What to Consider Before Buying a Business

In most articles, we tend to see more of a focus on providing information and guidance to those who want to sell their business versus first-time buyers of a business. If you are looking to buy a business (over $5M), you should, in most cases, engage a Mergers & Acquisitions professional. They will work on your behalf for a fee and help you assess whether a business you want to buy is worth the owner's asking price. Unfortunately for smaller businesses, there is not that much help available, as in most cases, most business brokers tend to work on behalf of the seller. Business brokers are governed by the real estate board and typically help smaller businesses find buyers for their business. Some will work for the buyer, but in many cases, buyers are not prepared to pay someone for helping with this function, so the main focus is on selling.

Suppose you are dealing with a business broker as a buyer. You have been contacted by a business broker on behalf of the seller, as with a real estate transaction. In that case, they are not working for you, they are working for the seller, so it is up to you to make sure that you do your due diligence. Just because a business is listed at a price does not mean that it is worth that price. It is up to you as the buyer to understand what you are getting. As with any real estate transaction, the business broker wants to sell his/her client's business at as high of a price as possible, just as with any real estate sale. The broker's fee is usually set as a percentage of what they get for the seller, depending on what other services they provided the owner.

What Is The Value of The Business I Am Buying?

There are two types of professionals that can provide you with a business valuation. Many CPAs, lawyers, and other professionals have taken additional business valuation training and perform valuations for smaller businesses. For a more extensive or complex business, there might be a requirement by the buyer for further due diligence. In this case, you may require a Chartered Business Valuator (CBV). You will usually pay at least ten to fifteen thousand dollars for this level of due diligence, but if you are going to make that large of a purchase, it is well worth the money and peace of mind. You do not want to rely on a business valuation provided by the seller, as the discount rates from the owner's perspective is quite different than the one purchasing.

If you choose not to get a business valuation, here are just a few things that you need to look at and find out about the business before you sign on the dotted line:

  • You should get at a minimum of 3 and up to 5 years of compiled statements prepared by a professional accountant. It is highly suggested that they are a Review or an Audit and not a Notice to Reader. Notice to Reader statements only account for the information given to the accountant by the owner. If the seller does not provide this to you, you should have a level of suspicion. It would be best if you never took the seller's word of what their revenues, expenses, assets, and liabilities are. You want to look at their net income (revenue-expenses before taxes), key financial ratios, and, in particular, pay attention to any shareholder and related party transactions on the Balance Sheet. These can turn into red-flag items very quickly.

  • If you are purchasing the assets in the business, such as equipment, you will want to understand the assets' age, what it would cost to replace them, and determine ongoing maintenance costs that are required.

  • If you are purchasing buildings with the business, you will want to have an inspection done on the building just as you would if you were buying a house to understand if you are going to have to invest further. If you are taking over the lease of a building, you will want a copy of the lease and have a corporate lawyer review it before taking on the responsibilities. You will want to understand if possible lease increases or requirements would differ from what is listed as a rent expense on the owner's financial statements.

  • Look closely at what is listed under accounts receivables as an asset and find out the ageing of the A/R. Anything that is over 90 days is most likely not collectible and should not be considered an asset for buying the business.

  • Verify the costs of the operating expense fixed items, such as utilities or any other large expenses.

  • Verify the cost of goods/sales and generate enough revenue to cover variable and fixed costs.

  • Verify if there are any potential liabilities related to customer issues resulting in lawsuits or costs to you down the road.

  • If you are purchasing a business with inventory, you will want to understand the inventory's valuation and the age, as you do not want to take the seller's "word" for it. There could be an obsolete inventory that probably should have been written off, which is still sitting on the Balance Sheet as an asset.

Though getting a business valuation is recommended, at the end of the day, a business is worth whatever the buyer is willing to pay. Current owners almost always overvalue their business. Most buying decisions are emotional and do not always focus on the accurate valuation at the time. Still, you want to make sure that you know what you are getting into and do not sign an agreement to purchase before you have done some level of due diligence. Hopefully these few tips will help you know areas you should assess when you decide to buy a business.

Engage the right professionals such as an M&A professional or business broker depending on the size and complexity of the business you plan to purchase. We highly suggest you get a business valuation, which is one of our services. If you require more in-depth due diligence, we can refer you to a Chartered Business Valuator.

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