There is A LOT to look at before you make the commitment to buy a business. Here we’ll talk about ten key things you MUST consider before you buy a business. This is not a substitute for full due diligence with the assistance of legal, financial and other experts, depending on the particular business, but it should help you think through some important issues before you invest a lot of time and money in pursuing an acquisition target.
Consider these 10 things before you buy a business:
1. Why is the seller selling the business?
Owners sell their businesses for a wide variety of reasons. Sometimes they’re ready to retire and no one in their family wants to or is prepared to take over the business. Other times, their health is bad and they need to sell the business because they’re no longer physically capable of runnig it. In some cases, though, the sale of the business has to do with declining markets or a deterioration in the performance of that particular business. It may be hard to get a straight answer to this question, but if you can get some good indicators before you get into your preliminary due diligence, that will help to inform your thinking and further analysis.
2. What is the financial condition of the company?
You’ll want to understand in as much detail as possible the financial condition of the business? You’ll need to review and analyze several years of financial statements — Income Statement, Balance Sheet, Cash Flow Statement, at a minimum — to get a sense of the current financial condition of the company and look for trends in its operating performance. One of the things this analysis can reveal, for example, is whether significant additional capital will need to be invested, beyond the purchase of the business, in order to reach the financial projections upon which the purchase price is predicated.
3. What are the key drivers of the company’s profits?
How does this business you’re looking to buy make its money? Is its profitability driven by one or two products or customers? Is the business highly seasonal? Is the year made or broken based on one or two big events? Do certain products or services enable the sale of other products or services that are even more profitable? Before you buy a business, you want to understand what makes it tick and whether you are likely to be able to keep it ticking at the same or an improved level once you buy it.
4. Is the seller realistic in the asking price for the business?
Just as with homes or any other major item a seller may want to sell, when a business owner is selling their business, often times their ego is wrapped up in that sale. They often feel as if they’re selling a part of themselves because they’ve invested so much blood, sweat, and tears in building the business over the years. When you buy a business where the owner has this mindset, sometimes, not always, you will feel like you’re fighting an uphill battle from the start. Beyond negotiating in good faith, sometimes an owner with too much ego investment in the business they’re selling may be unable to come to a reasonable price and terms for the sale of the business. In these situations, if it’s extreme, sometimes it’s just best to walk away. If you really want to buy the business, though, and you decide to proceed with negotiations, the best approach often is to keep the conversation as focused as possible on data and facts. Hopefully, you’re looking at a business where there is a decent amount of comparable sales and financial performance information available for reference during the negotiation process.
5. What is the market’s growth trend?
This one is pretty straightforward. Typically, you don’t want to buy a business in a declining market, unless you have a strong belief that trend will change, or that you’ll be able to make changes that allow the company to buck the market trend. Don’t kid yourself, though, it can be a Herculean effort to make or keep a company successful in a declining market. When you buy a business, you don’t have a crystal ball any more than you do when you start a business, but look at the sales and profitability trends for the market in general and for the target company more specifically. Do as much research and analysis as you can to make yourself comfortable that you’re buying into a market with good growth prospects, rather than into one that’s making and selling the equivalent of buggy whips at the start of the automobile industry.
6. Are there opportunities to improve the profitability?
This is a tricky one. It’s oftentimes easy to over-estimate your ability to positively impact the profitability of a business that’s been around a long time with a relatively consistent level of profitability. That said, there are certainly situations where you can improve the profitability of an existing business. If you are confident that there are operational improvements you can make that will improve the profitability of the business you’re looking to buy, and that the improved profitability will be sustainable, factor that into your decision to buy the business and how much you are willing to pay. Again, though, don’t kid yourself and rationalize a higher purchase price for the business based on questionable, very difficult to attain potential operational improvements.
7. Is the owner willing to stay on and have an earnout?
In most, not all, businesses, it will be very important that the owner stay on for a least a short time, so that the ownership transition can be as smooth as possible. There are usually very important relationships, both within the company and with important external constituencies such as customers and suppliers, that must be nurtured and transitioned in order for the business to continue to be successful. The highest probability of making this happen successfully is usually to have the current owner(s) stay on for a period of time and be incentivized via an earnout to make sure the company continues to be successful to, or beyond, the level anticipated in the negotiation of the sale price. Make sure the key owner(s) is amenable to this before you get too far down the path in buying a business. Such a transition will not always be possible, depending on the particular circumstances. If it’s not, make sure this is factored into the price and terms of sale.
8. Does the company have major pending legal issues?
Before you buy a company, even if you’re just buying the assets, you will want to understand if the company is facing any current or recent meaningful legal issues. Depending on the nature of those legal issues, they could be make or break for the future profitability and survival of the business. Ask the owner for a list of pending legal and regulatory matters or investigations, as well as any recently settled matters. Obviously, you’ll have a legal team that will need to do further legal due diligence, but from the very outset, you’ll want to understand if the deal has too much “hair” on it to pursue. Asking these questions up front can save you a lot of wasted time, money and effort in pursuing a deal that was toxic from the start.
9. Is the company’s health inordinately exposed to one or two factors?
You do not want to buy a business that has all its eggs in one basket, as the saying goes. Or, if you do buy such a business, you’ll want to do it knowingly, so that you can discount the purchase price accordingly for all the risk you will be assuming. Businesses that are predicated upon a single point of failure can cause you a major shock and financial loss post-closing should anything go wrong. Does the business have just one or two customers? Is the product it sells subject to the whims of one large supplier? Is the business based on one law that could change tomorrow? Before you buy a business, you must understand the answers to these questions and any others that make the business highly vulnerable to disappearing or becoming highly unprofitable very quickly.
10. Is this a business you really want to own and run?
When you’re considering buying a business, you’ll definitely want to ask yourself whether this is a business you really want to own. Be honest, as your happiness over the next few years of your life likely depends on it. Not all “good” businesses are necessarily ones that are good for you.
Good luck in your quest to find a business that you want to purchase. When you buy a business there are hundreds of questions you must ask and items you must carefully consider. The ten questions above should get you off to a good start in your initial screening of potential businesses to buy.
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