Deck 7: Buying an Existing Business

Question 1

Laurette has entered into a contract with Jackson to purchase his retail music shop. Jackson's lease on the existing building (which is in an excellent location) has five years remaining. If Laurette wants the lease to be part of the business sale:

A) she should include a clause in the sales contract in which Jackson agrees to assign to her his rights and obligations under that lease.
B) she should notify the landlord of Jackson's assignment of the lease agreement to her.
C) A and B are correct.
D) None of the above. Because Jackson does not actually own the building, he can transfer no rights to it to Laurette.

Answer 1

C

Question 2

Which of the following statements concerning financing the purchase of an existing business is not true?

A) The business seller usually is a good candidate for a source of financing.
B) The deal should allow the buyer to make the loan payment out of the company's cash flow.
C) The buyer should wait until late in the purchase process to arrange financing to avoid processing fees in case the deal falls through.
D) All of the above

Answer 2

C

Question 3

Advantages to buying an existing business that you do not have with a startup include:

A) greater access to venture capital.
B) the opportunity to participate in a national advertising campaign.
C) inventory is in place and trade credit is established.
D) easy implementation of innovations and changes from past policies.

Answer 3

C

Question 4

Important factors to investigate regarding the business to be purchased include:

A) assessing the physical assets of the business.
B) reviewing accounts receivable and business records.
C) reviewing contractual arrangements and assessing intangible assets.
D) All of the above

Question 5

Perhaps the ideal source of financing the purchase of an existing business is:

A) a venture capitalist.
B) the Small Business Administration.
C) the seller of the business.
D) an insurance company.

Question 6

An entrepreneur who is considering purchasing a business is analyzing a company's accounts receivable. The following table summarizes her findings. Age of Accounts Amount Probability of Collection
0 - 30 days $12,000 .96
31 - 60 days $ 4,000 .87
61 - 90 days $ 2,500 .71
91 - 120 days $ 1,400 .65
121 + days $ 800 .24
How much should this potential buyer be willing to pay for these accounts receivable?

A) Nothing ; a buyer should never purchase existing accounts receivable.
B) $20,700
C) $17,877
D) Not enough information given to determine

Question 7

The most common reasons owners of small- and medium-sized businesses give for selling their businesses are:

A) need for money and low return on investment.
B) boredom and burnout.
C) low return on investment and burnout.
D) greater opportunities working for someone else and low return on investment.

Question 8

When evaluating the assets of an existing business, the inventory:

A) is always current and salable.
B) usually appreciates over time, making the business a bargain.
C) should be judged on the basis of its market value, not its book value.
D) is usually stated honestly and does not need an independent audit.

Question 9

During the acquisition process, the potential buyer usually must sign a ________, which is an agreement to keep all conversations and information secret and legally binds the buyer from telling anyone any information the seller shares with her.

A) covenant not to compete
B) nondisclosure document
C) letter of intent
D) purchase agreement

Question 10

To ensure a smooth transition when buying an existing business, a buyer should:

A) communicate with employees to reduce their uncertainty and anxiety.
B) be honest with existing employees about upcoming changes and plans for the company's future.
C) consider asking the seller to stay on and serve as a consultant until the transition is complete.
D) All of the above

Question 11

The due diligence process of analyzing and evaluating an existing business:

A) may be just as time consuming as the development of a comprehensive business plan for a start-up.
B) helps to determine if the company will generate sufficient cash to pay for itself and leave you with a suitable rate of return on your investment.
C) helps to determine what the company's potential for success is.
D) All of the above

Question 12

When acquiring a business, the buyer should:

A) conduct a self-analysis of skills, abilities, and interests.
B) prepare a list of potential candidates.
C) investigate potential candidates and carefully evaluate them.
D) All of the above

Question 13

Which of the following is a potential disadvantage of purchasing an existing business?

A) The employees inherited with the business may not be suitable.
B) The previous owner may have created ill will among the company's customers.
C) Equipment and facilities may be obsolete or inefficient.
D) All of the above

Question 14

The first step an entrepreneur should take when buying an existing business is to:

A) explore financing options.
B) prepare a list of potential candidates.
C) analyze his or her skills, abilities, and interests in an honest self-audit.
D) contact existing business owners in the area and ask if their companies are for sale.

Question 15

Which of the following statements concerning financing the purchase of an existing business is true?

A) It is usually more difficult than securing financing for a start-up business.
B) Usually, the business seller is not a good source of financing.
C) The buyer should be able to make the payments on the loans out of the company's cash flow.
D) All of the above

Question 16

Generally, a seller of an existing business can assign any contractual right to the buyer unless:

A) the contract specifically prohibits the assignment.
B) the contract is personal in nature.
C) A and B are correct.
D) None of the above. Business sellers typically cannot assign any contractual rights to buyers.

Question 17

A toy manufacturer is sued based on the claim of injuries caused by a product it makes. This is an example of a:

A) product liability lawsuit.
B) promissory estoppel lawsuit.
C) restrictive covenant lawsuit.
D) contingent liability lawsuit.

Question 18

When done correctly, the due diligence process will:

A) reveal both the positive and negative aspects of an existing business.
B) be time consuming and expensive.
C) most often result in the purchase of the business.
D) rarely prove to be beneficial.

Question 19

Sources of potential legal liabilities for the buyer of an existing business include all but which of the following?

A) Problems with the physical premises, such as hazardous materials
B) Product liability claims
C) Labor problems and disputes
D) Errors and omissions

Question 20

Which of the following is required for the covenant not to compete to be enforceable?

A) Part of a business sale and reasonable in scope
B) Approved by a court of law and reasonable in scope
C) The assistance of an attorney and approved by a court of law
D) The registration of the due-on-sale agreement

Question 21

The amount the seller of a business receives for "goodwill" is taxed as:

A) a long-term capital gain.
B) regular income.
C) superlative income.
D) None of the above

Question 22

Business valuations based on balance sheet methods suffer certain disadvantages, including:

A) they are extremely complex and are difficult to calculate.
B) they do not consider the future earning potential of the business.
C) they fail to take into account what is usually the largest asset a company owns: inventory.
D) All of the above

Question 23

Which method of business valuation relies on three forecasts of future earnings: optimistic, pessimistic, and most likely?

A) Balance sheet technique
B) Excess-earnings method
C) Discounted future earnings
D) Market approach

Question 24

A valuation method that is more realistic than the balance sheet technique, because it adjusts book value to reflect actual market value, is the:

A) excess earnings method.
B) market approach.
C) capitalization method.
D) adjusted balance sheet method.

Question 25

Use the following information to answer the question(s) below.
Baubles and Bells, a small business, is up for sale. The book value of its assets is $397,650, and its liabilities have a book value of $148,500. After adjusting for market value, total assets are worth $386,475, and total liabilities are $153,600. The business is considered to be a "normal risk" venture. The new owner (if he buys) plans to draw a salary of $28,000. Estimated earnings for the upcoming year are $88,400. Complete net earnings estimates for the next five years are:
Pessimistic Most Likely Optimistic
Year 1 $82,000 $88,400 $90,500
Year 2 $85,000 $90,000 $93,000
Year 3 $88,000 $92,500 $95,500
Year 4 $91,000 $95,000 $97,000
Year 5 $94,000 $97,000 $98,500
Using the adjusted balance sheet technique, what is the business worth?

A) $397,650
B) $386,475
C) $249,150
D) $232,875

Question 26

If a business buyer estimates that 20 percent is a reasonable rate of return for an existing business expected to produce a profit of $27,000, its capitalized value would be:

A) $5,400.
B) $32,400.
C) $135,000.
D) $540,000.

Question 27

Which of the following is considered an opportunity cost of buying an existing business?

A) The salary that could be earned working for someone else and the owner's investment in the business
B) Dividends
C) The market value of tangible assets
D) The salary that the business has paid to previous owners

Question 28

During the acquisition process, the buyer and the seller sign a ________, which spells out the parties' final deal and represents the details of the agreement that are the result of the negotiation process.

A) covenant not to compete
B) nondisclosure document
C) letter of intent
D) purchase agreement

Question 29

Under the excess earnings method, what is the "extra earning power" of the business?

A) $86,219
B) $2,181
C) $11,175
D) Cannot be determined from the information given

Question 30

Which of the following valuation methods does not consider the future income-earning potential of a business?

A) Balance sheet technique
B) Excess-earnings method
C) Discounted future earnings approach
D) Market approach

Question 31

In a business sale, a letter of intent:

A) states that the buyer and the seller have reached a sufficient meeting of the minds to justify the time and expense of negotiating a final agreement.
B) should contain a clause calling for "good faith negotiations" between the parties.
C) addresses such issues as price, payment terms, a deadline for closing the deal, and others.
D) All of the above

Question 32

A method of valuing a business based on the value of the company's net worth is the:

A) balance sheet technique.
B) adjusted balance sheet technique.
C) earnings approach.
D) opportunity cost technique.

Question 33

When valuing inventory for a business sale, the most common methods used are:

A) first-in-first-out (FIFO) and last-in-first-out (LIFO).
B) first-in-first-out (FIFO) and average costing.
C) cost of last purchase and replacement value of inventory.
D) cost of last purchase and average costing.

Question 34

The capitalized earnings approach determines the value of a business by capitalizing its expected profits using:

A) the interest rate that could be earned on a similar risk investment.
B) the prime interest rate.
C) the normal rate of return.
D) the prevailing return of inflation.

Question 35

Using the excess earnings method, what is the company's "goodwill"?

A) $6,543
B) $33,525
C) $15,267
D) Cannot be determined from the information given

Question 36

In the earnings methods of business valuation, the rate of return associated with a "normal risk" business is:

A) 15 percent.
B) 25 percent.
C) 35 percent.
D) 50 percent.

Question 37

Which of the following statements about valuing a business is true?

A) The balance sheet technique is the best way to value a business.
B) Business valuation is partly art and partly science.
C) Buyers should rely on the seller's industry expertise and years of experience to determine what his company is worth.
D) Business valuation processes are consistently misleading regarding the future earning potential of a business.

Question 38

Use the following information to answer the question(s) below.
Baubles and Bells, a small business, is up for sale. The book value of its assets is $397,650, and its liabilities have a book value of $148,500. After adjusting for market value, total assets are worth $386,475, and total liabilities are $153,600. The business is considered to be a "normal risk" venture. The new owner (if he buys) plans to draw a salary of $28,000. Estimated earnings for the upcoming year are $88,400. Complete net earnings estimates for the next five years are:
Pessimistic Most Likely Optimistic
Year 1 $82,000 $88,400 $90,500
Year 2 $85,000 $90,000 $93,000
Year 3 $88,000 $92,500 $95,500
Year 4 $91,000 $95,000 $97,000
Year 5 $94,000 $97,000 $98,500
The valuation approach that considers the value of goodwill is the:

A) balance sheet technique.
B) excess earnings method.
C) discounted future earnings approach.
D) market approach.

Question 39

When evaluating the financial position of a business he or she is considering buying, an entrepreneur should examine:

A) its income statements and balance sheets from the past three to five years.
B) its income tax returns for the past three to five years.
C) the owner's compensation and that of relatives.
D) All of the above

Question 40

The main reason a buyer purchases an existing business is for:

A) its future income and profits for earning potential.
B) its customer base and access to those customers.
C) its tangible assets and the ability to liquidate those assets.
D) its goodwill.

Question 41

Mitchell Schlimer, founder of the Let's Talk Business Network, a support community for entrepreneurs, says that, initially, about ________ percent of small business owners who sell their companies to larger businesses remain with the acquiring company.

A) 40
B) 50
C) 70
D) 90

Question 42

The process of investigating the details of a company that is for sale to determine the strengths, weaknesses, opportunities and threats facing it is known as the:

A) hidden market process.
B) due diligence process.
C) skimming process.
D) business assessment process.

Question 43

When buying a business, an entrepreneur can usually purchase equipment and fixtures at prices well below their book value.

Question 44

With an existing business, the new owner can depend on employees to help him make money while he is learning the business.

Question 45

You are considering purchasing Babcock Office Supply. You estimate that the company's earnings next year will be $67,400. You have found three similar companies whose stock is publicly traded. Their P/E ratios are 6.8, 7.4, and 7.1. Using the market approach, you estimate Babcock Office Supply to be worth:

A) $478,540.
B) $9,493.
C) $67,400.
D) $498,760.

Question 46

An ESOP:

A) allows an owner to transfer all or part of his company to the employees as gradually or as quickly as he chooses.
B) works best in companies where pre-tax profits exceed $100,000.
C) is not beneficial to companies with fewer than 15 to 20 employees.
D) All of the above

Question 47

The ________ approach to valuing a business uses the price-earnings ratios of similar businesses to establish the value of a company.

A) balance sheet
B) capitalized earnings
C) discounted future earnings
D) market

Question 48

For a new owner of an existing business, physical facilities and equipment costs are very similar to what would have been spent on a startup with all new facilities and equipment.

Question 49

Which of the following strategies would not be suitable for an entrepreneur who wants to surrender control of the company gradually?

A) Forming a family limited partnership
B) Restructuring the company
C) Straight business sale
D) Using a two-step sale

Question 50

The due diligence process in analyzing and evaluating an existing business can be just as time consuming as the development of a comprehensive business plan for a start-up.

Question 51

The ________ approach to valuing a business assumes that a dollar earned in the future is worth less than that same dollar is today.

A) balance sheet
B) capitalized earnings
C) adjusted balance sheet
D) discounted future earnings

Question 52

Which of the following valuation techniques is best suited for determining the value of service businesses?

A) Discounted future earnings approach
B) Balance sheet technique
C) Adjusted balance sheet technique
D) Excess earnings approach

Question 53

A company's P/E ratio is:

A) the price of one share of its common stock divided by its earnings per share.
B) its profits per share divided by its equity per share.
C) its profits per share divided by its excess cash flow per share.
D) None of the above

Question 54

Which of the following is a disadvantage of the market approach to valuing a business?

A) Necessary comparisons between publicly traded and privately owned companies
B) Unrepresentative earnings estimates
C) Difficulty in finding similar companies for comparison
D) All of the above

Question 55

This type of business sale is best for those entrepreneurs who want to step down and turn over the control of the company to the new buyer as soon as possible.

A) Straight business sale
B) Earn-out
C) Sale of controlling interest
D) Employee stock ownership plan - ESOP

Question 56

Which of the following is a drawback of the market approach of evaluation?

A) It does not consider current earnings.
B) It may underrepresent earnings.
C) Its reliability depends on the forecasts of future earnings.
D) It overemphasizes the value of goodwill.

Question 57

________ gives owners the security of a sales contract but permits them to stay at the "helm" for several years.

A) Earn-out
B) A controlled sale
C) Company restructuring
D) An ESOP

Question 58

To avoid a stalled deal, a buyer should:

A) take a hard line and never give an inch.
B) understand that they may not be able to get what they really want.
C) go into the negotiation with a list of objectives ranked in order of priority.
D) be firm, focused, and unbending.

Question 59

Some business brokers differentiate between the types of buyers: ________ buyers see buying a business as a way to generate income and ________ buyers view the purchase as part of a larger picture to offer a long-term advantage.

A) strategic; financial
B) financial; strategic
C) strategic; optimistic
D) financial; passive

Question 60

A(n) ________ allows owners to "cash out" by selling their companies to their employees as gradually or as quickly as they choose.

A) two-step sale
B) controlled sale
C) company restructuring
D) ESOP

Question 61

A creditor's claim against an asset is referred to as lien.

Question 62

A due-on-sale clause is a loan contract provision that prohibits a seller from assigning a loan arrangement to the buyer and instead, the buyer is required to finance the remaining loan balance at prevailing interest rates .

Question 63

A prospective buyer should have an attorney thoroughly investigate all of the assets for sale in a business and their lien status before buying any business.

Question 64

Accounts receivable are rarely worth face value and should be "aged" when evaluating a company's assets.

Question 65

If a business has a lien against any of its assets at the time of the sale, the buyer must assume them and is financially responsible for them.

Question 66

Before purchasing an existing business, an entrepreneur should analyze both its existing and its potential customers.

Question 67

A due-on-sale clause requires a buyer to pay the full amount of the remaining balance on a loan or to finance the balance at prevailing interest rates.

Question 68

A new owner of an existing business can generally introduce change and innovation almost as easily as if the company were a new business because employees and customers expect change in business practice when there is a change in ownership.

Question 69

Financing the purchase of an existing business usually is easier than financing the startup of a new one.

Question 70

The reason an entrepreneur should conduct a self-audit of his or her skills, abilities, and interests is to help focus on those businesses that will best "fit."

Question 71

A due-on-sale clause allows an entrepreneur buying a business to "assume" the seller's loan (usually at a lower interest rate).

Question 72

The hidden market of companies -those companies that might be for sale and are not advertised-is one of the richest sources of top quality businesses to purchase.

Question 73

An entrepreneur should never purchase a business that is losing money.

Question 74

The most common reasons that owners of small businesses give for selling are the intensity of competition and an inability to raise sufficient cash to continue to grow.

Question 75

When a buyer purchases an existing business, she may "inherit" liability for damages and injuries caused by products the company has manufactured or sold in the past.

Question 76

When evaluating a business as a potential candidate for purchase, an entrepreneur should determine the real reason the current owner wants to sell.

Question 77

One way for a business buyer to avoid being surprised by liens against the assets purchased is to include a clause in the sales contract stating that any liability not shown on the balance sheet at the time of the sale remains the responsibility of the seller.

Question 78

The business acquisition process should begin with the search for potential companies to acquire.

Question 79

A principal advantage of buying an existing business is the purchaser's ability to rely on the previous owner's experience.

Question 80

A due-on-sale clause in a loan contract prohibits the buyer of a business from assuming a seller's loan even though it may carry a lower interest rate.