Most people today have turned to entrepreneurship due to the freedom, flexibility, and satisfaction it offers. Even though most people would prefer starting businesses from scratch, some would also want to buy existing ones. But you need to know these 13 things to look out for when buying a business.
This is because already existing businesses can be relatively affordable and less risky. In terms of finances, you’ll want to check the actual profits and losses the business might be incurring before you make your decision. You’ll also want to get an overview of sales history and whether the business has the proper legal documentation.
There are many reasons why founders sell their businesses, including relocation, poor performance, change of business, personal issues such as poor health, financial pressure, bankruptcy, competition, taxes, high demand, lifestyle change, pursuing other interests, etc. In most cases, the common misconception surrounding the sale of a business is usually associated with poor financial health.
Regardless of why people sell their businesses, buyers must also be keen on checking out some considerations before investing their hard-earned money in such businesses. They must be extra vigilant while valuing the business inventory, equipment, staff, competition, marketing, suppliers, and industry future. Below are top things to look out for when buying a business.
13 Key Things to Look Out for When Buying a Business
These 13 things to look out for when buying a business are lessons to live by, as mistakes we have made at Business Builders we want to pass on our experience to our readers.
1. Type of Business
This is the first thing you must consider before purchasing an existing business. You’ll want to consider the type of business on sale depending on your goals, interests, passion, and experience.
Typically, you’ll be happier and more relaxed if you purchase a business you’ve always wanted to own or if you have a bit of experience running. For instance, if you like cooking at home or you’ve been working at a restaurant as a cook for a while, it’ll be easier to purchase a restaurant or eatery business.
This is because you have the skills and experience to run such a business. Apart from this, you’ll also have an idea of the expected return on investment, products, services, business model to use, industry trends, and other innovative ways and ideas to get more customers and retain the existing ones.
2. Why the Owner Wants to Sell the Business
It’s essential to determine the actual reason why a business is on sale before buying it.
Typically, people don’t put their businesses up for sale without any valid reasons. In most cases, there might be issues arising from the business, or the owner wants to focus on other things or change their lifestyle.
Therefore, you should be keen on knowing the exact reason for the sale. Start by asking the owner whether there have been some problems arising from the business operations. In this case, if there are problems, ensure you ask the owner to narrow down the problems and what they’ve tried doing or their attempts to solve such problems. The other possible reasons for the sale of a business you’ll want to look out for include:
- Branding Issues
- Poor Location or Target Area
- Issues with Competition
- Bad or Lacking Equipment that is Expensive
- Increased Cost of Production
- Tax or Supplier Debts
- Legal Issues
- Poor Customer Satisfaction
- Poorly Designed Marketing Strategies
- Lacking Business Processes and Operations
Why the owner is selling might not affect your decision to purchase the business. But it could give you an insight into why it is either failing to produce the desired outcome of lacks in efficiency.
3. Your Budget & Expected Purchase Price
Your budget will determine the kind of business you’ll buy. However, this should also be aligned with your goals, resources, and interests.
For example, if you have a smaller budget, you might be looking to buy an involved business where you will be the driver of income. But if you have a large fortune you could buy a business where you have a more executive behind the scenes role.
Before you buy any business, it’s essential to check the the ‘4 S’s’… size, sales, scalability, and staff of the business and see whether they match your needs and budget.
Your budget doesn’t only count on the actual cost of buying the business but other essential aspects. Such as scaling up the business or changing certain aspects that contribute to its success. Even if your budget is adequate, you’ll also have to invest your energy and time in ensuring your business processes run smoothly.
Generally, the resources you’ll invest in buying a business will largely depend on the type of business, available workforce, and the level of industry experience.
4. Price of the Business
This is a key factor that buyers should be keen on evaluating before buying an existing business. Both sellers and buyers have varied pricing models when making transactions. Both parties usually involve an independent business evaluation expert to help them make a perfectly objective decision.
As a buyer, you need such valuation services to get a good estimate of a business. These valuation professionals such as RGE & Co use different approaches to value an existing business which include:
- EBITDA – Earnings before Interest, Taxes, Depreciation & Amortisation
- Discounted Cashflow
- Asset Book Value
- Income Approach & Future Revenue Expectation
- Equity or Balance Sheet Position
- Multiples of Turnover
Asset book value with the income approach is common practice for small businesses. They are best used when a buyer wants to purchase a business that has good sales conversions and is already making profits or has a remarkable earnings forecast.
On the other hand, the equity or balance sheet position is best when a buyer wants to purchase a capital-intensive business that hasn’t started generating profits. This is generally because you want to know what the assets are worth, and if any outstanding finance is left. Lastly, the market approach is best used for buyers who want to confirm the prices before making their final decisions.
5. What Assets are Owned
Before you buy any existing business, it’s essential to check the number of owned assets and their value. The actual business assets should match those listed in their financial books. This is because some assets might be overestimated on their management accounts.
As a buyer, ask the seller for their asset checklist and ensure they show you the physical items. Secondly, assess their inventory by doing a quick stocktake and valuation. If the business has fixed assets such as equipment, machinery, plant, fittings, and fixtures, ensure you inspect them and ensure they’re properly working.
In case the business had leased the assets, ensure you ask for lease copies. When assessing a business’ equipment, ensure you get the purchase dates, model numbers, warranty information, and maintenance schedules.
Other things to watch out for are…
- If any finance are funding was used to purchase the assets and if any is still outstanding
- What the depreciation rate of the asset is
- If the asset will still have any value when it’s useful life has ended
Before you buy an existing business, it’s essential to consider its profitability. You can determine whether a business is profitable by checking and analysing its financial statements for the past few years.
Typically, you can ask for their profit and loss account statements, cash flow statements, and annual reports for the last 3 years. You should ensure that these statements have been produced by an accounting professional.
To determine whether they’re audited, you should verify the information against independent proof of items like bank statements, sales records, loan statements, invoices, etc. You should also ask if there have been any cash flow problems or anticipated cost increases. By doing all these, you’ll be reducing the risk of purchasing a business that isn’t profitable. Proper evaluation of the key financial indicators will also help reveal all potential anomalies and red flags.
This is the key thing to look out for when buying a business.
If you want to buy an existing business, you must also be keen to avoid liability issues that might come along, thus resulting in severe losses in the future.
Buyers should conduct thorough due diligence to determine business liabilities. When it comes to asset purchase, the buyer might not be liable for liabilities, debts, and other obligations of the seller. However, there might be exceptions, especially if the buyer accepts to assume the liabilities, debts, and obligations.
Failure to look into the business liabilities means you might be responsible for any unpaid or defaulted loans and other liabilities as a buyer. However, you can protect yourself by checking if there are pending lawsuits or bankruptcy fillings, and also consider an indemnity agreement which will help you avoid unforeseen liability.
Equity is essential since it represents the value of the owner’s stake in a business. Business equity can be positive or negative. A business with positive equity usually has more assets than liabilities. On the other hand, a business with negative equity has more liabilities than assets.
It’s essential for a buyer to consider business equity before making a final purchase decision. Failure to consider this can possibly lead to balance sheet insolvency, especially when the business has negative equity. Typically, businesses with negative equity are considered unsafe and riskier. Although shareholders’ equity isn’t the only indicator of a business’s financial health, it plays a significant role in conjunction with other metrics.
Don’t be put off by negative equity, it could be down to something really simple that you can fix. For example, a loan that is easily affordable or a downturn in profit that can be remedied.
9. Tax Records
Before you buy a business, ensure you check the tax records. You can ask the buyer for their sales, payroll, and other business taxes for the past three years. If you don’t know how to analyze these records, you can find a tax professional to help you check business activity statements.
You should also check stamp duty records. If the business seller has other employees, inquire about their payroll service and check whether they’re making the required employment tax payments as stated by the HMRC. You can also ask the seller to provide a clearance letter or certificate from the tax authority to ensure their compliance in meeting their tax obligations.
10. Customers and Suppliers
Considering a business’s customers and suppliers before purchasing the entity is essential. You can ask the seller for a database or list of both key customers and suppliers for evaluation.
This list will help you get an idea of who you’ll be dealing with on a daily basis. In terms of customers, you’ll also want to get detailed information about what they like and dislike. Failure to get such information might drive them away to competitors even without knowing.
On the other hand, it’s essential to know the business suppliers and the terms of the agreement they’ve signed with them. Additionally, it’s essential to ask for sales contracts to determine their validity and future projections. Ask the seller to issue their details, including contact information. You can contact a few of these suppliers and get feedback.
The first rule of business is to determine the market competition. It’s essential to understand who you’ll be competing with and their general operations to make the right decisions.
Apart from asking the seller, you can also dig deeper and research other businesses you think might threaten your prospective one. You can also get relevant details from government departments, industry associations, statistics bureaus, and other independent bodies.
As a buyer, take time to check the prospective competitors by looking at their strengths, growth, threats, and weaknesses. If possible, get their earnings, profitability, costs, and price data for comparison.
12. Business Reputation
You shouldn’t rely entirely on the data given to you by the business seller. You must also take your time to analyse other essential aspects, such as business reputation.
Sometimes, you might find that the business you’re about to purchase has had a bad reputation or has been implicated in numerous scandals. In this case, if you end up buying such a business, you might be making a serious and costly mistake.
You should ensure that the business you’re about to buy has a sound reputation. You can go through its website and other social media accounts and check the kind of feedback, reviews, and experiences that its precious customers have had working with the business.
Too many complaints or negative reviews is a red flag that you might not be making the right choice. Ensure the business has at least many positive reviews than negative ones. You can also ask for contact details of some of their previous customers and ask them questions about their experience in dealing with your prospective business.
13. Existing Staff Members
Before buying a business, you’ll want to know the number of existing employees and their track records. Typically, every business has some key employees who help in the day-to-day operations of a business.
You’ll want to get in touch with such employees and find out whether they’re willing to continue working under your watch after the business takeover. However, this sometimes can be challenging since most sellers don’t want their employees to know about the business sale.
You can insist on this and give ideas on what you’re up to and even add a provision that allows some staff members to leave if they feel unsatisfied with the process. If you want to change the business operation model or staff contracts or terms and conditions, including employment conditions, and disciplinary or payroll procedures, you should make them aware to prevent confusion afterward.
In conclusion, these are the top things to consider when buying a business. The process isn’t as easy as it may seem. It requires a lot of rigorous and extensive research and learning to make the right decision. You should also ask as many questions as possible, including financial questions, and analyse them appropriately. You can also seek help and advice from other people who once bought a business to give you first-hand information and details which can assist you in sailing through quickly.