FDA, the substantial intellectual property that had accumulated over the businesses 40 year history and the always challenging dynamics of multi-generational ownership.

 

 

 

Small Business Administration (SBA) Lending to Buy a Business

Small Business Administration (SBA) Lending to Buy a Business

The Small Business Administration (SBA) continues to be the primary source of financing when buying a business in Texas.

Technically speaking the Small Business Administration loan is not a loan but actually a guarantee to a bank who actually provides the loan. It’s commonly referred to as an SBA loan due to the standard regulations imposed on banks who offer loans under the SBA program ( known as a 7A or 504 loan).

In today’s market an SBA Loan for the purchase of a business that doesn’t have real estate as part of the sale ( the business is typically located in a leased space) will generally have the following terms:

  • 10 year amortization
  • Interest rate of 2.75% over the prime lending rate, adjusted quarterly
  • Buyer down payment equal to 15 – 25% of total business purchase price
  • Bank will likely add adequate working capital to the loan for business operations

The bank will have substantial due diligence requirements. Both the buyer (borrower) and the business (seller) must be able to pass the banks due diligence requirements. The bank will want all business financial information to be correctly stated on the business tax returns.

The bank will also want the buyer to me certain requirements regarding credit score, no problems with student loan payments, no issues with child support or alimony payments, clear history of any criminal issues.

A very important element of getting approved for an SBA backed loan is the banks comfort level with the buyers ability to succeed in the business they buy. A core element is known as buyer’s “applicable skills”. Basically this means what in the buyer’s experience can be applied to the new business.

Most small businesses that sell for under $1,000,000 are purchased by individuals who will own and operate the business on a day-to-day basis. These SBA Loans are rarely used for “passive” investments.