Considering buying an existing business? Here’s some tips to help you assess if the business is suitable for you.
Buying an existing small business can be easier than setting up a new business from scratch. But the process can be daunting, especially if you’ve never been in business before. The main reason most people buy a small business rather than starting one is the advantage of having established systems, infrastructure and ongoing cash flow. People buy franchises for similar reasons – they usually come with supplier agreements and a proven system of what works and what doesn’t.
Once you’ve found a suitable business, you’ll need to verify the state of the business before making an offer. This includes ensuring that sales are as good as the owner says they are, that employees will be happy with a new owner, and that customers will remain loyal once you take over.
Make sure you investigate all aspects thoroughly. Are the business systems sound and documented, and is the cash flow sustainable? A business owner will want to sell their business for as much money as possible and as the buyer, you’ll want to pay as little as possible.
Establish your credibility
Formally register your interest in buying the business. The owner will usually have instructed a business adviser / broker, to sell the business. Approach the broker rather than the owner to register your interest. Your integrity and your future plans for the business are usually extremely important to the seller.
Analyse the seller’s objectives
Working out the seller’s motivation will assist you later in the process:
- Does the owner have to sell?
- Does the owner wish to sell just the trading part of the business, or a company that holds both assets (such as a building) and the trading part?
- Is money the prime motivation for selling or is there some reason, such as illness or divorce?
Before you make any offer, you will need to sign a Confidentiality Agreement in order to complete your ‘due diligence’. This Confidentiality Agreement will allow the Broker to disclose the Business’s financial details, thus ensuring the business has no major problems. Always ask yourself this question – “If the business is as wonderful as they make out, why they are selling?”
Sellers often gloss over the weak areas of the business or create short-term gains to give a favourable impression of the business. For example, lowering stock levels to artificially inflate profit (before stock needs to be re-ordered) can make a business seem more profitable.
Get a feel for the business
Immerse yourself in the business:
- Research its market and main competitors.
- Assess the risks associated with the business’s future trading and with the industry as a whole.
- If the location is important, stand (out of view) outside and estimate the sales activity.
- Visit the business at different times.
Ask industry experts
Tap into the knowledge of those in the know:
- What’s the current and future demand for the business’s products or services?
- Are prices (and margins) rising or falling?
- How is the competition in that market changing? For example, which new competitors are entering or who else is looking to exit?
- Contact the relevant industry association if there is one. For example, if you’re interested in a retail business, talk to your state retailing association.
Conduct detailed due diligence
Once you’ve indicated that you’re serious and interested in buying the business and you’ve signed a Heads of Agreement you can usually get access to more detailed information.
Analyse results and trends
Analyse historical information and trends:
- Look at sales growth, profit margins, overheads and working capital (review debtors, creditors, stock and work-in-progress).
- Is there scope for improvement? What specific value can you add to this business based on your skills and experience?
Look for changes
Take care to look for changes or inconsistencies:
- Has the business recently changed its accounting policy to show better profits?
- Compare the business’s financial projections with other evidence you have. Do the forecasts tally with the historical trends?
- Is the sales forecast achievable given the current order book and what you’ve learned from customers?
- Does the forecast reflect the outlook for the industry and the whole economy?
You may need to revise any projections that are out of step with these indicators.
Check the finances
Does the business have an efficient accounting system in place and does the owner monitor key performance indicators regularly?
Check the major balance sheet items:
- When was the last full audit? If it was over six months ago, ask for another one.
- What are stock levels? Rising stock levels may be a dangerous sign, especially in manufacturing, seasonal or fashion industries.
- How large are the bad debts and why did they happen?
Uncover any legal issues
As part of your due diligence:
- Confirm legal ownership of all key assets. This might include property, equipment, vehicles and intellectual property (such as registered patents, designs and trade marks). Is the ownership clearly defined in all cases?
- Check for any past, current or pending lawsuits.
- Examine all contractual obligations. This includes employment issues and contracts with third parties such as customers and suppliers. Look for any contingent liabilities.
- Consider what effect a change of ownership will have. Are you likely to lose any contracts?
Making the first offer
Before you make an initial offer, make your own sales and profit projections rather than relying on supplied figures.
If you have ideas on how to increase profits, this is your good fortune, so don’t inflate your offer price because of opportunities you’ve identified.
What is the risk?
Consider your level of risk. The risk is higher if the target business:
- has assets (stock and equipment) worth less than your offer price
- relies on one or two major customers – or suppliers or key employees
- is currently unprofitable or has a history of losses. In this case, you may have to fund losses for some time to come.
Though it sounds obvious, making a lower offer and increasing it if required is always a better strategy than going in high at the start. Ultimately, the business is only worth what someone will pay for it. The seller might have to lower their expectations.