When creating a confidential business review for a client it is imperative to maintain proper structure and formatting. A properly structured business review will convey all of the necessary information in a clear and concise way to the client whereas a review that is sloppily formatted can not only confuse and frustrate a client, but it can also misrepresent information.

Here in this article we will discuss the key formatting points that need to be followed when creating a confidential business review once all of the required data for the review has been gathered. Such points will include the table of contents, overview, necessary disclaimers, definitions of terms, appendixes, and more.

The first part of a confidential business review is a formal letter to the client with the conclusions of the review stated in the body. The conclusions will include the asset value, business value, and estimated current market value for the clients business. This allows the client the freedom to thoroughly read the rest of the extensive review at their convenience.

After the initial letter then you can outline the main points in the review through a table of contents. The main points should be as follows: Overview, Limitations, Contingencies and Disclaimer, Statistical Summary, Evaluation Methods, Justification for Purchase, and Appendixes. This table of contents outlines the rest of the review and, as you can see, the Overview is directly after the table of contents in the review.

The overview for this review is just that, an overview. It states all of the client’s data, what the nature of the assignment was, and the purpose for the evaluation. Additionally the overview has other information such as any interviews that were done, documents that were reviewed, what was valued in the overall review, and the evaluation effective date.

Next it is important to include a section dedicated to limitations, contingencies, and your disclaimer for the review. This lets the client know exactly what the review cannot be used for and also will educated them on the specific assets and liabilities that were excluded when obtaining figures as well as let them know where to get any advice for tax and legal services for the sale and/or transfer of stock.

Following is a section that contains the statistics, followed by an evaluation methods summary. The statistics section will simply be summary of all of the numbers used as well as any special conditions. Additionally the statistics will contain the estimates for the value of the company (asset value, intangible value, and market value). The evaluation methods section following the statistics will be an extensive section devoted to addressing all five components of a business’s value. These two sections are incredibly important as they contain the actual values the client needs.

Directly after the statistics and evaluation methods sections will be a portion explaining the justification for purchase. This is an explanation of a test done to evaluate whether or not a selling price for a business is reasonable. Make sure to explain that this is not the estimate for value of the business while you are listing out the details of this section.

Lastly, the Confidential Business Review will include two appendixes. The first appendix, termed Appendix A, will contain details about the Comparable Sales method while the second appendix, Appendix B, will be on the Evaluation Principles. These two sections conclude the Confidential Business Review.

A Confidential Business Review is a crucial set of documents that goes into extensive detail about a business’s value, the reasonableness of an asking price, the details on the estimated values, and much more. When creating a Confidential Business Review, it is important to maintain proper structure. This ensures you will relay all pertinent information to the client in a clear and concise manner.

What is Due Diligence?

Statistics show that nine out of ten people who begin the search to buy a business never actually complete their transaction. While there are many contributions to this, one of the biggest reasons buyers back out is because of the fear of uncertainty. If one feels that they do not know the company completely through and through and has not had the facts checked out, they will not be comfortable with completing the transaction. Performing these verifications is known as performing “due diligence”. Therefore due diligence is one of the most important steps in the buying process. Some specific things sought out during due diligence are the strengths and weaknesses, growth opportunities and competition, the industry, marketing, suppliers, and financial history.

When Does Due Diligence Initiate?

Once a buyer becomes interested in a business, the due diligence process is started. Due diligence basically involves the collection and verification of information. This process can take many hours of hard investigative labor and it is easy to overlook things if one is not familiar with performing due diligence. If the job is not done flawlessly, the transaction may not close.

The importance of embarking on due diligence as soon as possible is hard to express. The buyer needs to always be asking questions to the seller, and the seller must be prepared to answer them. Business brokers know what questions to ask and what to look out for, they also answer questions from the seller’s side. Having a broker take care of these things for you will save you a lot of time and money in the long run.

What is this about a Due Diligence Period? I thought we were already doing that!

In most if not all business transactions there is a period in which both parties come to an agreement that they want to move towards a deal. This ensues a period of time dedicated to due diligence where the buyer wants to confirm everything that the seller has claimed. During this time there is a scrutinizing financial review, so it is important that a seller gets all of their facts straight beforehand.

Take Your Time

Make sure that both parties take their time during the due diligence process. Don’t let anyone bully you into a short inspection period, they may be hiding something. Both parties should agree on a due diligence period that will let one complete a thorough investigation without wasting time. Generally Due Diligence periods will last 10-30 days.

Be Prepared

Before embarking on the Due Diligence period, the buyer-side should have a list of all of the materials needed to complete their investigation.

Surprise!

Expect the unexpected. Well, not so much the unexpected, but do try to remember that the seller is still a human and that small mistakes are normal. When the buyer comes across an inconsistency, they should get clarification and try to weigh the options. However, a large inconsistency or even a large amount of small inconsistencies will raise a red flag and the buyer will probably choose to seek out other options such as renegotiation or they may walk away from the deal altogether. Business brokers are experienced in Due Diligence. How well Due Diligence is handled will decide whether the transaction closes or not.

Make the Decision Easy

The seller side is responsible for making the buyer comfortable in completing the transaction. Trust, professionalism and experience are key to closing the deal. If Due Diligence is handled wisely, the decision to finalize the agreement is the easy part!

In a traditional property or business purchase, the buyer pays for a property using a loan from a bank or other institution. However, when obstacles such as lower credit ratings block the way, a creative solution may be seller financing.

Seller financing is an agreement, legally binding, that is made between the buyer and the seller for a property or business purchase. A down payment is made to the seller, leaving a balance owed. The buyer repays the balance owed in monthly installments much like a mortgage payment. Interest is agreed upon by both parties. This type of purchase makes up only about ten percent of all property or business purchases.

To create a legally binding agreement, a promissory note or purchase agreement is written. This promissory note outlines all agreed upon terms. No verbal or additional agreements should be made outside the four corners of the promissory or else they will not be legally binding. Once both parties agree to the terms outlined in the promissory note, it is signed by both and filed. Lawyers can assist in the creation of these promissory notes. Loan servicing companies can also assist, as well as collect monthly payments.

If the seller still owes their lender money on the property, the lender must agree to the seller financing agreement. This is rarely risked. Typically, seller financing is used when the property or business is free and clear of a mortgage. However, there is a solution to this issue. If the seller owes a small balance to their lender, the down payment from the buyer towards the property can be used to pay off the existing mortgage, clearing the way for the seller financing agreement.

There are significant benefits to seller financing. For the buyer, if they aren’t able to meet stringent loan requirements, seller financing allows them to purchase property. The buyer saves on expensive closing costs, and does not have to qualify with a loan underwriter.

For the seller, benefits include a solid investment with a guaranteed return. The home sale moves faster. In addition, the seller can ask a higher selling price and interest rate. The seller can also sell the home as is.

Without careful consideration and planning, there can be risks to seller financing as well.  The buyer could pay the loan every month. When the loan is paid in full, the title could be denied, restricted by causes the seller did not reveal. The buyer also is purchasing a property without the coverage of a home inspection. Without the benefit of an appraisal, the buyer purchases the property not knowing if they overpaid.

For a successful seller finance agreement that protects both parties, it is recommended that the agreement include a home inspection. This protects the buyer against costly repairs the property might need. An appraisal is also recommended. Both the buyer and seller can agree upon which party will pay these costs.

The promissory note should be secured by the property itself. If the buyer doesn’t make payments as outlined in the promissory note, the seller can foreclose. It is recommended that the promissory note include a down payment. If the buyer makes a down payment of a significant 10% of the total purchase price, this gives the buyer a stake in the property. A down payment assures the seller that the buyer will be less likely to walk away from the agreement. In addition, this down payment gives the seller a cushion against default.

Interest rates can be determined comparing area rates. It is not recommended to compare national rates, as they are not applicable. Services such as www.BankRate.com and www.HSH.com provide comparable rates.

For small business owners, finding financial security can be a difficult feat that is often rife with many uncertainties and tough decisions. Business owners need to look at their overall financial situation and find out what will be the most beneficial plan for both their personal lives and their business in the long run.

With the financial needs of small business owners in mind, DRDA created a self-directed 401 k plan called BORSA. BORSA stands for the Business Owners Retirement Savings Account and is a great financial plan that allows business owners, or people looking to purchase a business, to utilize funds from the 401k plan on all expenses related to their business while being taxed separately.

BORSA has been approved by the IRS and was designed by DRDA, PLLC, which is one of the top CPA firms in America. Overall the BORSA structure is simple yet it builds a firm financial foundation. From start to finish there are only four steps.

Before the BORSA plan is initiated, a C Corp must be established. The C Corp will ensure that the corporation is taxed separately from the business owner.

Once the C Corp has been created, then the client can have their BORSA 401k plan set up. This plan can even be used for other businesses that the client purchases without having to create a new account  – saving the client both time and money.

Next, the necessary funds must be transferred into the BORSA 401k plan. These funds are taken from the business owner’s preexisting 401k plan and then rolled over into the BORSA 401k which can cause some concern due to potential fees and penalties. Unlike other transfers and roll overs, this particular roll over is neither taxed or penalized in any way no matter what the client’s age is.

Now that all of the required funds are in the newly established BORSA account, the client can then invest this however they choose. This can be invested into purchasing a business, paying employees, buying necessary equipment, or even to get a loan.

With the BORSA plan now in effect, the business will in fact be a corporation that is owned by the 401k plan and the client. Since it’s a corporation, the employees, when they are eligible, are able to purchase shares of the business by participating in the 401k plan. Additionally the business owner will have to ensure that their new corporation is revalued each year.

As with most financial plans, the BORSA plan has a simple exit strategy that allows business owners the freedom to change their mind at any time in the future. Since the 401k is cut into various shares which are then owned by employees, the business owner would simply have to buy back the shares, freeze the BORSA 401k plan, and then transfer the funds of the existing account into a different 401k.

For small business owners and prospective business owners, finding a financial plan that fits all of their needs both currently and in the future can be incredibly difficult. Thankfully there is the BORSA plan – ensuring that you are on the right path to success.

Recasting is the adjustment of the financial statements to truly reflect the actual financial benefits of that business ownership. Recasting is done to change the companies’ financial statements from tax basics to economic terms. The owners want to pay the least amount of tax possible, while brokers and buyers need to understand the true economic performance of the business. Recasting creates a view of the assets that are being transferred and the earning capacity of the business.

It is necessary to adjust financial statements to reflect the actual cash benefits that are available.

Balance sheet adjustments

Accounts receivable

Inventory that is not sellable

Prepaid expenses if they go with the seller

Cash that is usually held by the seller – the balance sheets will be adjusted that have the amount of cash required to run the business

Any amount that is due from shareholders as assets or due to shareholders as liability

Book value of assets

Real estate needs to be taken off it is not in this purchase

Review intangible assets to see if they should be adjusted

Accounts payable, liabilities that are unpaid and accrued will be added to balance sheet

Profit and Loss Adjustments

Cost of goods to historic averages

Owner’s salary to a market rate

Any family members of owner (market rate)

Depreciation expenses (on par with underlying assets usefulness)

Business rent

Owner discretionary expenses

Any one-time expenses that are unlikely to occur in the future?

To recast your balance sheet, you will need to

• Remove all assets (not in the sale)
  
• Remove all debts (not assumed by buyer)
  
• Remove all ( damage, old ) inventory
  
• Value the remaining inventory at replacement cost
  
• Write off uncollectable accounts receivable
  

There are many areas to look at when recasting. When you are done, take time to project the future sales as well. Recasting, in essence, is done to support the full expectations of that company for the future.

Recast financial statements, while they are reconstructed, will reflect the earnings a buy would see from the business, after removal of the above expenses, but also takes into consideration abnormalities like depreciation.

Understanding financial statements

There are four types of financial statements: balance sheets, income statements, cash flow statements and shareholders’ equity statements.

Balance sheets show what a company owes at a very fixed point in time. These are very detailed and show assets, liabilities and shareholder equity, what would be left if everything was sold and paid off. The formula for a balance sheet is assets equal liabilities plus equity.

Income statements show what a company made (revenue) over a fixed period of time, usually a year or so. Unlike a balance sheet, income statements show EPS, earnings per share. This is the amount a shareholder would earn if the company was sold and everything was paid off.

Cash flow statements are simply that – they indicate where, and why, money flowed. Cash flow statements can tell if a company was able to generate cash.

Shareholder equity statement – the financial statement that details changes made to the balance sheet (the equity portion)

While each sheet and statement provides differing figures, they are all connected and only in totality do they give a complete history of the company’s financial standing.

Once an understanding of the four different financial statements is made, steps can then be made to establish business worth.

Income statement recasting – Recap

This expense list can be very long and will depend on what business it is. Common expenses that may be recast include

    Owner salary, Other Salaries, One Time Expenses and revenue and Interest

Financial statement recasting – Recap

Both your income statement and recent Balance sheet will need to be recast

    Remove all assets not part of the sale

    Remove all debts not assumed by the buyer

Remove damaged, obsolete inventory, value remaining inventory at replacement cost

Write off receivable accounts that are uncollectable

Determining the value of a business can be difficult and confusing. Many equations and opinions have convoluted the process. A few basic factors will allow you a clear understanding of the valuation process.

Simply stated, to understand what a business is worth, you must understand its past, present and future. Valuating a business for today’s worth does not allow for future earnings. Understanding the history of a business may allow for accurate projections on where that business may grow, but does not factor in declines in the market or potential growth. All are needed for accurate valuation.

To understand the value of a business, you must first understand the business itself. What does the business provide or sell? A business in retail or manufacturing will be evaluated differently than an Internet-based company. Begin by determining what the base worth of the business is, by examining the assets. Assets include stock, cash, inventory, even the replacement cost of the business itself.  A simple system of valuation is to add up the value of the business assets and subtract the liabilities, such as bank debts and payments. Known as asset valuation, this method is used primarily in retail and manufacturing, and will allow you to examine the business worth at that moment. This method does not factor in generated future revenue. Simply stated, this system undervalues the business.

Goodwill can be a factor in determining the value of a business, especially if the business is service-based or retail. Goodwill represents the reputation of the business, its location, relationships and service. Goodwill also represents the branding, the reputation, of that business. Goodwill is important and an extremely valuable commodity; however, it is not always be transferable.

Examining a business’ profit and loss statements and averaging the net profit will be detrimental in learning how the business might grow. Smart comparison is done in differing time periods, to understand the business growth or decline in comparison to the industry around it. A growth during a time of market slump is indicative of a stable and growing business, while one that fluctuates in comparison may prove risky. This examination will allow you to determine the risk assessment, as well as determining discount rates.

Valuation of a business through income is vital. Earnings, the income of that business, are calculated by adding sales (revenue) and subtracting the costs of those sales, such as operating expenses and taxes. Earnings can be multiplied for the next few years, using such intangibles such as industry trends and sales projections. However, earnings are not always stable. Price changes and competition can affect a business’ profits.

Market-based valuation uses methods to establish the business value in comparison to historic sales involving similar businesses. These methods rely on the pricing multiples which determine a relationship between the business economic performance, such as its revenues or profits, and its potential selling price. In essence, this valuation compares the business with others in a comparable market.

Another important factor in valuation is determining if the business has USP, unique selling propositions. USP determines the business position in the market. If that business is unique in a particular way, such as slogans, international patents, cutting edged technology or fills a particular and unique niche, the business will be worth more.

Hidden costs can be harmful to a business’s worth, and should be taken into account. Potential non-renews of a large account, poor credit standing with suppliers, liens, even potential  increases in product liability insurance will affect the value of a business.

The value of a business, its worth, is as much as its ability to generate profits based on how much money must be put back into it. Smart valuation should include the past, present and future of the business. The more information you know, the more accurate your valuation.