Buying a business instead of starting it from the ground up can make eminent sense. You get the benefit of a time- tested business model, a set of paying customers, and positive cash flow from day one.
But there can be pitfalls, as well. There’s no guarantee that the company you acquire will perform as well as you expect it to.
Is there any way to ensure that your purchase provides you with the targeted return on investment? How can you maximize the probability of making a success of your purchase?
Buying a Business? 10 Tips You Can’t Miss
Here are ten things that you can do to boost your chances of achieving a favorable outcome when buying a business:
1. Buy it at the right price
Buying a company at an inflated value can sabotage your acquisition from the outset. Everything else about the business may be in your favor. The company could be expanding quickly, its products or services may be in high demand, and it could have a solid reputation among its customers. But if you pay too much for the firm, you’ll lose all these advantages.
Question all the assumptions the seller has made to arrive at the asking price. And don’t forget to negotiate. Consider approaching a broker for help when buying a business.
You can use this Business Valuation Calculator to arrive at a starting point for the valuation of the companies that you have shortlisted. Of course, this won’t give you an accurate purchase price. It can only help to point you in the right direction.
2. Why is the owner selling?
This is a question that you must ask. However, you may not get a completely frank reply.
The current owner may want to retire or could be medically unfit to run the business. These are valid reasons for selling.
But it could be useful to dig a little deeper. Has there been a change in the industry in the recent past? Do insiders know that the business may no longer be viable?
Speak to customers, suppliers, employees, and ex-employees as well. You may discover facts that could influence your decision to buy the business. If you still think it makes sense to go ahead with the acquisition, the information you gather could help you to negotiate a better price.
3. Is the inventory valued correctly?
Don’t rely solely on the seller’s valuation. An impartial third party is preferable. Better still, check the inventory yourself. If that’s impractical, at least verify some of it. After all, you will be responsible for selling it if the deal goes through.
Here is what you should look out for:
- Obsolete or non-moving items – is a significant portion of the inventory old?
- Method of valuation – how does the book value of the inventory compare with the expected sale price?
- Quality issues – are the goods of similar quality?
- Recordkeeping – does physical inventory match the accounting books?
4. Arranging the money
Most buyers look for external financing, although it’s possible to purchase a business without a business loan.
If you are buying a company that provides a product or a service that is related to your existing business, you could be eligible for a loan from Camino Financial. Our credit norms permit us to extend finance to entrepreneurs who run firms that have been in existence for a minimum of 9 months.
Our motto is “No business left behind.” Get in touch to find out if you’re eligible for funds that could pay for the company you are planning to acquire.
5. Is there a good culture fit?
This is one aspect of buying a business that many entrepreneurs tend to ignore. When you merge your existing operations with the firm you acquire, will the sum be greater than the parts? Or will you have to contend with squabbling employees and a clash of organizational cultures?
There’s no easy way to find out if the two companies will work well together. But that doesn’t mean you shouldn’t try. Speak to the people at the target company and try and discover for yourself if their values align with yours. Do you follow similar processes? Does one company give workers a great degree of operational freedom and is the other top-driven?
Don’t underestimate the importance of this issue. A cultural mismatch could prevent the two firms from working together and wreck your chances of making a success of the acquisition.
6. Study the documents carefully
You’re probably going to need help from an accountant and a lawyer when you are buying a business. But you should review all the documentation yourself as well.
Get copies of the operating agreements of the target company. What are the obligations that you will be taking on? Are there any liabilities that the seller hasn’t told you about? Remember that all the information you are provided with should be backed up by the appropriate documentation.
Here are some of the records and papers you should ask to see:
- Financial statements for the last five years.
- All the agreements that the target company has entered into.
- Tax returns for the last five years.
- Inventory records.
- A list of assets that the company owns.
7. Make a checklist for the due diligence process
Comprehensive due diligence is essential. You don’t want any unpleasant surprises after the deal is finalized.
How can you ensure that you don’t miss the critical issues? It may be a good idea to use a due diligence checklist. Even if you hire a professional to help, it is advisable to develop your own business purchase checklist when you are carrying out an appraisal of the company that you plan to acquire.
8. Think of ways to reduce expenses at the company that you plan to buy
This is a critical issue. One of the most significant benefits of buying a business is that you could have the opportunity to slash expenditure by eliminating duplication. In the newly merged company, you shouldn’t have two sets of people carrying out similar tasks.
Examine this aspect carefully and determine the scope for cost reduction before you finalize the purchase.
9. Is the business dependent on the current owner?
Some enterprises have well-established processes and standard operating procedures that everyone in the company is aware of. In other companies, the owner takes every decision, big or small. This person handles the big customers and negotiates with the suppliers. The company can’t function if the owner leaves.
When you are buying a business, you must find out if this how the target company operates. If it is, you may want to reconsider your decision to buy. Alternately, you could think of asking the owner to stay on as a consultant.
10. Look at the industry and the environment as well
Many small business owners time the sale of their companies to coincide with a spurt in profits. But buyers shouldn’t fall for this ruse. Look at the long-term picture. Is the industry changing? Is a new entrant reducing prices and taking away market share?
Focus on the big picture and don’t view the company in isolation.
Common Mistakes When Buying a Business
Mistake #1: Many company purchases involve buying receivables, as well. However, you shouldn’t assume that all the debtors will pay. The receivables will include customers who have made purchases recently and are expected to pay soon. But there may also be old debts. If someone had bought goods on 30-day credit and has delayed payment beyond 90 days, you could be looking at a bad debt.
Analyze the receivables carefully and determine if you can collect the payments that are due. You could consider excluding older debts from the deal.
Mistake #2: Sloppy due diligence is a big contributor to unsuccessful acquisitions. You should retain competent professionals to help. Paying the accountants and lawyers a little extra is okay if it saves you from buying a company at a valuation that is higher than is justified. However, don’t leave the due diligence process entirely to others. Ask questions about the things that you don’t understand. After all, it’s your money at stake.
Mistake #3: Finally, when buying a company, don’t make the mistake of overestimating revenues and profits and underestimating expenses. The seller is going to emphasize the positive aspects of the business and try to gloss over the negatives. It’s up to you to see through the hype.
The Bottom Line
When you are buying a company, it’s better to overpay for a well-run and profit-making business than negotiate a low price for a firm in poor shape. Take your time with the due diligence process and refuse to be rushed. When you are committing a large sum to the acquisition, you shouldn’t decide in haste.
Confused about which business to buy? Here’s a list of the 35 most profitable businesses to get you started.