Buying a Funeral Home Business

by T. Scott Gilligan

The final article in our three-part series on succession planning will look at the buyer's perspective in a funeral home transaction. For a buyer, there are three overriding concerns:

• not to overpay for the funeral home business;
• getting what you paid for; and
• to avoid getting stuck with any unknown or unwanted liabilities.

1. Don't Pay Too Much

The best protection against paying too much for a funeral home business is to obtain an independent appraisal. We recommend using one of the well-known experts in the field such as Vanderlyn Pine, Bob Ninker or Paul Kuper of Kuper Consulting Services. Because the funeral home industry is so unique, the use of an appraiser that has prior funeral home experience is critical.

There are a handful of general methods used to value funeral home businesses. For example, one rough rule of thumb is valuing the funeral home business at $10,000 per call. Of course, this method fails to account for average revenue per call. Obviously, a funeral home with 200 calls doing 90% traditional funerals is worth more than a 200 call firm with a 60% cremation rate.

Another valuation method that is employed is to multiply earnings before interest, taxes, depreciation and amortization ("EBITA"). Usually, a multiplier factor of from 1.8 to 3 is used. For example, if a firm had average earnings of $500,000 before interest, taxes, depreciation and amortization, under this method the firm would be worth anything from $900,000 to $1,500,000 depending on the multiplier that is used. The choice of which multiplier to employ may depend on the particular facts of the funeral home business such as whether its market share is increasing, how effective its preneed program is, etc.

Appraisers with experience in valuing funeral homes do not rely exclusively on these or other standard valuation methods. Rather, they closely examine the funeral home's financial statements, market share, preneed program, ownership, assets and employees in arriving at a value. The purpose of this examination is to predict as accurately as possible how the funeral home will perform in the future. The appraiser is seeking to identify trends in the market and in the funeral home's historic performance in order to forecast earnings in the future. The appraiser will then employ several of the standard valuation methods in order to confirm the valuation made by the appraiser.

While appraisals of funeral homes are not inexpensive, they can protect the buyer from paying an excessive amount for the business. They are also useful to the buyer who is seeking outside financing for the acquisition. Finally, an appraisal can assist the buyer in preparing a business plan for the new acquisition.

2. Getting What You Paid For

After the buyer and seller agree on a price and the parameters of the transaction, there are two primary actions which a buyer will want to undertake to insure that what the buyer actually will receive meets his or her expectations. First, the buyer will perform "due diligence." This means that the buyer's accountants, lawyers and other representatives will examine the books and records of the funeral home, perform OSHA, ADA and structural inspections of the funeral home facility, and obtain title reports, surveys and a Phase I Environmental Audit of the funeral home real property.

Due diligence typically takes anywhere from 30 to 90 days depending upon the size of the operation and the response time of surveyors, title examiners, accountants and attorneys. The overriding purpose of due diligence is to verify that the funeral home facility and business is in the condition the seller represented it to be. For example, accountants may want to review the list of preneed contracts and verify that trust deposits or insurance policies have been purchased in order to fund the preneed contracts. Financial statements for prior years should be confirmed by reviewing funeral contracts to make sure revenue has not been overstated.

The second method buyers use to insure they receive what they paid for is representations and warranties in the Purchase Agreement. Typically, a seller will be required to represent in the contract that the seller has good title to the funeral home assets, that the seller is legally capable of selling the stock or assets, that the assets are in operational condition and not subject to claims of third parties, and that the business is in compliance with OSHA, ADA, FTC, environmental laws, state licensing requirements, state preneed requirements, and local zoning ordinances.

Another critical element to the transaction from the buyer's perspective is protection against future competition by the seller. A non-competition agreement must be included as part of the transaction. In that agreement, the buyer will attempt to preclude the seller from competing in any fashion against the funeral home for such time and within as broad a radius of the funeral home as necessary to preclude the seller from siphoning off any of the new or future business of the funeral home. The art of drafting the non-competition agreement is in balancing the legitimate needs of the buyer from competition against being so overbroad that the agreement is overruled by the courts.

3. Avoid Getting Stuck With Any Unknown or Unwanted Liabilities

Due diligence is a buyer's first line of protection against inheriting any unknown or unwanted liabilities of the funeral home. However, due diligence may not be able to uncover unknown claims such as an OSHA complaint that has not yet been filed, a payment on a preneed contract that went into the seller's pocket rather than into the trust fund or an unpaid casket bill. To protect against these liabilities, it is vital that the buyer has the seller stand behind the warranties and representations made in the purchase agreement. This is done with an indemnification provision by which the seller agrees to indemnify the buyer from any damages the buyer incurs a result of seller's breach of a warranty or representation.

Sellers will attempt to limit the effectiveness of an indemnification provision by placing survival periods on the representations and warranties in the agreement. Oftentimes, the length of a survival period is a matter of negotiation. We typically propose a range of survival periods so that representations regarding environmental or preneed trusting may extend for 10 years after the purchase agreement while other representations such as the absence of OSHA claims may be subject to only a 1 or 2 year term.

In order to enforce indemnification provisions in the event a seller does breach a representation, it is very helpful if the buyer has the right of offset. For example, if the buyer is paying the purchase price or the non-competition agreement in installments, the buyer can offset against those installments any damages that the buyer suffers because of the seller's breach. Not surprisingly, the right of offset can be a highly contested point in purchase negotiations.

We emphasize once again that effective succession planning--whether selling, buying or simply transferring the funeral home business within the family --requires advance planning and the assistance of knowledgeable experts. The retention of qualified and experienced lawyers, brokers and appraisers can be one of the most important steps a prospective buyer or seller can take. Ask your colleagues or state association for referrals. Speak to funeral directors who have bought and sold funeral homes to gauge if they were satisfied with their representatives. And most importantly, obtain in writing fee schedules and budgets so you know how much you will be paying for this expertise.

The investment you have made in your funeral home, both from a financial standpoint and an emotional one, is too valuable to ignore succession planning issues. Qualified assistance is available, but be careful and patient in your selection.

Third part of a three part article. Reprinted from the Summer 1999 Ohio Funeral Directors Association newsletter. T. Scott Gilligan is General Counsel for the National Funeral Directors Association.