Buying a Business
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IHAVE recently received a number of inquiries concerning the procedure to be followed when a person is negotiating for the purchase of a haulage business. One such inquiry related to a business in which the owner possessed A licences for vehicles totalling 28i tons unladen. A sum of £3,500 was being asked for this undertaking plus the tangible assets, that is to say vehicles, equipment, buildings, etc., at valuation.
One aspect should be given consideration before estimating the value of the business, and that is the transfer of the licences. It should be well known that, technically, the licences are not transferable. To purchase any business without making provision for the acquisition of the licences would, of course, be folly. I have been told that a practical way out of the difficulty is to convert the existing business into a 'small company, that is, of course, if it has not already reached that stage. The prospective buyer should acquire shares in the business and subsequently negotiate for the purchase. .
In assessing the value of the business, no provision should be made for any value attached to the licences. The two principal items are the actual assets and the goodwill. So far as the tangible assets are concerned, the services of an expert valuer should be obtained. Even that part of the transaction is somewhat difficult to deal with inasmuch as, as I shall show, the value of the assets is sometimes affected by that of the goodwill.
Three Years' Profits
The goodwill in a haulage business—indeed, in most businesses—is measured by the actual profits which have been earned over a period of years. There is no hard-andfast rule but so far as a haulage business is concerned the purchase price is usually equivalent to four times the net average annual profit as obtained from the haulier's books. In assessing the average for this purpose it is customary to take figures for the three years before the date of purchase.
In assessing this profit, I am assuming that the gross takings are agreed. The next step is to ensure that the operating costs are complete and accurate, and in carrying out this part of the investigation particular care should be taken to ensure that provision has been made for maintenance and depreciation. One way is for the buyer to check the haulier's assessment of the cost of operating the vehicles by classifying the expenditure, using as headings the 10 items
of operating cost. A serious error might arise if the purchaser is misled because the entries under the headings of maintenance and depreciation are inadequate.
The establishment charges, including wages of clerical A38
staff, management expenses, accountancy charges, advertising and legal expenses, trade and travelling expenses, insurances, printing, stationery, telephone and telegrams, most also be included. In assessing these items, the expenditure on hirepurchase interest and income-tax payments are to be omitted. The total of the above vehicle operating costs and establishments costs, subtracted from the revenue each year gives the net profit. The sum of that for three years divided by three gives the average net profit per annum. Multiply by four and there is the value of the goodwill as an item in the purchase price.
Assume, for example, that the profits of the three years are shown to be £100, £120 and £160. The total is 1380, so that the average profit per year is approximately £128, which means that the goodwill can be assessed at £512. If the actual assets are, say, vehicles at £2,000, property and buildings £500, other assets (including such items as spare parts and accessories, new stores in stock, petrol, oll and grease, garage equipment, furniture, clothing, unexpired Road Fund tax and insurances), total £250, the fair estimate of the purchase price is £3,262.
Depreciated Value Now I would like to deal with a point I have already raised, the risk that because of lack of real goodwill, the value of the assets may be depreciated. What happens can best be demonstrated by example. Assume a small business comprising four vehicles, all engaged on contract work. There is every prospect that the contracts will be renewed on their expiration and viewed in that light the goodwill offered appears to be of good value. It is stated that in a full year the profits would be in excess of £300. The four vehicles are all used and their value, if they had to be sold in the open market, is negligible. They are, however, in reasonably good condition and, therefore, if the business were to be considered as a going concern their value to the owner is likely to be in excess of the market value. Actually on valuation it was agreed that the total value of the four was £300.
Unfortunately, 1 discover some serious omissions in the proprietor's calculations for the cost of operation of his vehicles. Instead of the prospect of £300 profit per annum there is actually a loss of approximately £110. This error had beris made in good faith but was because there was no provision for maintenance or renewal of tyres in the figures for operating costs. Making a moderate and reasonable provision for that means increasing the allocation for operating costs by £180 for the four vehicles. Next it is discovered that there is no provision in
the establishment charges for Management expenses or contingencies. The item contingencies, in the case of a business in which four vehicles are operating on contract and where it might at any time be necessary to find substitutes, might be a serious one. A minimum allowance for that should be £180 and actually I
think that even at that I am taking a risk. Even if the manager drew only £2 per week as wages for himself—a ridiculous amount—there is less than £80 per annum available for contingencies.
If I seem to be harping upon this matter, I should point out that in the contract, which followed the usual wording, there was an obligation on the part of the contractor to put an alternative vehicle on the road in the client of any one of the four being damaged or otherwise Out of commission. It seems that I might serve a useful purpose by enlarging upon some of the aspects of this case.
The four vehicles which I will call A, B, C and ID, are engaged upon an annual contract for the conveyance of a material for which the demand is much greater during six months of the year than during the remainder. Roughly speaking it is fair to assume that the tonnage carried during the good six months period. is double that hauled during the slack The proprietor has no accounts Worthy of the name. He is able to give some rough figures for expenditure and revenue covering only three months during the busy season. On the debit side are the following items: petrol, oil, wages and National Insurance, Road Fund tax, vehicle insurance, garage and depreciation. On the credit side are entered the amounts received for carriage. The difference between these two is assumed to be net profit and it was from those figures that the alleged £512 had been extracted.
According to these records, the business showed, during the three months for which figures are available, net profits as follows: vehicle A, £33 5s.; vehicle B, £30 Ss.; vehicle C, £14; vehicle D, £22 10s.;. total, £100. Assuming that the same profit was earned io the other three months of the good part of the year and that for the rest of the year the profits were halved, the total profit would be £300.
Actually, this assumption favoured the proprietor, because some of the items of expense would not be reduced although the volume of the business was less. Taxation, the garage and the cost of insurance, for example, would be the same during the slack period as in the busy months.
Stretching a Point
The purchaser, at any rate, was generous, for he not only agreed that the profits for the slack period of the year could be taken as suggested, but he also accepted the total, namely £300 per annum, as a satisfactory basis for the calculation of the value of the goodwill. This clearly was stretching a point because figures were not available for more than three months and the business itself had not been established for a full year. He took a wise precaution of offering only three years' purchase which made the goodwill 1900.
The four vehicles were the only assets. There was nothing on account of the garage equipment or buildings Or anything of that kind. All the vehicles were old if riot decrepit: they were used when acquired and on one of them was still a balance of hire-purchase payments due. Nevertheless. before investigating the figures for goodwill it seemed to me that the proprietor was justified iroantieipating that he would be able to make the vehicles do three years' work. At least, that expectation applied to three of them, Vehicle A had cost £224. It had been in use only one year, and I assessed the depreciation at £40, leaving the present value at £184. Vehicle B had been purchased for £250 at about the same time as vehicle A, and I assessed its present value at £200. Vehicle C was the poorest and I was of the opinion that it should be disposed of as soon as reasonably possible; I assessed it at £50. That was more than its market value if offered for direct sale, but I thought it possible that that sum would be obtainable in part-exchange for a new vehicle or for a used one of good quality. The fourth vehicle had cost £500 and I assessed it at £400.
The total value of the four is thus seen to be £834. From that sum, however, it was necessary to deduct the £100 still owing on a hire-purchase agreement on vehicle D, which reduced the net value of the assets to £734. On the face of it, therefore, the business was worth £1,634, of which £734 was for tangible assets and 1900 for goodwill.
Here, however, is where the wisdom of keeping accurate cost records becomes apparent. In the above statement of debit items there are serious omissions—those to which have already referred. In the first place, considering only the cost of operation of the vehicles, there is no mention of expenditure on tyres and nothing relating to maintenance or repairs. There is no suggestion that the proprietor, in preparing his accounts for my inspection, had deliberately omitted these with the intent to deceive.
gathered that during the period under review there had been no substantial expenditure on repairs, nothing had been spent on tyres, and as for those maintenance operations, such as washing, polishing, greasing, minor adjustments,. they had been carried out by the drivers as part of their normal duties.
Obviously, however, this was a state of affairs which could not be assumed to continue indefinitely. The fact that so little has been spent on maintenance rather pointed to the likelihood that some big sums would have to be disbursed in the near future. Moreover, in view of the age of the vehicles, it was more than likely that the cost of mainteriance,averaged over a three years' life which I am giving to three of the four vehicles, might prove to be high.
I came to the conclusion that the allowance of £140 per annum per vehicle was the minimum which should be made to cover tyres and maintenance. That meant a reduction in the net profits by that amount, bringing the total from £300 per annum to £160 per annum.
Proprietor's Wage It will also be clear that there is no provision for establishment charges. Obviously the man in charge, although he was the proprietor, would require a wage. In the absence of any provision at all 1 think the best thing I can do is to put in £150 a year for that, whilst I well appreciate that that is a nominal amount and an absolute minimum.
In addition, as I have already mentioned, there must be some provision for a contingency fund to meet the expenses of providing a substitute vehicle when one or other of the four is out of commission. A sum of at least £100 should be set aside for this purpose.
Clearly, therefore, instead of a profit of £300 per annum the business was being run at a loss of £110 per annum. The contracts were worse than valueless; without them there was no work for the vehicles for there were no licences available to operate them. The value of the vehicles as assets could be calculated only on the basis of what they would fetch in the open market and I cannot imagine anyone paying £500 for the four. The business, therefore, instead of being worth £1,634 could be valued at only the low figure of £500, which is the assumed value of the four vehicles in the open market. Rate-cutting had brought about a state of affairs in which the goodwill of the business was less than nothing, and without the goodwill and licences the vehicles were of little value.
I should therefore advise any prospective purchaser to examine with care the figures presented to him, for certain
vital items may have been omitted. S.T.R.