Topic 17.6: Nature of Business Brokerage

Learning Objectives

After successfully completing this topic, you will be able to
• state similarities and differences between real estate brokerage and business brokerage,
• describe the types of expertise required in business brokerage,
• distinguish among the methods of appraising businesses, and
• describe the steps in the sale of a business.

Overview

A small number of real estate licensees specialize in the sale or purchase of businesses. They are known as business brokers. Florida law defines real estate and real property as “any interest or estate in land and any interest in business enterprises or business opportunities, including any assignment, leasehold, subleasehold, or mineral right.” Because business opportunities are real estate, a person needs a real estate license to sell businesses.

Similarities to real estate brokerage

• Business brokerage usually involves the sale of real property or an assignment of a long-term lease.
• Business brokers must be licensed by the Florida Real Estate Commission.

Differences from real estate brokerage

• The sale of a business usually involves assets other than real estate.
• Personal property includes cash in banks, accounts receivable, inventory, and equipment.
• Goodwill is an intangible asset. It’s the additional amount an investor would pay over and above the tangible value of the business’s assets because of its profitability.
• The value of the business may be less than, equal to, or greater than the value of the tangible assets. The “going concern” value may be higher than the value of the tangible assets if the company is profitable. If a business is doing poorly and may not continue in business, it has no going concern value.
• Markets for business enterprises are national because of investor interest in businesses.

Expertise Required in Business Brokerage

Real estate licensees who sell business must have greater training and expertise than residential brokers. Many accountants or former corporate employees are excellent business brokers. Many business brokers have a “team” of people they bring in to help bring about a sale. The team might include an attorney and a CPA to help in the analysis and legal questions.

Corporate finance

The broker will normally be well-versed in corporate finance. That would include knowledge of budgeting, working capital, and corporate stock.

Business accounting

The broker will be familiar with accounting principles and will be able to analyze:

• income statements—the summary of income and expenses for a specific time.
• balance sheet—the company’s financial position at a specific time which includes the assets, liabilities, and net worth of the company.
• cash flows—the cash flow is often different from the income of a company because it excludes accounts receivable, and accounts payable, and depreciation. The cash flow statement is usually the most important statement to investors.
• taxes—the tax status of a business can make an investment more attractive, especially if there are large non-cash deductions like depreciation.

Valuation of Businesses 

A business appraiser will use the three approaches to value that real estate appraisers use, along with an additional analysis—liquidation analysis.

Comparable sales approach

A business appraiser may have knowledge of similar businesses that have sold recently and compare the sales and income of the two businesses. For example, assume the subject business has annual sales of $500,000 and $240,000 in annual income. If a comparable business sold for twice its annual sales, and four times its net income, the business would seem to be worth $960,000 ($240,000 x 4) and $1,000,000 ($500,000 x 2).

Cost approach

The cost approach is the least meaningful measure of a business’s value because it is used for valuing only tangible property. Most investors buy businesses for the profits not the asset value.

Income approach  

This method is probably the most appropriate approach to the value of a business. It capitalizes the net profit to project the value of the business. For example, assume a business makes $240,000 average annual income. If the capitalization rates of several similar businesses are 26%, divide the income by the rate to get approximately $923,000. ($240,000 ÷ .26 = $923,077).

Liquidation approach  

This is the most conservative approach, and is unique to business appraisals. This technique assumes that the business assets will be sold off and debts paid. It could also be because of a divorce or death, when the business must be sold. Lenders usually pay close attention to the liquidation value of a business.

Steps in the Sale of a Business

The following is a list of steps to be taken to sell a business.

1. The broker should identify the assets of the business. This valuation will be based on the market value, not the original cost of the assets as shown in financial statements.
2. Once the broker estimates the market value of the assets, the broker should deduct the liabilities to find the owner’s equity in the business.
3. The broker will examine the gross income, expenses and net income of the business to ensure that the figures are reasonable.
4. Based on the figures shown in the equity analysis and the net income, the broker should estimate the market value of the business.
5. If the owner and the broker agree on a listing price, the broker should list the property. It’s important to get instructions from the owner regarding privacy. For example, if the employees are not to be told, the property would not be shown during business hours.
6. The broker should inform the owner that the buyer may require a non-compete provision for a period of years.
7. If the business has stock, the stock should be valued by dividing the listing price by the number of outstanding shares. Because of potential unknown liabilities of a corporation (like pending lawsuits or unresolved tax issues), most buyers of small businesses buy the assets separately rather than shares of stock.
8. The broker will market the property in conformance with any privacy concerns of the owner.
9. Any buyers who express interest in the business should be qualified because many inquiries will be from competitors who would like information. All potential buyers should sign a non-disclosure agreement.
10. The broker will write the offer to purchase and present it to the seller.
11. The buyer is given a due diligence period to inspect the operations and financial statements.
12. Preparation for closing might include title work if real estate is involved, or a lease assignment prepared for the landlord’s signature.
13. Close the transaction.