Buying a Business: 9 Questions That Will Keep You From Being the “Greater Fool”
Buying an established enterprise can be a great way to expand your firm or to get into business for the first time. When acquiring an existing business here are some of the benefits that are often included:
- established cash flow
- established customer base
- proven operational system
- trained employees
- supplier relationships
- bookkeeping/accounting system
- a recognized brand with geographic market share
But even with all the perks listed above, purchasing an existing small business falls under the old adage of “buyer beware.” Foolish buying decisions are made almost daily as shrewd sellers burden unsuspecting buyers with unprofitable or failing businesses.
A savvy buyer always does research, often called “due diligence,” to fully ascertain the true condition of the target business. Here are some questions that should be completely answered in order to make an informed buyout decision:
- What is the REAL reason the current owner is selling? The two most common reasons stated by the seller are “health reasons” and to “spend more time with family.” Although these may appear to be straight forward on the surface, they can also be a smoke screen designed to mask inherent flaws with their current business.
- Is the business profitable and providing a good living for the current owner? It is of critical importance that the potential buyer ask for and receive accurate current and historical (past three years) financial records from the seller. These records include tax returns, income statements, balance sheets, equipment lists, inventory records, accounts payables, accounts receivables, etc. Seek out a finance or accounting professional to help you review the numbers. If the seller refuses to share their financial information, that’s a huge red flag.
- How did the seller determine the asking price for the business? Business valuation is often done by way of one of the following three methods (with generic explanations):
- Income approach (usually based on the total monetary benefit enjoyed by the owner)
- Asset approach (how much would it cost to purchase the assets needed to duplicate this business?)
- Market approach (how much are similar businesses selling for?)
On occasion, a seller will use the “times revenue” approach to justify the selling price, but a savvy buyer will usually ignore this approach when making a purchase decision since it is rarely favorable or reasonable for the buyer.
Again, seek out a finance or accounting professional with business valuation experience to help you determine a reasonable offering price.
- Is this an entity purchase or an asset only purchase? What legal responsibilities does the current ownership have to third parties? Is there any pending litigation such as an employee lawsuit, environmental liability, IRS liens or other past due debts? When purchasing the entity, the buyer should have a full understanding that they may also be buying old legal problems or past debts of the current owner.
- What intellectual property comes with the sale? Will the buyer receive control of patents, copyrights and trademarks?
- How long has the current ownership been in place? Is the current ownership new, just flipping this business? Has there been a number of shareholder partners that have come and gone?
- Has the seller filed timely annual reports with Florida’s Department of State: Division of Corporations? It is easy to verify by going to sunbiz.org.
- Does the business operate in a mature or declining industry? Has there been a major social, regulatory or economic shift in the industry? (When was the last time you used a payphone?)
- Is the local competitive landscape about to change? Is a new, stronger competitor moving next door? Are the traffic patterns about to change due to road construction or the opening of a by-pass?
Getting complete answers to these nine questions will get you well on your way to understanding the REAL reason a business is for sale. Unfortunately, all too often poorly performing businesses are packaged beneath slick sales campaigns touting their “great potential” and then dumped on unsuspecting, unexperienced and uninformed buyers.
Remember, the current owner is intimately familiar with their industry and the direction their business is going. They know when it’s foolish to hang on. They also know whether they have a healthy business or a sick one that they are trying to unload on a “GREATER FOOL!”