One of the most effective ways to grow your business is to buy another business. It’s also less risky that starting one from scratch. But that doesn’t mean that it’s not without certain risks and challenges – they do exist. The trick is to look for the less obvious, or even hidden, dangers that sometimes accompany a business purchase. If you know what you’re looking for, you’ll lessen those risks during the purchase process.
A key point to remember is that when you’re considering a business purchase, you’re looking at the past in terms of its sales records and data. There’s no guarantee things won’t change going forward. No-one can predict the future, but doing your due diligence and knowing what to look for can certainly help.
Find out why they’re selling
A business owner who has nothing to hide will probably include the reasons for the sale in the advertisement. They might have decided to retire, and now’s a good time because the business is genuinely in a growth phase and showing a healthy profit. But if you try to pin them down on their reasons for selling and they sidestep the question, then beware. Chances are good that the business has some internal problems that would be quite difficult to resolve.
They might also be selling due to demographic or political changes. The community could be changing in a way that will see sales decrease, or there might be too much competition. It’s a good idea to check with the local council to make sure that there aren’t any zoning changes planned, or that something like a huge shopping mall isn’t about to rise up and snatch away all the business’s customers.
Determine the Owner’s Discretionary Income (ODI)
This is basically what the current owner pays themselves. It’s their salary after all business expenses have been paid, and it’s what they live on. The first thing you need to determine is whether you can live on it, and the second is to compare the ODI to previous years. If it’s been declining, then the business could be in financial difficulty. Beware of business owners who talk up their ODI, when the actual reports say something different.
Check out the competition
Let’s say you’re thinking of buying a gardening business. Do some homework and find out what other gardening services are being offered in the same location. Determine if those businesses are offering something that your prospect isn’t, or vice versa.
Weigh up the competitive advantages of each and decide if you could improve on them. Then do some customer research. Try and find people who’ve used the gardening services and get their feedback. If the business you’re thinking of buying has a bad reputation and customers are consistently using their competitor, ask yourself if you want to take on the responsibility of turning the business around.
This is also a good way of finding out what reputation the business has in the community. You could also:
- Read online reviews of the business and compare them to the competition
- Go to the library and skim past local newspapers. Has the business had any publicity? Has it been good or bad?
Spend as much time as you can talking to the locals about the business. After all, if you buy the business they’ll be your customers, so they are not only a great source of information on the business’s reputation, but you’ll get a clear idea of how many of them will be customers in the future.
Internal difficulties
Once you’ve identified the potential external risks, it’s time to turn your attention to the business’s internal systems and processes. In particular, look out for:
- Equipment and machinery. Make sure it’s in good condition. If the business owns the equipment, make sure warranties are up to date and nothing needs major repair work done. If it’s leased, check the leases to confirm that maintenance is part of the deal.
- Disgruntled employees. You can often tell how well a business is being run by the attitude of those who work for it. If it has good systems and processes, you’ll find that staff are happier and more secure than if they’re forced to work under conditions that make their days difficult. Take a measure of staff morale and if it seems low, try to find out why.
- Debts hidden off the balance sheet. Don’t look just at the profit and loss and cash flow; look at loans, debts etc. This is where many an acquisition goes wrong – you don’t actually know what you’re buying!
- Outdated inventory. Check the stock levels and be aware of anything that’s expired, out of date or just not selling. If you’re buying a business that sells perishable goods, you need to re-adjust their value on the balance sheet. Some business owners are slow to write down goods or write them off as obsolete or expired.
Make sure taxes are up to date
Sometimes, people make the mistake of thinking that since they don’t take on responsibility for the seller’s debts, obligations and liabilities, this also includes sales taxes. Not so. It’s essential that you make sure the seller has paid all outstanding taxes on the business. If you buy the business and there are still taxes owing, or there are penalties for late taxes, they’ll become your responsibility as well.
Summary
Your analysis of the risks involved in any business prospect should be undertaken with a business broker or your lawyer or accountant. Professionals will know what questions to ask and how to spot when debts are being hidden or records are being fudged. Always look for transparency in the seller; they are protected by the non-disclosure agreement you will have signed and should therefore be open and honest about their business. Beware of sellers who seem reluctant to provide detailed information.