The Bottom Line in Buying a Business- Five Crucial Questions to Answer Before You Make a Deal
Buying a business can be a very good way to get into your own business.
The advantages are obvious- you get instant cash flow, customers and a way of doing business that is already well established.
The tricky part is finding a business for sale that isn’t going to be a major headache or complete money pit, which is the reason many of them are for sale in the first place.
The key is to separate the few good ones from the many bad ones, and it all comes down to some simple points to evaluate. If you can get the right answer to these questions, you are well on your way to buying a business you can make into a solid success.
Here are the five things you must find out before you make any deals:
How is the business really doing?
It is all well and good to get basic financial information from the seller, but you need to dig a lot deeper than that to really understand if the rosy picture in the financial statements they showed you are really a good reflection of how the business is actually doing. If you don’t know enough about this to judge for yourself, then by all means get help.
First, if cash is part of the equation, be very skeptical. They may tell you they are making a killing off the books, but if there is no way for you to verify this, then there is no reason to believe it. It may be true, but you’ll never know for sure. Likewise, if they are making a lot of payments in cash under the table, then you have to be very skeptical about their real profits. They may not be telling you about all kinds of other expenses they have which aren’t leaving a paper trail.
Less obvious but just as costly is the fact that if you run the business right- according to the law, it will cost you a lot more in taxes, insurance, overtime, etc. than what it is costing them to run it illegally- meaning your profits will be commensurately lower.
The best defense against this problem is to get their tax returns, and compare them with what they are actually telling you. And don’t just take the tax returns they hand you (if they aren’t willing to show you this during the due diligence period, then you should be very nervous about their honesty), get their permission to request a copy of the returns be sent to you by the IRS. That way you know it is what they actually filed, not just what they cooked up in their own fake version of Turbotax or printed reports from their fake QuickBooks bookkeeping to pull the wool over your eyes.
Also be sure to get as many years back as you can- at least three. Don’t just take the last twelve months. And request that they give you a month by month report, not just a year end summary. A lot of bad stuff can be hidden by a good couple months at the end. Request a cash flow statement as well as a balance sheet, in addition to the income statement. Just because they are showing profits doesn’t mean the business is actually making money, or even solvent.
Be clear you understand exactly what they are adding back and what they are calling personal expenses, and make sure they can back up their claims with receipts or other documentation.
If you are going to be investing a big chunk of your money, hard work and hopes and dreams into buying a business, you want to know exactly what you are getting. The numbers have a lot of information to tell you, and it is your right and in your best interest to examine them thoroughly, and ask questions about anything you don’t understand, or anything at all. How forthcoming they are will speak volumes in itself.
Can you run this business?
Most sellers, during the show and tell process, will take pains to explain how easy their job is and how there is “nothing to it”. That is true for very few businesses- nearly all have “tricks of the trade” and some literally take years to master.
If you aren’t familiar with the business you are buying into, make sure you have a very good understanding of the actual day to day aspects of the job, how much time and effort the owner spends on the business, and whether they have any special skills, licenses, relationships or other knowledge you will need in order to be able to duplicate their successes.
See if you can spend some time observing the owner at work before you close the deal, so you can see exactly what goes on. If this isn’t possible, then try and contact an industry trade group, or talk to some owners of similar businesses outside the area you would be competing in and ask them what the business is like and what kinds of things you will need to know.
The main point here is to make sure the business won’t suffer while you get up to speed in learning how to run it, since you may run out of time and customers before you know enough to make it pay if the learning cycle is particularly long or complex.
Can you improve this business?
If the answer to this is no, then you should probably keep looking. There are lots of businesses where the current owner is overpaying for services, not making any effort to market the business, has been experiencing declining sales due to poor customer service, or some other easily fixable malady.
There are also plenty of businesses where you can grab more sales quickly by expanding the product line, the store hours, adding an online component, or using any one or more of dozens of ways to grow the business.
The problem comes when you are looking at a business that is already maxed out. This may be due to intense competition, a limited market, or a capacity limitation or some other reason that would be very expensive or impossible to fix. If you can’t grow the business then chances are what you will actually face is a steady decline.
How fast it happens depends on the reason for the limit, but in any case a business that can’t grow is one to avoid, as it will quickly eat up more and more profits until it becomes a money loser, and then not only will you not be making any money, but you won’t be able to sell it, either.
Make sure, before you buy any business, you have a plan in place to grow the business, and you are sure that the changes you will put into place will definitely have a positive effect on the sales and bottom line. For example, if you plan to add a new sales rep, make sure there are customers for him to call on, and that they will be receptive to hearing the pitch. If you can’t figure out any way to grow the sales, then your best bet is to walk away from the business- quickly.
Is anything going to happen that is going to fundamentally change this business?
This is hard to know, but it requires investigation because it can make a crucial difference in your success or failure.
What are some things that could change? Your main supplier could be changing their terms, or pricing, or be about to stop carrying your products altogether. The facility could be across the street from what is about to become a nuclear waste plant, or a major highway could be coming through that would completely destroy the drive by traffic business. A huge competitor could be planning to move in down the street, or the industry itself could be about to undergo a big change.
If you are getting into a business you already know well, this is less likely to catch you off guard, though there could still be problems relevant to the specific business you aren’t aware of which will cause trouble. If you nothing about the new business, you could really be in for a shock.
The best defense against these kinds of issues is to talk with as many related people as possible. Talk to other tenants in the building, talk to the sales reps for your biggest vendors about the industry, talk to any competitors who will chat with you, and talk to some customers. Make sure you understand where the business is going, and any potential pitfalls that are coming up along the way.
This isn’t something you will ever completely cover, but often just some basic research will uncover problems if they exist. You owe it to yourself to ask around before you buy, and avoid anything that looks like it could be big trouble down the road.
Why is this business really for sale?
The issue is that despite what they may say, very often the real reason they are selling has to do with one of the reasons listed above. If you find out why they want out, you will be much closer to knowing how the business is really doing, and whether it is something you want to take on, or if it is best left alone.
These five things are ones you should delve into after a business has passed the basic level of interest. While they don’t take a long time, it does require some time and effort on your part to research, so you don’t want to go to this level of detail with all the businesses you look at, only the ones that show initial promise.
If you can satisfactorily answer the above questions about the business you are looking at buying, you can feel confident you are getting in on a good buy. If any of the above issues make you feel nervous or uncertain, it is probably best to pass on it and continue the search.
As always, if you run into questions during your search, or want a second opinion on what you’ve found, send us your question and get a quick, expert answer to your dilemma. That’s what we’re here for, after all!