Brief comments on Letter of intent and other items in an Acquisition process

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Dr. John Psarouthakis
, Executive Editor, The Business Thinker, llc.
Author of “How to Acquire the Right Business”, go to books at the home page.

 

This is the 7th of short articles of my thoughts about Acquisition of a business.

Letter of intent and formal due diligence

This article briefly introduces some of the basic concepts of valuation of the company. Although four basic approaches, the profitability method, the asset method, historic cash flow and discounted cash flow, are all described, the discounted cash flow method is considered the most accurate valuation of the company. However, a comparison of values from different methods can provide useful insights, especially in the early stages of valuation of the business.

This article also point out the distinction between value and price. The value is the worth of the company as will be operated by the buyer. The price is the amount you wish to pay for it. The synergy you can realize from the sale, the motivation of the seller, and the projected growth of the industry, and the type of financing are just a few of the factors you might consider in negotiating the final price.

Valuing and pricing the company

This article  introduces some of the basic concepts of valuation of the company. Although four basic approaches, the profitability method, the asset method, historic cash flow and discounted cash flow, are all described, the discounted cash flow method is considered the most accurate valuation of the company. However, a comparison of values from different methods can provide useful insights, especially in the early stages of valuation of the business.

Keep in mind the distinction between value and price. The value is the worth of the company as will be operated by the buyer. The price is the amount you wish to pay for it. The synergy you can realize from the sale, the motivation of the seller, and the projected growth of the industry, and the type of financing are just a few of the factors you might consider in negotiating the final price.

Negotiating the deal

Perhaps too much has been written about elaborate or indirect negotiating techniques in business situations. At least in the case of acquisitions, we espouse a direct, problem-solving oriented approach. This builds trust between buyer and seller and allows for resolution of key issues.

Thorough understanding of the seller’s motives and details about his or her company and industry will aid your negotiating ability. You should thoroughly understand the prospective company, including the likely risks and potential problems you might encounter if you take over ownership. Further, you should be able to present such concerns in a way that the seller will find believable and will be able to accept.

You may run into a seller whose perception of the company is too different from your own to resolve in negotiation or in some other way becomes unreasonable. For this reason, it is always critical that you keep your lead flow going. This may necessitate having a cash reserve or going back to investors for more money so that you can investigate other leads. Be cautious about holding all your “eggs” in one basket. Keeping your leads flowing will also reduce the chance that you romanticize any one deal. Also keep in mind that there are always other “fish in the sea”. You want to guard against escalating commitment, the phenomenon that you become more strongly committed to the deal just because you have invested more time and money in it.

No deal is perfect, but if you really uncover a major concern, it is never too late to back out of a deal prior to closing. It is better to lose even $100,000 than to pay $5,000.000 or more for a business that is headed for serious trouble.

 

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