Mgt602 Assignment No. 1 Solution
Thursday, October 28, 2010 Posted In MGT Edit ThisBuying an Existing Business
One of the best advantages to buying an existing business is that the business is already operating and there is no time needed to get established. This drastically reduces or eliminates the start-up time. Most existing businesses will already be viable and functioning.
An existing business will have the business structure and organization in place. Employees are already trained and the process and systems are most likely established. However, an existing business also brings with it the challenges of restructuring, improving and modifying the business. Inherited employees are often nervous about new changes and new management. As a new owner of an established business, it is important to learn the business culture and understand how the employees operate. In many businesses, especially in a service industry, employees may be the real assets of the business.
Goodwill, the reputation associated with the business, can have a tremendous effect on the future of the business. Social awareness brings clients and future employees to the business. Buying a business with goodwill is more costly. A bad reputation spreads quickly so it is vital to know what the community response to the business is. When a business has little history, it may be important to research and confirm that the company is a legitimate business and not a scam.
A major drawback to buying a business is the initial capital requirement. The cost to purchase a business can be inhibiting. Businesses with credibility in history, past sales records, and profitability are often easier to finance than start-up businesses. There is also the possibility that the current owner may provide vendor take-back financing. Finding funding for a well-established business is often easier than with a new business. The purchase cost of an existing business will include items such as the business name and trade name, the legal entity, business licence and permits, established brands, client lists and the goodwill. Much of the foundational work has been done and the start-up costs covered.
Existing businesses will have offerings in place. They may not be the exact products or services that the entrepreneur desires to provide but they are a starting point and can allow an immediate cash flow. It may be possible to make money on the first day of operation.
Buying an existing business is good when:
* The entrepreneurs lack business knowledge
* The thought of a start-up is overwhelming
* The business is a way to purchase expensive specialized machinery or equipment
* Financing is needed from a financial institution
* The client base and goodwill are important.
| | Advantages | Disadvantages |
| Goodwill | One of the major advantages to purchasing an existing business is that you get the benefit of the customer base, name recognition and other goodwill of the existing business. | If, for any reason, the existing business has a poor reputation in some respect, then you may inherit this as well when you buy the business – especially if you continue to trade under the same name. |
| Employees | You may get a set of experienced and capable employees, eliminating or reducing the need for you to interview and hire a lot of new employees. | You may get employees who are not necessarily people you would have selected. You might also inherit problems with employees, such as disputes with particular individuals, unreasonable expectations as to pay and working conditions, or trade union issues. |
| Supplier relationships | You could get the advantage of favourable credit terms from suppliers who have a long-standing relationship with the business. In addition, suppliers may have a good understanding of the specifications for goods supplied and the other needs of the business. | There may be supplier relationships that are not so good, or key suppliers that have had bad experiences with the business in the past and therefore offer worse credit terms than they would offer to a start-up. Or suppliers offering good terms might want to re-negotiate on the change of ownership. |
| Banking and other financing arrangements | Although banks frequently will require that a business re-negotiate its credit arrangements on a change of ownership (even where the transaction is a share purchase rather than an asset purchase), the fact that the business has an earnings track record will likely make it easier to get better financing arrangements than a start-up business could obtain. | You could find that the business has a poor reputation amongst lenders. |
| Other credit arrangements (equipment hire-purchase, etc) | As with banking arrangements, the fact that an existing business has a track record may help you in procuring equipment financing, invoice discounting and other arrangements. In some circumstances, you may be able to keep existing arrangements in place after you buy the business. | The business could have a black mark with certain finance providers. |
| Liabilities: trade creditors | If the business has a good record of paying trade creditors, you will get the benefit of that. | If the business has a record or late payment, disputes and default in payment to trade creditors, you will inherit it. |
| Liabilities: debts, pending litigation | If you are purchasing the business in an asset deal (rather than buying a company) and have carried out good due diligence, you should be able to insulate yourself from any liabilities associated with the business prior to your period of ownership. To give the buyer added protection, sometimes a business purchase agreement will require the seller to indemnify the buyer against any such liabilities, and a part of the purchase price might be withheld by the buyer for a period after completion – in order to provide security for that indemnity. | If you buy an existing business by purchasing a trading company (rather than just the assets of the business) then the company you purchase will continue to have all of the liabilities it had prior to your purchase. Ordinarily, the buyer will ask the seller to disclose all such liabilities, and the buyer will have a claim against the seller for any undisclosed liabilities that surface after the transaction completes. Without adequate protection, though, the buyer could, in effect, end up with responsibility for liabilities that the business incurred prior to the date the buyer purchased the business. |
| Premises | For a variety of reasons, there can be significant benefits in taking over existing premises rather than finding a new site for a start-up business. A solicitor can advise you as to the details. | Leases can be full of traps for the unwary. If you are taking over a leasehold or other premises occupied by the business you are purchasing, you should get detailed legal advice as to the responsibilities of the business in relation to such premises, including rent, service charges, dilapidations and other matters. |
| Stock | An existing business is likely to have sufficient stock to meet its near-term requirements, and as a buyer you may be able to negotiate an attractive price for the stock. | The value of stock may not be as it appears. Some stock could be old, damaged, obsolete or otherwise non-saleable. Where the stock represents a significant part of what the buyer is purchasing, a stock-take at completion is usually sensible – with an understanding that there will be a reduction in price for stock that is not likely to be useable or saleable. |
| Equipment / Vehicles | An existing business will likely have the equipment and/or vehicles and other capital items required for the operation of the business – although it will be important to agree on the value of such of items for purposes of the depreciation that will be available to you, as buyer. If the sale is a “transfer as a going concern” it is likely that you will not have to pay VAT on such items. | The equipment, vehicles, etc owned by the existing business may be worn out or poorly maintained. Also, it may be difficult to establish a value for each such item. |
| Regulatory Consents | If the business requires some form of regulatory consent in order to operate, then the consent held by the existing business might – in some cases – be assignable or transferable or might continue to be valid despite a change in control. | Regulatory consents might not be assignable, so you will have to obtain new ones. In addition, the business you are purchasing might have a poor compliance record – which you will inherit. |
| VAT registration | If you purchase a limited company that operates the business, you will likely take over the existing VAT number of the entity. If, however, you simply purchase the assets of the business (not the entity) then you will need to register the business for VAT. | If you purchase the entity and take over its VAT registration, you may find that there are irregularities or liabilities associated with the entity’s VAT account that the seller did not disclose to you. |
| Tax “assets” | If you purchase a limited company that operates the business, you will get the advantage of any built-in tax assets, such as accumulated losses, depreciation, amortisation, etc. If you simply purchase the assets of the business, you will be able to depreciate certain assets based on the price allocated to them – but you will not get the benefit of losses and similar tax “assets” that belong to the seller. | The “tax assets” of a limited company that you purchase may be of little or no value to you, and in any event if you start a new business you will get depreciation on equipment and certain other capital items that you might purchase when you start the business. |
| Book debts | Sometimes as the purchaser of an ongoing business, you will get the benefit of uncollected book debts – generally the terms on which you do so are negotiated as part of the transaction. The ability to collect some of the existing book debts for your own account might help you generate cash shortly after you buy the business – rather than having to wait until you generate your own invoices and collect them. | The seller’s debtor book may be full of debts that are old or otherwise difficult to collect, and therefore could end up yielding little cash. |
| Non-competition | Frequently, the purchaser of an existing business will get the benefit of a non-compete covenant from the seller (since the value of the goodwill the buyer is purchasing could be seriously undermined if the seller were to continue to trade in the same type of business). Even in a crowded marketplace, the non-compete covenant will remove at least one potential competitor. | Non-compete clauses can be difficult to enforce, and must be carefully drawn if they are to be enforceable. |
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Another solution
Buying a going concern seems like such an obvious, common-sense approach to business ownership, and yet the thought doesn’t even occur to many entrepreneurs. The dot-com era popularized the notion of businesses started by college students in garages, basements and dorm rooms and then sold for billions (often without having generated a penny of profit). Those stories are amazing, to be sure, but what about those of us with aspirations that lean more toward Main Street than Wall Street?
According to many, it’s a buyer’s market right now. The last year has produced countless stories of business owners with cash in the bank taking advantage of a “shopper’s paradise,” seizing the opportunity to grow through acquisition. If you’ve been planning to start your own venture — or expand your current operations — consider some of the advantages of buying an existing business:
Less Risk
Some entrepreneurs think it’s cheaper, and therefore less risky, to start from scratch. But risk is relative. Take the example of an established business with a $1 million asking price and consistent annual cash flow of $350,000. Compare that to taking out a $250,000 loan to finance a start-up, where projections may or may not be realized. Assuming you make a reasonable down payment, a bank may be more willing to finance the $1 million transaction with historical revenue and enough cash flow to service debt than the smaller loan for an unproved concept.
I’ve met plenty of bankers who have given me the cold shoulder because they assume I work with start-ups. When I clarify that I help people buy and sell existing businesses, their chilly exteriors begin to thaw (a little). Buying a business versus starting one definitely tips the risk/reward ratio in your favor.
Don’t forget the opportunity cost associated with starting a business from scratch. What is the total cost if the start-up fails? In addition to your initial investment, you’ve spent one, two or possibly three years without income or the ability to save and invest. If purchasing an existing business seems pricey, make sure you’re factoring in all of the costs associated with start-ups — both money spent and income forgone.
More Cash Flow
The purchase of an existing business is typically structured so the buyers can a) cover the debt service, b) pay themselves an owner’s salary and c) have something left over to take the business to the next level. This eliminates the entire “ramen” (a k a starvation) phase associated with start-ups. It’s not unusual for a start-up to take anywhere from one to three years to make a profit.
“Sales will be generated the day you take over,” explains Richard Parker, president and founder of Diomo and an expert on the business-buying process. “In fact, when done right, you can get the keys to your business on Monday and take a paycheck on Friday.”
Established Infrastructure
When you buy a business, you can immediately focus your energy on running, improving and building the business. The sellers have already taken care of the heavy lifting associated with starting the business. They’ve built the infrastructure with operational necessities like computers, phone systems and furniture. They’ve developed policy and procedures, and they’ve forged relationships with suppliers. These are all things that take an enormous amount of time, money and energy and don’t always generate direct or immediate cash flow. And there maybe other less tangible benefits associated with buying an existing business, such as an established brand and customer base, a proven business model and a team of trained employees.
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IDEA A:
I think ali should buy a company instead of initiating a new company because he does not have any experience of developing his own business and also he possesses a small amount of money and it is quite hard to initiate a business with small investment....
IDEA B...
As this business is concerned to the travelling and outing.... ali has experience of outing and travelling this is one of the biggest edge for him.... also this is the thing that made him convinced to do this business although he does not have any experience.....
another thing in this business is ....he can bring new trends and inovation to this business because he has a great experience and interest regarding this field
This is not a solution but a though that came to mind when i saw this question and according to me i think this can help us to give solution to this assignment.
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Semester “Fall 2010”
“Entrepreneurship (MGT602)”
Assignment No. 01 Marks: 15
Important Tips
1. This Assignment can be best attempted from the knowledge acquired after watching video lecture no. 1 to lecture no 10 and reading handouts as well as recommended text book.
2. Video lectures can be downloaded for free from www.youtube.com/vu.
Schedule
Opening Date and Time
October 27, 2010 At 12:01 A.M. (Mid-Night)
Due Date and Time
November 1, 2010 At 11:59 P.M. (Mid-Night)
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Case
Ali had worked with his father in a successful building materials business. The family had sold the company, and the Ali received a portion of the sales price. After several months, Ali began thinking about starting or buying a company. One of his hobbies was backpacking; he had hiked the highest peaks in 30 of the 50 states. In his search for a new business, Ali heard of a company that made small trailers for motorcycles. These trailers were fairly popular with retirees who were cyclists and with individuals who liked to travel on motorcycles in order to go into the back-woods where a car could not go.
After several meetings, Ali and the current owner of the firm negotiated a selling price and the deal was consummated. Immediately after the purchase, Ali moved the business from its present location to his own town, several hundred miles away.
Glossary
Backpacking- hiking and camping, Backwoods- wasteland, Consummated- to conclude something
1. Why should Ali buy the company instead of starting his own firm? (7)
2. What are the pros and Cons for Ali’s buying of this particular business?(8)
