Despite stringent disclosure rules which aim to even things up between the supposedly rapacious seller and the innocent purchaser, it’s very easy for a buyer of a small family business to be caught by buying a dud.

If you’re stuck with a dud business as a result of being deliberately deceived you certainly can take them to court. But you don’t need me to tell you of the costs of litigation, the time it takes (years!), and the very real chance you may not succeed anyway.

This article is the fifth in a series on how to detect the traps and uncover the secrets the seller may be hiding from you.

When I had visited my GRB Shop friend I noticed that there were always two people behind the counter. But the profit figures only showed wages for one. He had stated that his wife did not work very much in the business because she was too busy looking after the kids at home.

Given that this was a 7 day business, 12 hours a day, and that he had to do a delivery run sometime in the day he obviously needed more than one employee.

Trap 16. Family Workers Not on the Payroll:

In fact there were two more and they turned out to be their teenage kids – and it seemed his wife was a regular as well. When I asked about the kids’ wages he said he was teaching them the business and they only got private pocket money.

But if I (or any other buyer) took over the business and did not have kids willing to work in the shop I would have to employ outsiders and pay much higher wages than he was showing.

This is in fact a very common situation in small businesses like this. Imagine two identical businesses, one run entirely by a large family and paying no wages and the other with an absentee owner who employs everybody. The bottom line on each would be vastly different, but yet they are the same business.

So they should be worth the same value, right? You would think so, but in practice asking prices are based on a multiple of the bottom line, so one is overpriced and the other is a bargain.

I will show you below how to adjust the figures so you can get a fair comparison. Firstly though you need to work out exactly what workforce you need and for how many hours a week, taking into account busy and slack times and days.

Trap 17. Not Adjusting for Salaries & Wages and & Retirement Benefits Of Owners

This is another twist on the same situation. Think of two businesses both having a net profit of $100,000 before the owners take any out. One decides to leave it all in the business, so the $100,000 does not change, the other decides to show a wage to him/herself of $60,000 – so the $100,000 now becomes $40,000.

So it is clear that the only way to make a fair comparison is to ignore the $60,000 wage.

The answer to both the above traps is to apply notional wages at commercial rates to all family members outside one fulltime business owner – the “Primary” business owner – (or employed manager in the absentee owner situation).

So if my GRB Shop owner had his wife working for 20 hours a week and his teenagers there after school and/or on weekends, I would calculate notional wages for them for the time spent in the shop and deduct it from the net profit.

This article was written by Brian K Fitzgibbon CPA.

Brian is an experienced accountant and small business consultant. He runs his own business, lectures extensively on small business topics and has checked out and valued many hundreds of small businesses for buyers.

Brian is also the author of the highly acclaimed and invaluable
"How To Value A Business And Buy It Without Fear"
A do-it-yourself guide for first-time and experienced buyers alike.

To download a FREE Chapter from Brian's book please follow this link: "HowToValueBusiness.com"

July 31st, 2009 | Tags: accountants valuation, business valuations, buying a business, buying a dud business, checking out a business, checking the figures, dangers of business valuations, disclosure rules on buying a business, diy business valuations, due diligence on a small business, family members in a business, how to buy a business, how to check a lease, how to value a business, tips on buying a business, traps to avoid in buying a business, valuing franchises | Category: articles | Subscribe to comments | Leave a comment | Trackback URL  |